When creating a retirement plan there are a lot of factors to consider, but have you heard about how converting your traditional IRA into a Roth IRA has the possibility of creating tax-free income in the future? Joining Gregory to discuss this topic is Jude Heath of J Heath & Co CPAs.
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Gregory Ricks 00:00
Hey, welcome. I’m your host Gregory Ricks a financial advisor here to answer your questions and help you win with your money.
On today’s episode of the Ask Gregory podcast, Gregory is joined by Jude Heath of J. Heath & Co. CPAs. And together, they are going to be discussing the recent changes that have happened to the inherited IRA process for nonspousal beneficiaries and different items that you can think about when creating your retirement plan. We also have a complimentary download waiting for you on this topic. If you go togregoryricks.com/podcast98 Again, that is gregoryricks.com/podcast98
Gregory Ricks 00:36
So a number of things are also impacting us going forward? Is the IRS changing rules on inherited? IRAs, what are you seeing from a standpoint of have you dealt with many cases lately where inherited money, qualified money because the rules have changed, we used to have the stretch IRA and now most cases that money has for a non spouse beneficiary, it’s got to be spent down over a 10 year period.
Jude Heath 01:12
Right. And so, you know, taxpayers clients are making decisions based on that, again, we encourage and you and I’ve talked about this many times, we encourage our clients to look at their IRAs. While they’re in those years where they’re pre law highest bracket. Consider Roth conversions consider making changes. Once you get into requirement distribution territory, sometimes it’s hard to make changes that can impact your beneficiaries. And so we look at it from from from the last 20 or 30 years of life, sort of speaking of, you know, what are you going to do with those IRAs presume that the markets are going to continue to go up? You know, yeah, we’re in a little bit of a downturn. But we still know that markets are going to continue to go up over the years, and plan for those beneficiaries. Because I can tell you, it is a big tax hit that 10 years is a small window,
Gregory Ricks 02:16
there’s kind of two parts to that, and we’re talking about non spouse. So typically, the order of things is, let’s say, you and your wife each have 401 K and or IRAs, whether they’re Roth, or traditional, but let’s stick to traditional because Roth’s not affected the same way, by the new rules. 401 K, or traditional IRAs, one of you pass, assuming the spouse is the beneficiary, to simplify it, the spouse, the surviving spouse becomes the owner of those are arrays, and then they’ll have if they’re of RMD age, at some point they will be will take RMDs from those accounts, at some point in time that person will pass. And the remaining assets there are going to pass to what would be a non spouse beneficiary, then let’s say their age of majority, no disability or anything, they’re going to have to take that money out over 10 year period. It’s got to be depleted or spent down in year 10. Post death. Now, there’s another thing to consider was that before required beginning date, or and that’s have RMDs required beginning date of RMDs. Was it before that if it was before that, you’re not going to have to take RMDs over that 10 year period, but still year 10 It has to deplete if it was after required beginning date that they passed and you inherit that as a non spouse Benny, you’re going to have to take RMDs starting year, one of post the year after death, and account still has to be depleted in year 10 of that inheritance there. So one of the things we’re getting at is and everybody doesn’t have giant accounts, but But I can tell you what they can grow to be pretty big accounts during retirement. The thing is, you’re giving them taxable income and here’s a question I get also do they say well, is that money tax? taxable? Absolutely all of there is no cost basis. Typically, you know that 401k, that IRA, you’re leaving behind, there’s no cost basis on that. Generally, that’s all taxable money that’s being left behind. So it’s 100%. Tax. So if you’re, say, leaving it to non spouse, Benny’s, which is likely children, and let’s say you’re at, and maybe your kids are in the 50s, you’re, you’re leaving that money to them in their higher income years, and you’re pushing in the max tax brackets. If you’re leaving 500,000 behind, and they averaged it out over the 10 years, that’s 50,000 a year without at a 0% return of spending it down there. So you’re adding that on top of their tax brackets. So you’re also leaving behind money, that’s probably going to be taxed at max tax brackets in the future. And that’s one reason we talk about the planning going forward. Roth conversions are important to consider. If you’ve got margin in your tax bracket, I say, don’t waste it, is there an opportunity to pay taxes at a lower tax bracket than now than what it’s going to be in the future. And I say taxes are lower today than they’re going to be in the future tax cut jobs act is set to sunset and of 2025. So that tells us right there, taxes are going up. If you’re leaving inheritance, it’s got to be piled on top of your income to a non spouse, Penny, you’re leaving behind money that’s going to be taxed at higher tax brackets, your thoughts Jude.
Jude Heath 06:43
And absolutely. We talked, we’ve talked about this many times that with the sunset of the tax cut and Jobs Act, that’s two years away, we’ve got two more years of tax brackets that you can take advantage of. The other continuing theme that you and I have talked about is is that, that we feel like on top of the tax cut and Jobs Act, that rates are going to continue to go up for the higher brackets. And so what you’re talking about is these children that are going to be say in their 40s 50s 60s that are going to inherit these 10 year windows are going to be paying in excess of you know, a third 40%, something like that. We don’t know if we’ll get to Reagan brackets, but with pre 1986. But we will have an increase because quite frankly, with higher interest rates, and still a nice healthy federal budget, there’s the money has to come from somewhere. And as we’ve seen with this most recent inflation Reduction Act, it’s either going to come on the front end in terms of tax brackets, or it’s going to come on the back end in terms of enforcement. And so money is coming out of the select few in the higher brackets and you’re leaving for your children a mess. If you’ve got some play, before you get say you’re in the middle bracket, you’re in the 20s. And you’ve got some play before you get to the higher brackets, you’ve got to come in have a conversation, we’ll run some projections and some some some scenarios and see what we can take within the next few years. It’s it’s not a one time planning thing. It’s what are we going to plan for in 2022? What are we going to plan for in 2023? What can we either convert over to Roth? Or what can we move and take out to provide some protection from this 10 year window that your children are going to are going to be faced with?
Gregory Ricks 08:51
It’s not unusual to have conversations with families regarding what are your plans for this money, you know, you’ve not started taking income and like, I don’t have to take the RMDs I don’t need that money. Well, what’s the purpose of to leave on I want to leave, we really don’t need we thought we were going to need it but we really don’t need the money from it. And that doesn’t mean that these are folks that were millions of dollars that, you know, they’ve got good income, and they’re probably reached a point in retirement that they’re not needing as much income cut, you know, pension and Social Security. You know, we’re good, we have savings and we save every year. So we’re good. And this might be four or five or 600,000 and IRA money. It’s not like they’ve got massive money built up but if they don’t need it here, here’s the example of compounding. If you’ve got $100,000 and average is 7.2% Return that’s using the rule of 72. In 10 years, it’s going to double. So if you’re 60 in 10 years 100,000 goes to 200,000 at age 80 It’s 400,000 So at 90, it’s $100,000, you’re probably gonna live to 100. I know you don’t think so but then we’re talking about $1.6 million, then if you die then and leave it inheritance. If it could be deferred, you’re talking about $3.2 million, say, time in compounding is the magic. That’s why 95% of Warren Buffett’s wealth was created post Social Security qualification for him there. So think about that, let’s say you pass and it goes to your spouse, the spouse can then take ownership of your IRA, essentially, it can be merged. We did that, for a household recently where that money was merged together. So it’s their money, and they’re taking RMDs, based upon their age, that’s required minimum distributions, those have to start when you turn 72. And at some point, your spouse is going to pass. And let’s say you have your average household, you have two kids, something like that. And then that money’s going to pass them. And they’re, obviously because of your age, when you’re passing, say, in the 80s, they’re probably say in their 50s. So they’re grown adult beneficiaries in their higher income years of their working life. And a non spouse beneficiary has to take that money out. There are some exclusions to this. But most cases, they’re taking the money out required to over 10 years. And because they inherited it, after you started taking required minimum distributions, they have to start taking RMDs year one, but that’s not going to spin down the account, they’re going that probably should take more, because in year 10, the count has to be liquidated. So that’s going on that money, that tax money is going on top of their income that they’re taking pushing up tax brackets, and then that money is going to be taxed at a higher tax rate than if you were spending it down. Now. So how do we prepare for that? Coming forward? Is that a pretty accurate description, dude? Yes, that’s what we see. So one of the things I like is game planning, Roth conversions, one of the things I talk about is tax bracket management, I’m sure you’ve probably got to take on that as well. But we want to look at what’s the gap? What’s the margin left in your tax bracket for you move to the gnat. Next, there is a sweet spot under current tax brackets of that 22 to 24%. Right, right. It’s a pretty wide berth there of that, that you could move into another 2%, which without much tax pain, and shift money, but doing a Roth conversion. Once again, to be clear, when you do that conversion, it’s done. You can’t change your mind. So make sure you’re comfortable with the tax impact of that. And then that allows that money to shift to tax free money. One reason we like and here’s why we like Roth money for the non spouse Benny’s, they don’t have to take RMDs because Roth is not RMD money. So if you’ve got Roth money, you’ve turned 72, you do not have to take required minimum distribution. So the bare knees don’t have to the non spouse Benny’s do not have to take the RMDs but they still have to spend it down by the end of year 10. They could just let it ride and compound. What I missed there, how do you look at tax bracket management,
Jude Heath 13:57
we do the same thing that what you were talking about is if if if the owner is in the in the 20% brackets, even if we you know Miss up a step and we we fold over into some of the higher brackets, it’s just a small amount of money that’s going to be in the higher brackets. We’ve still captured those nice middle brackets over the course of some years and been able to put aside or or or have a Roth account of some amount of money that now is dependable upon you know, for retirement for the non spouse Benny’s for whatever their purposes are, you know, like you, every client that comes in the door has a specific situation. We are analyzing according to their will and what they want to do, and we’re producing calculations for their benefit. And so that that’s where we are is is that there’s almost no cookie cutter when it comes to this. It comes down to Hey, what’s their intent? Who’s the non spouse, bene, age bracket management, all those things go into producing the best benefit for our clients.
Gregory Ricks 15:11
Let me give you another example I like to use on that. And let’s say, now we’re not trying to convert your whole IRA and create giant taxable events. But we can you know, how do you eat an elephant? One bite at a time? How do we convert assets to more tax efficiency, it’s a bite at a time. And it might just be a small amount. Let me give you a quick example here. Let’s just say it’s $33,000.03 times one each of the next three years. And I’m all rounded up to $100,000. So we’re taking a small by creating small taxable events and doing so and let’s say that’s all we do, and we get you to age 60. That’s $100,000 in a Roth account, using the rule of 72, Let’s hypothetically say it doubles every 10 years at 7.2% return, but that 100,000 will grow to 200,000 at age 70. At age 80, it’s 400,000. At age 90, it’s $800,000. And how much taxes is due on that money?
Jude Heath 16:22
Gregory Ricks 16:23
How much taxes? What money did you pay taxes on $100,000. And let’s say you died at that standpoint, your non spouse, Benny, your kids inheriting that money, they don’t have to take RMDs they could live, they could leave it in that Roth status for another 10 years. And that 800,000 can go to $1.6 million at 7.2%. Hypothetically, talking about a life changing event. Yeah, they got to spend it down. It’s got to be taken out year 10. Is it taxed? No, no, it’s not say and all we did was shift a little bit of money and let the magic of compounding take care of the rest. And you can impact it with even more money being shifted if the situation is right for you. But that’s what planning is. And it’s not we oh we do the plan and we’re done. Now. It’s it’s adjustments that are going to be made going forward. Thanks so much for listening to ask Gregory where we answer your financial questions. You can find us anywhere Podcasts can be found and on YouTube and Facebook Live every Saturday from 10 to one subscribe, leave a review and tune in next time.
We also have a complimentary download waiting for you on this topic. If you go to gregoryricks.com/podcast98 Again, that is gregoryricks.com/podcast98 Gregory Ricks & Associates is an independent financial services firm that utilizes a variety of investment and insurance products. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Gregory Ricks & Associates are not affiliated companies. Gregory Ricks & Associates, The Total Wealth Authority is our trademarked tagline, it does not promise or guarantee investment results or preservation of principal nor does it represent a certain level of skill. Investing involves risk, including the potential loss of principal. Any references to protection, safety or lifetime income, generally refer to fixed insurance products, never securities or investments. Insurance guarantees are backed by the financial strength and claims paying abilities of the issuing carrier. Please remember that converting an employer plan account to a Roth IRA is a taxable event increased taxable income from the Roth IRA conversion may have several consequences including but not limited to a need for additional tax withholdings or estimated tax payment the loss of certain tax deductions and credits, and the higher need on taxes for Social Security benefits and higher Medicare premiums. Be sure to consult with a qualified tax advisor before making any decisions regarding your IRA. This podcast is intended for informational purposes only. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. Gregory Ricks & Associates is not permitted to offer and no statement made during this show shall constitute tax or legal advice. Our firm is not affiliated with or endorsed by the U.S. Government or any governmental agency. The information and opinions contained herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Gregory Ricks & Associates. Any media logos and/or trademarks contained herein are the property of their respective owners and no endorsement by those owners of Gregory Ricks & Associates is stated or implied Gregory Ricks & Associates has a strategic partnership with tax professionals and attorneys who can provide tax and/or legal advice. AEWM, Gregory Ricks & Associates, WJ Blanchard Law, LLC, J Heath & Co. and Mortgage Gumbo are not affiliated companies.