Is A Roth IRA Conversion Right For You?

'Tis the season to consider a Roth IRA conversion.

If you own a retirement account that you funded with pre-tax contributions, such as a Traditional IRA or a 401(k), those accounts are growing on a tax-deferred basis. You avoid paying taxes today, but will pay taxes in retirement as you take withdrawals.

Alternatively, what if you could have those savings grow tax-free?

Roth IRA conversion explained: This is what a Roth IRA conversion accomplishes. You elect to reclassify some-or-all of your tax-deferred IRA savings into Roth IRA savings. Those funds will begin to grow tax-free, forever. There is a trade-off though. You must recognize whatever amount you convert as income in your current year's tax return. This means a potentially big, one-time tax bill today.

All in favor: Roth IRA advocates will argue that it is better to have your money grow tax-free than tax-delayed. Seems logical, right? If you are 10 or 20 years from retiring, that is a long time to reap future earnings. It is hard to lobby for the tax later characteristic of a Traditional IRA or 401(k) given the tax never opportunity of a Roth IRA.

With Roth IRA conversions specifically, a popular question to ask is: Do you think tax rates will be higher or lower when you retire? This is a rhetorical, loaded question that many advisers will ask. It insinuates that tax rates will assuredly be higher in retirement, and so you might as well pay taxes today rather than at a higher rate in the future. Despite having no way to prove that, it sounds compelling because it tugs on our collective distrust of government and our disdain for the tax man.

All opposed: Roth IRA skeptics will argue that it is important to take advantage of tax-deferral now, while your tax rate is peaking during your working years. They will say to wait until your tax rate falls in retirement - when you presumably have less income coming in - and then start taking withdrawals when you are in that lower tax bracket.

The truth: Either argument can be right. It just depends on your situation and the assumptions used relating to your financial future and tax rates. Nonetheless, if you have a $100,000 Traditional IRA, what do you do? Here are a few rules-of-thumb we use with clients...

  • The younger you are, the longer you stand to benefit from the tax-free growth that a Roth IRA provides.
  • If your income is abnormally high in any given year, refrain from doing a Roth IRA conversion, as the converted amount might kick you into an even higher tax bracket.
  • If your income is abnormally low in any given year, you might execute a Roth IRA conversion to make use of the lower, more generous tax rate.
  • Before you pull the trigger, make sure you have ample cash available to pay the tax bill. If you converted $100,000 in this example and land in the 33% income tax bracket, you will need $33,000 available to pay taxes.

These are a few general guidelines. Now let's look at a few specific situations we have encountered with clients...

Life at 70: Do you foresee taking regular IRA withdrawals in your 70s? Or will you predominantly live off of other income? Tax-deferred IRA and 401(k) accounts are subject to Required Minimum Distribution (RMD) laws, which kick in the year you turn 70.5 years old. The IRS forces you to withdraw a certain amount each year, which is based on your age and calculated as a fraction of your total IRA/401k balance. This is government's way of collecting tax revenues from you that they have spent decades waiting to receive.

Roth IRAs, meanwhile, are not subject to RMDs. This means you never have to worry about how much you take out year-to-year when you turn 70. The notion of having to take withdrawals on your own money may sound like a first-world problem that you will gladly confront down the road, but you may not want to touch your savings at that point if you have other sources of income. With a Roth IRA you never worry about that.

What about the kids? Along these same lines, if you desire to leave behind a certain amount to your heirs, RMDs can disrupt that. As money comes out and is taxed, the tax-deferral benefits slowly fade. Also, RMDs do not disappear when you die. Whoever inherits your tax-deferred savings must continue taking minimum amounts each year.

RMDs do kick in on Roth IRAs after the owner's death. However, because no taxes are owed the impact is muted when heirs take those distributions.

Sort-of retired? The years leading up to retirement, or just barely into retirement, may provide a sweet-spot for timing a Roth IRA conversion. For example, your income could be really low if you are not receiving a paycheck and have yet to begin receiving certain benefits like Social Security or pension payments. You may squirm, understandably, at the notion of paying taxes on a six-figure (or seven-figure) IRA balance all at once. So, instead of converting a massive balance all in one year, spread it out and do multiple, smaller Roth IRA conversions over a series of years. This will help suppress your tax rate.

You want to make contributions: While anyone can do a Roth IRA conversion on whatever amount they wish, you cannot make annual Roth IRA contributions if you earn too much money (for 2018, income above $135,000 if single or $199,000 if married). If you plan to contribute any amount up to the annual cap of $5,500, first make sure that your income qualifies you.

This makes the distinction between a Roth IRA contribution and a conversion an important one. Suppose your income is rising quickly year-to-year. While you may qualify to make Roth contributions today, you may not be able to for long. As a result, it might not make sense to do a Roth IRA conversion if you won't be able to contribute to it in the future. Financial planning is about skating to where the puck is going to be, not where it is now.

Why do a Roth IRA conversion right now? The end of the year is ideal because you should know where your income will end up for the year. It is easier to estimate your tax rate and overall tax burden in December than it is in February.

There are a number of factors that can sway your Roth IRA decision. Use these to get the ball rolling and to start planning ahead in the event this is something that will benefit you in the coming years.


- Brian E Betz, CFP®

Why So Emotional? Avoid These 5 Irrational Thoughts About Investing

Investing is emotional, even though it should not be. They impair whatever investment discipline you have, clouding better judgment.

So rather than trying to remove our emotions completely, look to harness them. This starts with acknowledging certain biases you have, many of which you probably deny. Here are 5 emotionally driven biases that can hurt you as an investor:

1) You love your company too much. Beware of owning a disproportionately high amount of company stock relative to other investments, whether through your 401(k) plan elections, restricted stock shares (RSUs) that have vested or stock options you have exercised. This may seem crazy if you work somewhere like Amazon, Google or Boeing -- companies that have thrived in recent years. And in fairness, there is some irony here in that it is likely due to company success that you own a lot of company stock in the first place. But realize your risk exposure if something bad does happen to your company's share price.

There is no specific percentage to own, as it depends on your particular situation. If you have stockpiled shares at least take inventory of all your investments and determine how comfortable you are being heavily weighted in the one company you have an irrational, positive bias towards. You may work for a great company (especially around Seattle or San Francisco) but odds are you do not know exactly how your company will perform in the future and you certainly do not know how investors will react to that performance. Find some balance and diversify, which you can do without selling all your shares or even the majority of your shares.

2) You believe the market is due to crash, fall, correct, etc... Just because you think the market cannot keep going higher means absolutely nothing. If you believe stocks are overvalued, that "another 2008 is coming" or that the market is rigged, more power to you. But those are irrational feelings. Waiting to invest based on such fear could cost you significantly in the long run by preventing you from earning what you need to achieve future financial goals.

But let's suppose you are right and it is not long before the market plunges. Let's say the market drops -10% tomorrow. Would you invest then? If not, how much further would the market have to fall beyond -10% before you would buy?

Consider what it really means if you wait for a recession, or simply a market decline of some arbitrary magnitude that you have stuck in your head but cannot clearly define. First, you have to be right about the market falling. The longer that takes, the more you miss out on potential gains. Second, you have to be right about when the market bottoms so you can pinpoint when to invest on the rebound. That bottoming process will likely take months, if not longer. Being right about both when the market falls and when it eventually recovers will be extremely difficult, especially if your decision-making stems from emotion rather than a disciplined investment process.

3) You see a falling stock and want to buy it. If an investment is consistently losing value over a period of weeks, do not try and guess when that bleeding will stop. More often than not you will find yourself buying a falling stock that subsequently falls even further.

4) You own a rising stock and want to sell it. This is less common, because a lot of investors go the other way and want to hold a rising stock they own. But more risk-averse investors will often look to sell simply because they have made money on the investment. Like the opposite of a falling stock, if a stock is rising you may not want to mess with it because rising trends usually continue higher.

5) You cling to an investment because it has special meaning. We see this among investors who hold a certain stock simply because a trusted family member owned it. This is prevalent when clients inherit shares from a family member. "Uncle Joe owned this stock and I trusted Uncle Joe, therefore I do not ever want to sell it." This type of inherent confidence is flawed and leads to misguided judgment. The world changes so much generation to generation, as does the market. Companies that were great 25 years ago may not be so today. The name of the game is making money, not to own investments that we implicitly trust based on an emotional connection.

You should have an investment plan that is free of emotional biases and focuses on what you need to earn to meet your future needs. Establish and execute an investment process, whether that involves working with a financial adviser or performing it on your own.


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Brian E Betz, CFP®

How The RMD Laws Could Rock Your 401(k) Or IRA In Retirement

If you are in your 60s and own a 401(k) or IRA account (or both), you need to know about the RMD rules that take effect shortly after you turn 70.

RMD stands for "Required Minimum Distribution". It is the amount you must withdraw from your tax-deferred (or pre-tax) retirement accounts each year once you turn 70 years and 6 months of age (no idea why the IRS uses your half birthday and not age 70 or 71). The RMD rules are government's way of saying you have delayed paying taxes for too long and must begin recognizing your 401(k) and IRA savings as taxable income.

How RMDs work: The IRS provides two different age charts. One of them will apply to you. Your age on the appropriate chart will correlate to a "life expectancy factor", which you divide into the total value of all tax-deferred retirement accounts you own. The result is what you must withdraw for the year and recognize as ordinary income in your tax return. Each subsequent year you look up your new age and divide the corresponding factor into your year-end account balance. This life expectancy factor declines every year. The IRS presumes that your accounts are shrinking throughout retirement, so the life expectancy factor/divisor goes down to proportionally reflect that.

Beware... the first year is tricky! Pay close attention in whatever year you turn 70.5 years old. Your very first RMD must be taken by April 1 of the year after you turn 70.5. Every year after that the deadline is Dec. 31.

Why is the first RMD deadline different? Likely because most retirees are unaware that the RMD laws even exist, so the IRS gives you a grace period out of the gate. However, not only must you take the first RMD by April 1, but you must also take the second RMD by Dec. 31 of that same year (again, the year after you turn 70.5). So the first year is unique because it requires that you take not one, but two separate RMDs.

Let's put pen to paper and work through an example. Assume you turned age 70.5 on July 12, 2017. Here are the deadlines for your first few RMDs:

Year 1, taken by April 1, 2018 = (Balance on Dec. 31, 2016) / (Factor for age 70)
Year 2, taken by Dec 31, 2018 = (Balance on Dec. 31, 2017) / (Factor for age 71)
Year 3, taken by Dec 31, 2019 = (Balance on Dec. 31, 2018) / (Factor for age 72)
Year 4, taken by Dec 31, 2020 = (Balance on Dec. 31, 2019) / (Factor for age 73)

It is important to note that each year's RMD calculation requires that you go back and sum your previous year-ending account balances, since Dec. 31 is when your RMD is based on.

What if I don't take my RMD? This is where the IRS cleans up... You will be penalized 50% of whatever amount you were supposed to withdraw but did not. So if your RMD is $10,000 and for whatever reason you only withdraw $2,000 the IRS will penalize you 50% on the $8,000 you failed to withdraw, which means an additional $4,000 tax penalty!

How do I avoid RMDs? The best way to avoid taking RMDs is to convert a portion (or all) of your tax-deferred funds into Roth IRA funds prior to age 70. RMD rules do not apply to Roth IRAs. Of course, whatever balance you convert to a Roth IRA must be recognized as income, so you are paying Uncle Sam one way or another. However, performing a Roth IRA conversion does mean avoiding the administrative hassle of calculating RMDs during retirement and it also means future tax-free growth (the biggest Roth IRA perk of all).

A Roth IRA conversion could also mean cheaper Medicare Part B premiums in retirement too. The higher your income is, the higher your Medicare premiums are. Roth IRA withdrawals are not considered income, since those funds have already been taxed.

I often recommend doing Roth IRA conversions in chunks as you approach 70 so that you spread out the tax burden over multiple years. Even better, if you anticipate a year or two where your income will be unusually low, that would be a good time to convert to a Roth IRA because your income tax rate would be lower than normal. One example of this would be if you have stopped working, and are living off savings for a while rather than taking Social Security or receiving sizable pension payments (if applicable).

Can I apply 401(k) or IRA withdrawals taken before age 70 toward future RMDs? No, you cannot.

If I take more than my RMD for the year can I apply the excess toward next year? No, you cannot. There is no future RMD benefit for withdrawing more than the mandated amount in any given year.

Do I combine my spouse's accounts with mine? No, you calculate your RMD based on your age and he/she uses their age to calculate theirs. If your spouse has yet to turn age 70.5, they do not need to take a RMD.

What if I have a Roth 401(k)? The RMD rules apply to Roth 401(k) accounts, despite the fact they are funded with after-tax dollars and grow tax-free. An easy solution is to rollover your Roth 401(k) to a Roth IRA and avoid this mess altogether.

If I plan to spend the money in retirement anyway, what's the big deal? In fairness, RMDs may not pose a huge problem. But for many clients and others we know, the RMD rules have forced them to take out more than they want or need in their 70's. This has resulted in a larger tax bill than they prefer to pay, not only because they are recognizing more income that is subject to taxation, but because that extra income kicks them into a higher tax bracket to boot. They can no longer benefit from the tax deferral shelter that their 401(k) or IRA reaped for years and years.

There are other adverse situations that can arise too stemming from the RMD laws. For a more comprehensive list, feel free to contact us. The RMD rules are very real, very annoying and very costly if disregarded. Make sure you plan ahead!


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Brian E Betz, CFP®

Your Most Important Job Before Retirement

You plan to retire within 5 years. But can you?

There are over 76 million “baby boomers” in the U.S. - 1 out of every 4 people - born between 1946 and 1964. The Social Security Administration defines retirement as age 67, which means most baby boomers are closing in on retirement. If this is you, you may be asking yourself...

“Have we saved enough?”

Hopefully the answer is yes, but for many boomers the answer is unclear. Consider this your most important job yet.

Of all the retirement goals we hear among baby boomers, there is one that is universal: Peace-Of-Mind. That sense of comfort, of not worrying about money in retirement. Here are 10 financial planning areas that you can focus on ahead of retirement, to achieve peace-of-mind before you transition from the office chair to the lounge chair:

#1. The Nest Egg

What will your assets and debts look like on Day 1 of retirement? This baseline reveals how balanced you are. Wealth that is concentrated in real estate may pose a liquidity concern if you need cash. Wealth that is concentrated in your company stock poses specific company risk should the company's value decline. Wealth that is concentrated in bank savings may not earn enough in retirement.

WHAT TO DO: Tally up the value of all assets and debts you own and estimate what you think they will be worth at retirement. List out your retirement accounts, stocks, bonds, properties, pensions, annuities, life insurance, cash, mortgages, etc. If you are still a few years from retirement, be modest with your growth assumptions.

#2. Monthly Retirement Spending

How much will you spend each month during retirement? This could vary dramatically from your working years. Traveling and dining out are just two of the areas where you may splurge in retirement. Debt payments may decline if, for example, your mortgage is nearly paid off.

WHAT TO DO: Make a list of your anticipated retirement expenses – both needs and wants. Some expenses are likely to spike and then fall over time (e.g. travel & leisure) but others will rise (e.g. health care). A good financial adviser can help identify unexpected costs and also budget for them as they evolve with age.

#3. Sources Of Retirement Income

Where will money come from? You should seek a tax-efficient withdrawal strategy if you own 401k or IRA accounts. You should maximize your Social Security payout by delaying benefits, while making use of the spousal rules (if married, divorced or widowed). If you prematurely retire you may need to increase your retirement plan withdrawals, which shrinks the life of your savings.

WHAT TO DO: This is another area where an adviser can help you navigate decisions like how to take IRA withdrawals in a tax-efficient manner, or when to file for Social Security so that you get the highest payout in retirement. You should be aware of the required minimum distribution (RMD) rules on tax-deferred 401k/IRA accounts. The RMD rules kick in when you turn age 70 ½ and can be costly if ignored.

#4. Maximizing Social Security

Do you know your Social Security benefits and payment options? Social Security comprises 39% of the average retiree’s monthly income (per the Social Security Administration). You must decide whether it is best to:

  1. Take reduced benefits starting at age 62
  2. Take your full benefit at normal retirement age, which is 65, 66 or 67 depending when you were born (find your retirement age here);
  3. Take increased benefits by delaying payments until age 70

WHAT TO DO: Obtain your latest benefits estimate through the Social Security website. You can view your projected benefits and check your earnings history for accuracy (to ensure your benefits are not short-changed - the SSA does make mistakes!). Married couples should coordinate the timing of when they claim their respective benefits. The goal should be to obtain the highest, collective payout that accommodates when you need income.

#5. Health Care Costs

Medicare does not kick in until age 65. Will you retire before then? If so, budget for paying medical expenses. Individual insurance can be expensive and provide inferior coverage to what you have through your employer.

WHAT TO DO: Before retiring early, seek out health care options and budget accordingly. If one spouse continues working that helps you delay or avoid the need for individual insurance if his/her employer provides it. To prep for age 65, estimate your Medicare Part B premiums and research additional coverage such as Medigap and Part D prescription coverage.

#6. Long-Term Care

This need is swelling by the year, as baby boomers see their aging parents experience chronic illness, such as Alzheimer's, dementia or the physical decay that comes with age. Retirees are getting squeezed by the costs of in-home care, assisted living and nursing care due to people living longer and the general rise in health care costs.

WHAT TO DO: If you are under age-60, explore options for long-term care policies. Long-term care insurance can help bridge the budget gaps that arise from paying for chronic illness. The wealthier you are the easier it will be to self-insure your risk of living too long. Assisted living can run $3,000 to $5,000 per-month and nursing care is typically even more expensive. Medicare does not pay for assisted living facilities but it will subsidize the first 100 days in a nursing home (with a pricey co-pay after Day 20).

#7. Investment Needs

What must you earn to keep pace with withdrawals? Get too aggressive and a major investment loss could risk you outliving your savings. Get too conservative and you may not earn enough to combat your life longevity. These opposing paths lead to the same bad result.

Do not sleep on inflation, either. Your returns are actually less after you account for the general rise in goods and services (transportation, groceries, health care, etc.) that occurs over time. Also, if you intend on leaving money behind to family or charities that may increase your earnings needs.

WHAT TO DO: Forecast various returns and the investments needed to get there. Consider how much you can stomach if your portfolio falls by a certain percentage and always adjust for inflation. This is specifically an area where a smart adviser will provide big value.

#8. Housing Plans

Are you in your "forever home" or do you plan to move at some point? If you live in a big house those long staircases and unused rooms could become burdensome with age. If your primary residence makes up most of your nest egg, you may need to sell/downsize in order to obtain spending money.

WHAT TO DO: Look ahead and map-out what you think you will need in a home. Forecast your home’s equity over time to gauge your options, including negative outcomes that could result from a housing downturn.

#9. Remaining Debts

Where do you stand on your mortgage or other debts? It is okay to have a mortgage in retirement, but you should be close to paying it off. Make sure any debt will not be burdensome to your surviving spouse if you predecease him/her.

WHAT TO DO: Develop an aggressive plan for paying off your mortgage and other debts, particularly if you have the excess funds to do it -- meaning your current take-home pay exceeds your monthly living expenses.

#10. Life Insurance

If you already own life insurance, does it still meet the reasons you bought it? If you own a permanent policy – such as whole life, variable life or universal life – what is the policy's cash value? If you do not own life insurance, your surviving spouse may need it to bridge an income gap or pay off a mortgage balance.

WHAT TO DO: Review your existing policies for usefulness/need. If cash value exists within a policy, consider using that as a source of retirement income.

Take initiative now to identify where your retirement gaps lie in these 10 areas. A trusted financial adviser can guide you. Tackle these now and increase your peace-of-mind that the transition from your working years into retirement will be a smooth one.

Now get to work!


Brian E Betz, CFP®