Year-End Retirement Account Reminders

Hi everyone,

Click below to watch this week’s blog. Enjoy.

(video created in Camtasia)
(charts created in stockcharts.com)

Have a great week!

Brian E Betz, CFP®
Principal

What To Know About The RMD Laws

Hi everyone,

If you are aproaching age 70 and own a 401k or IRA, you need to know about the Required Minimum Distribution (RMD) laws, which mandate that you withdraw a certain amount each year starting at that time. Our video below explains what you need to know about the RMD rules, when they apply and how to calculate them.

The RMD rules run deep. Please ask if you have any questions, especially when it comes to the calculations. You can access this video — and others — by visiting the “FAQ” page on our site.

In The Market...

The S&P 500 gained +1.9% last week. Let's look under the hood:

(price data via stockcharts.com)

Stocks put together consecutive weekly gains for the first time since early November. It was a pretty bumpy ride getting to last week’s gains, as is often the case around year-end. We saw decent improvement, but it is tough to make too much out of it considering the market was sleepwalking through New Year’s Eve and closed altogether on New Year’s Day.

The S&P 500 experienced its first truly negative year since 2008, falling -4.5% (including dividends). Coming off of the worst December on record ever for the U.S. stock market, are better things to come in 2019?

The headwinds remain the same as they were in late-November, when stocks looked primed to mount a meaningful rally but instead fell hard in December. There is much ground to be made up, so we must be careful when it comes to trusting any of these short-term rallies. Looking at things through the broad lens of the S&P 500, the following issues persist:

  • Price of S&P 500 is below its 200-day moving average (would like to see the price be above it)

  • Slope of the 200-day moving average is falling (would like to see it rising)

  • Nearly 80% of the companies that comprise the S&P 500 are below their respective 200-day moving averages (would like this to be above 50% or better)

  • Relative Strength (RSI) remains weak, just below 50.0 (would like to see it above 60.0)

These are just a few. Ideally with time the market will stabilize, these measures will strengthen and the long-term outlook will improve as a result. The challenge is how long that may take. Right now we should remain cautious when it comes to short-term gains because we are likely to see more volatility to the downside as well.

We did not make any major portfolio changes last week. We did add to our Long-term Treasury bond fund (SPTL) across most accounts. If the stock market continues to move higher this week we may selectively add to our stock positions, but again, patience is key.

In Our Portfolios...


What's New With Us?

I spent Saturday night sick from a 24-hour stomach flu I picked up from my daughter. It was either that or the Seahawks game that did it. Rough weekend for me, but I’m back at it.

Have a great week!

Brian E Betz, CFP®
Principal

The Decline Of General Electric Teaches A Cautionary Lesson

In The News...

Thomas Edison's company did something for just the third time in its 125-year history.

General Electric (GE), founded by Edison back in 1892, slashed its dividend payment in half from 96 cents to 48 cents per-share annually. According to CNBC it is the 8th-largest dividend cut in history (the 7 others greater than this occurred during the last recession). When were the other two times GE's longstanding, steady dividend was reduced?

1938
2009

Notice something those two years have in common? The first was during the Great Depression and the other was during the 2008/09 financial recession. Interestingly, those previous dividend cuts occurred near the tail ends of stock market recessions. So this likely says more about the health of GE as a standalone company than it does about the broader economy, considering we are not currently in a recession.

GE shares are down a staggering -42% from the highs back in 2016 and -24% in the past month alone. The value of GE stock has not been this low since 2012.

The lesson learned from GE: I bring this up for a couple reasons. One, because of how rare it is to see a dividend cut of this size. Two, as a reminder of something I wrote about a few weeks ago where I highlighted four ways that investors are overly emotional about investing. One of the ways is that we become too infatuated with a particular company, often because it is where we work. As a result we make risky decisions such as owning too much of that one particular stock or loading up on that stock in a 401k account.

If you worked for GE this type of downside risk is now a reality as the stock price has precipitously fallen some -40% in less than a year. I say this with great sympathy, in the event someone you know works there. But fairly or unfairly this is an example of what the other side looks like, not what we are more prone to hear about with companies like Google, Amazon or Boeing, where share prices have been on fire for the past decade.

It is likely that GE stock will rebound at some point, but how soon will that be? Also, what constitutes the rebound? Will it ever get back above $30 per-share? Hard to say.

A step toward tax reform: In other news, the Republican-led House of Representatives passed its tax reform bill on Thursday. This was expected. What is more unclear is whether there will be enough votes in the Senate to pass this bill, or some iteration of it, given that Republicans only out-seat Democrats by two members in the Senate. The biggest debate forthcoming is whether a repeal of the individual health care mandate will be included in the reform. The mandate was part of the Obamacare plan that took effect in 2010. Repealing it would reduce government spending but also mean millions of Americans would be without health insurance. (I covered some of the proposed tax changes here.)

In The Market...

The S&P 500 slipped -0.1% this past week. Let's look under the hood:

(price data via stockcharts.com)

Ironically, it was an eventful market week despite the S&P 500 going nowhere. It was a total mixed bag, without much reason. Some growth sectors rose, like Consumer Discretionary, while others fell, like Industrials and Technology. Meanwhile, the more defensive sectors (Utilities, Consumer Staples) gained, while the bond market rebounded in unison as well.

The market rally has leveled off over the past month, as the S&P 500 index has stalled out just shy of 2,600. But because we have seen more volatility at the sector-level that has created some good buy/sell opportunities for us. This past week we were more active than usual in buying and selling investments (listed below), which is how we tend to be when the market is rising. For more on why this is, see the OPINION section below.

In Our Opinion...

I get asked how often we buy and sell investments within client accounts.

Daily?
Weekly?
Monthly?

The answer is it really depends. We tend to buy an investment and hold it for a number of weeks before selling -- usually between 3 and 8 weeks. Because client accounts own multiple investments our transactions are staggered, which may give the appearance that we are buying/selling more actively than is the case. Larger accounts will have more investments and more transactions than smaller ones. We try to limit transactions on smaller accounts (under $50,000), because each $7.00 buy-or-sell transaction cost is proportionately more impactful on small accounts than larger ones.

When the market trend is rising we are usually more active and when it is volatile or falling we try to be more patient. In a rising market there tend to be ebbs and flows where certain sectors perform better than others, kind of like right now. This lends to being more active. If the market is choppy, patience and poise are key. There are plenty of instances where we will own an investment that has fallen in value, but rather than sell it we will re-evaulate and may hold it for a period of time in anticipation that it will rebound.

What I am describing speaks to our investment process as much as anything. Our process isn't short-term and it isn't really long-term. It is somewhere in between. If we were to rapidly trade investments that would be inefficient to you. If we were to buy-and-hold for years our value would be pretty moot after the initial allocations are made because we would not actually manage anything over time.

In Our Portfolios...

Q&A/Financial Planning...

I encountered a situation rolling over a client's Boeing 401k this week that might apply to you.

When you leave a job or retire, we almost always recommend rolling over your 401k to an IRA. Most of the time 401k rollovers are straightforward. Your pre-tax funds are rolled over into a Traditional IRA. Your Roth 401k funds (if you have them) are rolled over into a Roth IRA.

Simple enough, right? But what if you have "after-tax" funds in your 401k?

Not to be confused with Roth 401k funds, after-tax 401k elections are the contributions you make when you want to contribute more than the $18,000 limit. A lot of company 401k plans allow this, often unbeknownst to the employees. After-tax contributions are similar to Roth 401k contributions in that the funds contributed have already been taxed. But there is one key difference... Your Roth 401k contributions grow tax-free, whereas after-tax 401k contributions grow tax-deferred. This means the after-tax bucket of your 401k contains BOTH pre-tax and post-tax dollars, despite the "after-tax" misnomer.

How this affects your 401k rollover: Your 401k statement may not separate your pre-tax and post-tax dollars relating to your "after-tax" contributions. In fact, your 401k provider may include the entire after-tax bucket of funds in one rollover check, instead of separating that chunk into a tax-deferred rollover amount (the earnings that stem from after-tax contributions) and a tax-free amount (the contributions themselves).

Why this poses a problem: If you do not separate the tax-deferred earnings portion from the tax-free contributions portion, you may accidentally rollover all of it as tax-deferred funds into your Traditional IRA. This means you would end up paying income taxes TWICE on those savings -- once when you originally contributed them into your 401k and again when you withdraw them in retirement!

Why? Because unless you maintain records showing the after-tax money that was contributed years/decades ago, no one else will either. The IRA custodian will assume those withdrawals are all taxable down the road when you begin taking withdrawals. Even if you do have such records, such record-keeping will be frustrating to maintain in future years. Plus, you will constantly have to recalculate what percentage is taxable from what proportion is not (a whole other issue that I won't detail here).

Our client's Boeing statement luckily provided enough detail for me to figure out how much of her total 401k is pre-tax vs. true after-tax, but other 401k plans may not be that helpful. 401k rollovers are pretty easy, but it is important to take inventory of your tax-deferred vs. tax-free money to ensure that the right amounts are rolled over to a Traditional IRA and Roth IRA, respectively.

What's New With Us?

I wrote a new article on our general blog page: How The RMD Laws Could Rock Your 401(k) Or IRA In Retirement. Much of this I discussed a few weeks back in our weekly blog, but I wanted to expand on the Required Minimum Distribution (RMD) rules and provide something informative for non-clients. Feel free to share.

Have a great weekend!

Betz Signature 250px.png
 

Brian E Betz, CFP®
Principal

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.

Read More

Quite Possibly The Worst 401k Idea Ever

In The News...

After dropping off our daughter at day care this week I stopped by Walgreens to refill a prescription. There was just one problem...

The pharmacy didn't open until 9am.

I was not going to wait an hour so I continued on to the office. As I sat in traffic on Highway-99 I thought: there must be a better way. Six hours later, the solution has arrived.

Dr. Amazon: The Seattle logistics giant reported quarterly earnings on Thursday, which included news that Amazon has acquired pharmaceutical licenses to distribute wholesale prescription drugs in 12 states. This implies being able to order prescriptions and have them delivered right to your doorstep. On the earnings call Amazon was coy about its pharmaceutical intentions, but I assume their plans will disrupt the industry and spell trouble for the likes of Walgreens and CVS. Additionally, the move into health care introduces potentially millions of Baby Boomers to Amazon.

The worst 401k idea ever: In an effort to balance their tax reform package, Republicans have apparently discussed reducing the 401k contribution limit from the current $18,000 per-year to a fraction of that, reportedly $2,400 per-year. Their logic: If workers put less into their 401k plans, which provides tax-deferral, they will be forced to pay more in current income taxes year to year.

This is true. It is also incredibly stupid.

A 401k plan is as much about providing a vehicle that encourages good retirement savings behavior as it is about postponing taxes on contributions. The overwhelming majority of Americans do not save enough for retirement. I know this because I am in the trenches. I routinely see situations where people could save more and should save more, but do not. Most Americans consume what they do not save and it would be naive to think that those lost 401k contributions would seamlessly get funneled elsewhere (though we would do our best to help). Maybe the alternative will be the "MyRA" savings vehicle that President Obama unveiled in a State Of The Union speech a few years back. Remember that? Exactly, because it was a poorly engineered idea and has since been phased out.

If the 401k contribution cap is somehow cut by 86% ($15,600), I would likely advise most of you to scrap your 401k contributions and max-out a Traditional IRA instead. The maximum IRA contribution right now is $5,500 per-year ($6,500 if over age 50). For comparison, your employer would have to match 130% of your 401k contributions just to break-even with the IRA cap!

(max 401k contribution of $2,400) + ($2,400 x 130%) = $5,500

The good news is that this proposal appears to be dead-on-arrival, wisely shot down by President Trump (though it hasn't gone away completely). But the fact it was even muttered outside of a group brainstorm has me worried about whoever is in charge of tax reform.

In The Market...

The S&P 500 climbed +0.2% this past week. Let's look under the hood:

(price data via stockcharts.com)

This was a bumpier week for stocks than we have seen in a couple months, which is what I had said I expected in last week's blog. The S&P 500 was higher by week's end, but not before falling more than -1% midweek. The S&P extended its weekly winning streak to seven, which is rare territory.

While the 10 sectors were largely split between gainers and losers, this was a net-positive week for stocks, in my view. I do still think we'll see some flattening out in the weeks ahead, but it was good to see buyers step in and "buy the dip" (ourselves included) when stocks started to fade.

Earnings season seems to have lured buyers back into the fold too, particularly across the big tech names like Google, Facebook and Microsoft. Technology was the runaway winner, up +2.4% weekly. This was nice to see considering most client accounts owned the tech-sector fund (XLK) or the comparable Nasdaq-100 fund (QQQ) -- the former being tech-exclusive and the latter being tech-heavy. We sold XLK off Friday's gains. I still like the long-term outlook for technology but selling made sense in the near-term based on my analysis. This resulted in a nice gain for accounts that owned it.

In Our Opinion...

Have you ever heard a financial professional say that investing is about removing emotion?

I would hope so, because I have said it before. But that statement needs to be tweaked. Investing is about limiting emotion, not removing it. It is impossible to totally remove emotion when deciding when to invest, what to invest in or if it is time to sell. Here are a few examples:

  1. Loving your company too much. As a result, many people own a disproportionately high amount of company shares relative to other investments (primarily through their 401k plan, exercised stock options or restricted stock).
  2. Believing the market is "due to correct". Just because you think the market cannot continue at this pace means nothing. If you think we are on the brink of World War III or that the market is rigged, to each their own. But such sentiments are usually rooted in emotion, not rational analysis.
  3. Being quick to buy a falling stock or sell a rising one. I often say there is a reason an investment is rising or falling and you typically want to be on that side of the trend.
  4. Holding an investment due to special meaning. I see this often when investors hold a certain stock simply because a family member owned it for years. There is implicit confidence because someone you trust owned it. This is poor reasoning, in a vacuum, because the world changes so much generation to generation.

You may work for a great company, especially around Seattle or the Bay Area. But do you truly know both how your company will perform in the future as well as how investors will react to that performance? The answers are maybe and no.

Now, it is ironic in a sense. If you are heavily weighted in company stock it is probably due, in part, to company success. But at some point it makes sense to find some balance and diversify away from that one stock. I'm not saying sell everything or even sell the majority, but put down the kool-aid for a moment and assess the investment risk.

If you believe the market is going to fall or crash, why is that? Fear that we will see a repeat of 2008? Your political views? Anything can happen but it could be a long wait.

Just for fun, let's say it isn't. Let's say the market drops -10% tomorrow. Would you buy then? If not, how much would the market have to fall before you buy? If you are determined to wait until the next recession passes, you have to be right not once but twice. You first have to be right about the market falling in the near future. You then have to identify when the recovery begins, which could take weeks or months. Easier said than done, especially if your rationale stems from emotion rather than a disciplined investment process.

I would be lying if I said emotion never creeps into my decision-making process when choosing investments to buy or sell. But it is a fraction of thought as compared to leaning on our statistics-driven investment process.

In Our Portfolios...

Q&A/Financial Planning...

If you own an IRA or 401k and are approaching age 70, here are three letters to know: RMD.

RMD stands for "Required Minimum Distribution". It is the amount you must withdraw from your tax-deferred retirement accounts each year once you turn age 70 1/2 (don't ask why the half year applies -- the IRS is weird). The RMD rules are the government's way of saying that you have delayed paying taxes for too long and now must start recognizing your savings as taxable income.

How RMDs work: To keep it simple, you look up your age on one of two charts provided by the IRS. Your age will correlate to a "life expectancy factor" that you divide into the cumulative value of your tax-deferred 401k's and IRAs. The resulting figure is what you are required to withdraw and recognize as ordinary income in your tax return. Each year thereafter you look up your age and divide the new factor into your overall account balance. This life expectancy factor declines as you age past 70 because presumably your account balance is falling each year that you withdraw more and more funds.

The first year is unique! Take special notice when you turn 70.5 years old. Whenever that is, your first RMD must be taken by April 1st of the following year. Every year thereafter your RMD must be taken by Dec. 31st.

Why is the first RMD deadline April 1st rather than Dec. 31st? Likely because most people are unaware of the RMD laws so the IRS gives you a break in that first year. However, it gets a bit more complicated. Not only must you take that first RMD by April 1st, you must take the second RMD by Dec. 31 of that same year. Year 1 is the only year subject to taking two, separate RMD amounts.

Let's work through a quick example. Let's assume you turned age 70.5 on July 12, 2017. Here are the deadlines for taking 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)

Note that this requires you to go back and look at what your account balance was at the previous year-end. If you need help calculating this, let me know.

What if I don't take my full RMD? This is where the IRS cleans up... You are penalized 50% of whatever amount you did not take but were supposed to take. So.... let's say your RMD is $10,000 and for whatever reason you only withdraw $2,000. The $8,000 missed RMD is penalized 50%, which means an additional $4,000 tax penalty! Now you see why the RMD rules are a big deal.

Can I avoid taking 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 still paying Uncle Sam one way or another. However, by not being subject to RMDs it is less administrative hassle during retirement and it also means future tax-free growth because that is the biggest perk provided by a Roth IRA.

I often recommend doing Roth IRA conversions in chunks by doing a series of them as you near age 70. This spreads out the tax burden over multiple years. Or even better, if you anticipate a year or two where your household 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.

Can I apply IRA withdrawals made prior to age 70 toward future RMDs? No.

Say I am 72 years old and I take MORE than my stated RMD for the year. Can I apply the excess amount toward next year's RMD? No.

What's New With Us?

Unfortunately we do not get any trick-or-treaters on our street, which I think is due to being on a steep hill. But we will be dressing up and going to a Halloween party this weekend.

Have a great weekend!

Betz Signature 250px.png
 

Brian E Betz, CFP®
Principal

Hiring Falls But Employment Rises... Wait, What?!

In The News...

The number of U.S. jobs fell for the first time in 7 years. And it may not be a big deal.

First, the facts...

  • A total of -33,000 jobs were lost in September. This followed the prior three months where an average of +180,000 jobs per-month were added.
  • Despite this jobs decline, the unemployment rate fell from 4.4% to 4.2%.
  • The participation rate improved to 63.1%. This measures the number of those either working or looking for work as compared to the total working-age population.

How can this be? How could unemployment improve as jobs are being lost? Two reasons: Hurricanes Harvey and Irma. Those natural disasters threw off the census that measures the number of jobs added or lost for the month, called the Establishment Survey. In this poll, anyone unpaid for whatever week the 12th falls on is considered unemployed. While the Department of Labor claims the hurricanes skewed the -33,000 job-loss figure, the DOL does not believe it affected the unemployment figure of 4.2% or the participation rate, both of which are computed by the other employment census -- the Household Survey.

Household Survey: This census considers anyone with a job as employed for the month, even if they miss work the week the 12th falls on. I mention this because "Employment falls for the first time in 7 years!" will likely lead news headlines. Ironically, President Trump has long-called the Dept of Labor jobs numbers "false" or "phony", but this time the unemployment numbers may actually be misleading given the unique impact of two massive hurricanes striking within weeks of each other.

The eye of the beholder: It certainly does not help that we have dozens of different ways to interpret employment data. Depending on your bias you could find any nugget you want and use that data point to argue whether the jobs market is doing well or poorly. In my opinion, the participation rate matters as much as anything because it gives a complete view of employment relative to the total working-age population. Participation had been on the decline since early-2000, until making a positive turnaround roughly two years ago. This will be key as more Baby Boomers retire and younger Millennials and Generation Z'ers step into the workforce.

In The Market...

The S&P 500 gained +1.3% this past week. Let's look under the hood:

(price data via stockcharts.com)

STOCKS: The S&P 500 index climbed for the 4th-straight week and 6th time in the past seven weeks. So much for the volatile summer, huh? Since the blip in early-August the S&P has rallied +5.5% over the past seven weeks. Again everyone, this is bullish behavior. Eight of 10 sectors were higher last week, led by those we want to see leading amid a bull market -- Materials and Consumer Discretionary.

We sold our Financials sector fund (XLF) this past week for a nice gain of roughly 5%. Not all accounts owned this -- larger accounts and smaller, more aggressive accounts did. I still like Financials long-term but based on my analysis looking out over the next few weeks it made sense to take the gain and evaluate other options. One sector I am eyeing is Industrials (XLI).

BONDS: A down week for bonds, but not as bad as I would have expected given the S&P was up more than 1%. Of course, stocks and bonds are not negatively correlated anyway, even if they show tendencies from time to time. I don't read too much into this past week. For now I still favor the odds that bonds will rally in the coming weeks.

In Our Opinion...

It happened again.

As I sat down for lunch with someone I know through volunteer work, the first question I got was... "So when do you think the big correction will happen?"

I have written at-length about how I believe pessimism has fueled the stock market higher, though there are no data points to confirm/disprove that. Major market declines -- I am talking more than the -5% or -10% drops we see every year -- do not typically come until investors have become euphoric, or at the very least, complacent.

Looking at the data, stocks are technically "overbought" right now if you look at the Relative Strength Index (RSI). This measurement actually plays a central role in our analysis because it helps substantiate whether I believe a certain trend will continue or a new one is forming. RSI gauges price momentum by comparing the size of gains versus losses over a period of time. This is typically 14 periods, which could be 14 days, 14 weeks, 14 months, etc.

A RSI reading above 70.0 is considered "overbought". The S&P 500 is currently at a daily RSI reading of 78.0, a weekly RSI of 76.0 and a monthly RSI of 83.0. Sooooo, using the S&P as our barometer, the stock market is technically overbought on all three primary timeframes we use in our analysis. This would indicate that the market is overheated and due for a loss.

But it just isn't that straightforward. A stock can stay overbought for a very long time before ever realizing the sell-off that is expected. RSI is almost counter-intuitive in that way. Momentum breeds momentum until it doesn't, if that makes sense. Even when RSI falls back below 70.0 it often leads to greater demand among investors who want to buy the price dip, which in turn sends RSI higher as momentum picks back up.

To illustrate this, look at how the S&P 500 behave back in 2013 and then again during this current bull market rally. Notice that in 2013 the S&P ripped off another +30% gain after RSI crossed above 70.0 and was technically "overbought":

(chart created via stockcharts.com)

The opposite holds true too. When RSI for a particular investment falls below 30.0 it is considered "oversold" and due to rally. Similarly speaking, when this happens you have to be careful because the investment in-question can fall further and further and RSI can remain below 30.0 much longer than anticipated. This often occurs when investors unwittingly see that a stock has precipitously fallen in value and they buy it thinking they are getting a discount. More often than not that investment falls even further, resulting in unexpected losses for the investor who thought they were going to make some quick money.

The bottom line is that there is usually a reason an investment's value is rising or falling. If it is rising you should embrace the trend. If it is falling you do not want to be on the wrong side of that, hoping for a rebound. This is where trend-analysis matters, but I won't revisit that concept here.

In Our Portfolios...

Q&A/Financial Planning...

Will your income be lower than normal this year?
Are you 10 years or more away from retirement?
Are you retired and have enough savings to avoid dipping into your 401k or IRA?

If "yes" to any of these, you might want to consider converting a portion of your 401k or IRA account into a Roth IRA.

Why do a Roth IRA conversion? To lower your tax bill. Right now the money sitting in your 401k or IRA are pre-tax (unless you opted for the Roth 401k option), meaning you have deferred paying income taxes on those contributions and the earnings that stem from them until you retire. Eventually you will have to pay taxes as you withdraw money down the road. But if you convert now you will pay taxes today in exchange for never paying them again, no matter how large your account grows.

That last part is key, because I think we would agree that your account will be larger in the future than it is today (if you are still working). That means a much greater tax burden down the road. If you think your household income will be abnormally low this year, it might make sense to do a Roth IRA conversion so the funds can be subject to a lower tax bracket than they would be if you converted them next year.

But Brian, why not just wait until I am retired and withdraw money then? At that point I won't be working and my tax rate should be much lower anyway.

Fair point, but there are a few holes in that argument. First, remember what I just said about your savings being much greater by that point than they are today. Even if you are in a lower tax bracket in retirement, the gross amount of taxes you pay will cumulatively be greater than taking your tax medicine now on a smaller nest egg.

Also, by converting to a Roth IRA you avoid the Required Minimum Distribution (RMD) rules that kick in at age 70. The RMD rules mandate that you take out a certain amount from your tax-deferred 401k or IRA accounts each year until you die. This is the IRS' way of ensuring you eventually pay your taxes, rather than continuing to stockpile savings and deferring taxes even longer.

Though the RMD rules seem like a first-world problem to have, they can be annoying by forcing you to pay taxes. They can also make other parts of your life expensive. For instance, your Medicare Part B premiums increase as your income exceeds certain thresholds. RMD withdrawals will send your income higher and higher, particularly when you add in other sources like Social Security or pensions.

If you are nearing retirement, consider mapping out whether it makes sense to convert some portion of your tax-deferred savings. You can convert as little or as much as you want. For example, you could take a $50,000 IRA and convert $10,000 of it every year for 5 years, thus spreading out the tax burden across five tax returns. This may pose an administrative headache over time, but it is still an option.

One last thing: I want to make sure I distinguish a Roth IRA conversion from a Roth contribution. A Roth conversion is taking pre-tax ("tax-deferred") IRA funds already in existence and turning them into Roth IRA funds. A Roth contribution is making a deposit of cash into your Roth IRA. The maximum you can contribute is $5,500 if under age 50 and $6,500 if older, provided your household income is within IRS limitations.

Deadlines: The deadline to do a Roth IRA conversion for 2017 is Dec. 31st, so you have some time. The deadline for making a 2017 contribution is tax day of next year. Let us know if you are interested in either and we can help determine if it makes sense to do so.

What's New With Us?

I will be traveling for work down to San Jose and San Francisco later next week, but will be available as always.

Have a great weekend,

Betz Signature 250px.png
 

Brian E Betz, CFP®
Principal