RPF0504-Stretch_IRAs
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00:00:29.800 | Had a question come up to me last week that I thought would be fun for me to tackle as
00:00:36.360 | the topic of today's show because it brings together a little bit of technical financial
00:00:40.100 | planning with some discussion of various scenarios and gives me a chance with a real world example
00:00:46.080 | to talk through a few strategies that I want you to be aware of.
00:00:50.000 | Listener asks this, "I want to make sure that I'm not losing my mind.
00:00:53.040 | I know somebody who is 72 years old who has a traditional IRA who is thinking of converting
00:00:58.580 | some of that IRA to a Roth IRA.
00:01:02.920 | They call their advisor at Merrill Lynch today and he told them they would only pay taxes
00:01:06.120 | on the contributions and that the gains would roll over into a Roth IRA tax free.
00:01:11.020 | This seems to me to be incorrect advice.
00:01:13.800 | Everything rolled over to the Roth, contributions and gains would be taxable as income.
00:01:18.660 | Any rollover amount would have to be above and beyond the required minimum distributions
00:01:22.320 | and then obviously any new gains would come out tax free.
00:01:24.560 | Is that right?
00:01:25.560 | I think this guy was a certified financial planner."
00:01:29.020 | So the scenario here to make it a little bit simpler is that you have a 72 year old person
00:01:33.740 | with a traditional IRA who is trying to figure out what are the rules of converting some
00:01:38.260 | to a Roth IRA.
00:01:40.980 | Now let's start with why somebody would want or not want to do such a conversion.
00:01:47.260 | When you have a traditional IRA and that IRA could be accumulated either from a rollover
00:01:52.720 | from some sort of qualified pension plan such as a 401k or a 403b plan or it could simply
00:01:59.700 | have been accumulated over time with systematic yearly contributions.
00:02:03.580 | But when you have a traditional IRA, one of the things that happens is about the age of
00:02:07.780 | 70 you start to have what are called required minimum distributions.
00:02:12.100 | Remember how the money gets into an IRA in the first place.
00:02:15.780 | The money gets in before taxes are paid.
00:02:19.180 | The US federal government wants to have taxes paid and so you have a choice.
00:02:23.080 | You can either pay them now or pay them later.
00:02:26.740 | But you've got to pay them.
00:02:27.740 | Just remember, the government's going to get paid, pay now or pay later.
00:02:31.500 | Well a traditional IRA concept allows you to pay your taxes later.
00:02:37.300 | When you earn a dollar, you don't pay income taxes on that earning.
00:02:41.060 | You just slide it right into the IRA and then it can accumulate over time and the tax is
00:02:46.220 | deferred until you take it out.
00:02:49.440 | Of course, the government wants to make sure they get their tax money and so they allow
00:02:53.200 | you to keep the money in there until about the age of 70 and at the age of about 70 then
00:03:00.220 | they say, "Okay, you've got to start taking money out of the account whether you need
00:03:03.920 | it or not."
00:03:05.960 | Many people are quite anxious to tap the funds in their retirement accounts but there are
00:03:10.860 | also many retirees who don't really need the money.
00:03:15.540 | There could be various reasons for this.
00:03:17.460 | Frequently, perhaps a retiree has their house paid off and so their outlay of cash is lower,
00:03:23.140 | especially in those early years of retirement when medical expenses are also lower.
00:03:27.660 | Or perhaps their social security benefit ended up being higher than they thought or they
00:03:31.100 | may have other supplementary forms of pension income and they don't actually need the money
00:03:35.920 | from the traditional IRA.
00:03:38.920 | And so this type of moderately wealthy to fairly wealthy retiree often finds it a little
00:03:44.320 | bit annoying to have to start adding extra income to their tax return every year.
00:03:51.220 | And at the age of about 70, then they have to start taking those distributions.
00:03:56.920 | Now there are a few ways to take those distributions out but the way that you should just think
00:04:00.220 | about required minimum distributions is simply there is a table that goes based upon the
00:04:05.900 | life expectancy and a percentage of somebody's life expectancy, a percentage of the years
00:04:12.380 | that they have remaining, however many years that is, that's what characterizes how the
00:04:16.660 | money comes out.
00:04:17.660 | So some small percentage of the money is going to come out each and every year.
00:04:21.940 | And that's when the taxes are going to be picked up.
00:04:24.100 | So that's how a traditional IRA works.
00:04:26.640 | Now in this case, this particular person is thinking about converting money into a Roth
00:04:31.780 | IRA.
00:04:32.780 | So why would somebody want to have a Roth IRA?
00:04:34.340 | Well, the major benefit, there are a few major benefits of a Roth IRA.
00:04:38.180 | First let me explain how it works and I'll talk about the benefit of a Roth IRA, specifically
00:04:42.540 | focused on retirement.
00:04:44.580 | Remember the government's going to get paid now or get paid later.
00:04:47.420 | In a Roth IRA, what you do is you pay the government their taxes first so that you don't
00:04:52.620 | have to pay them later.
00:04:54.540 | So during your working years, you earn a dollar and you pay your tax rate on that dollar when
00:05:01.180 | you earn it.
00:05:02.180 | Let's say you paid 20 cents out of your dollar in taxes and you contribute 80 cents into
00:05:06.860 | the Roth IRA.
00:05:09.220 | The benefit of that, of course, is as that money grows, there are no year by year taxes.
00:05:16.640 | And as long as you take that money out after the age of about 60 years old, then you can
00:05:23.140 | take it out tax free and all of the money comes out tax free.
00:05:27.400 | Now notice for a moment that there's not really any difference in taxes.
00:05:31.480 | You might think that a Roth IRA actually allows you to pay less money in taxes than a traditional
00:05:36.740 | IRA.
00:05:38.020 | But if your tax bracket is the same during your working years as it is during your retirement
00:05:42.420 | years, that's not actually the case.
00:05:44.820 | You're going to pay the same amount in dollars or the same amount in percentage in taxes
00:05:49.780 | whether you put the money in a traditional IRA or a Roth IRA.
00:05:53.940 | Frequently, people think that a Roth is better because of that reason.
00:05:57.820 | It's not true.
00:05:59.020 | Again, for the sake of let's do a little bit of math, if you put the money in and you deposit
00:06:04.300 | 80 cents and then you fast forward say 30, 40 years over the investing timeline and then
00:06:10.580 | you calculate how much money you get out after taxes whether you paid them up front or in
00:06:14.820 | the back end, as long as you're in the same tax bracket, you'll pay the same amount in
00:06:19.180 | taxes, which is why when you're choosing between a traditional IRA and a Roth IRA, the number
00:06:24.620 | one factor you want to consider is usually, well, when am I going to pay money in a lower
00:06:31.180 | tax bracket?
00:06:32.420 | Is it likely that I'm going to be in a higher tax bracket at retirement because my income
00:06:35.740 | is going to be higher or lower?
00:06:37.820 | And then choose accordingly.
00:06:39.660 | However, that's not the whole story.
00:06:43.080 | One of the benefits of a Roth IRA is there are no required minimum distributions during
00:06:49.660 | the lifetime of the account holder.
00:06:53.260 | So you can reach the age of 70 or 71 or 72 or 80 or 90 and you can continue to keep those
00:07:00.580 | assets in the Roth IRA.
00:07:03.060 | You don't have to force them out of the Roth IRA into the world of taxes.
00:07:08.540 | For somebody who has other forms of income, this can be a very valuable benefit, especially
00:07:13.900 | if they have substantial amounts of money in the Roth IRA.
00:07:17.980 | The longer you can defer taxes, the better.
00:07:22.900 | And this can be a really powerful tax planning tool, which is why it's reasonable for people
00:07:29.980 | to consider converting some of their traditional IRA assets into Roth IRA assets.
00:07:37.500 | And it's wise to do that before you have required minimum distributions because you can keep
00:07:44.300 | the money in the IRA longer, which allows it to grow more and to ultimately be worth
00:07:50.540 | more.
00:07:51.900 | The longer you can keep the grubby little hands of the government goons who collect
00:07:55.720 | the taxes off of your money, the more you'll have.
00:07:59.640 | Just like with fees, the fewer fees you can have on money, all things else being equal,
00:08:04.100 | you'll have more money.
00:08:05.100 | And so tax efficiency is very important, very important when it comes to financial planning.
00:08:11.580 | Now back to the original question.
00:08:13.460 | This particular client thought that they had been told by their financial planner that
00:08:18.860 | they could convert the money from a traditional IRA into a Roth IRA and that they would only
00:08:24.340 | pay taxes on the contributions of the account, that the gains would just roll over into the
00:08:28.460 | Roth IRA tax free.
00:08:30.240 | Now of course that is erroneous.
00:08:32.180 | Now my guess is not that the CFP probably gave this particular person the right advice,
00:08:37.140 | but the individual client of the CFP probably just misheard and misunderstood.
00:08:43.060 | It's certainly possible that financial planners give bad advice.
00:08:46.060 | I've given my share of wrong advice.
00:08:48.300 | The rules and regulations change.
00:08:51.340 | Things are very complex.
00:08:52.340 | It's hard to keep it all straight.
00:08:53.640 | Sometimes you just don't keep your head.
00:08:54.780 | It just doesn't work.
00:08:56.060 | So I've given my share of wrong advice and I think many of us would admit that we've
00:08:59.660 | done that.
00:09:00.660 | But more frequently it's that somebody who's not a professional hears what they think they
00:09:05.940 | hear and the professional said the right words but it didn't really connect with the meaning.
00:09:12.300 | So let's talk about how a conversion would work before age 72 and after age 72.
00:09:19.340 | Now pretend that you are say 40 years old.
00:09:21.940 | So we don't have any dates.
00:09:23.460 | We're not worried about the 59.5 numbers.
00:09:26.060 | We're not worried about that 70.5 number or that about 60 and about 70.
00:09:30.740 | We've just got these – you're a 40-year-old person and we're trying to figure out whether
00:09:34.500 | you should convert some of your money over.
00:09:36.820 | Now because you've put money into a traditional IRA, let's say you have $100,000 in your account,
00:09:41.460 | you have the option now with no income limits to convert any amount of it from traditional
00:09:47.380 | assets to Roth assets.
00:09:49.740 | And when you do that conversion, basically what it means is you pick up some income.
00:09:56.860 | Now that example would be if you were going to convert $50,000 from your traditional IRA
00:10:01.860 | to your Roth IRA, you could move it over in the accounting with the brokerage firm that
00:10:07.180 | you have it and then your tax return this year would have an additional $50,000 of income
00:10:13.980 | on it that you would pay taxes on.
00:10:17.620 | Why would somebody do it versus why would they not do that?
00:10:21.060 | Big reason to do it is to be able to move the asset into the Roth and to get some of
00:10:25.700 | the benefits of the Roth, the longer-term growth, the fewer – no required minimum
00:10:31.700 | distributions, which has some options in a moment that I'll talk about.
00:10:35.700 | The big disadvantage of course is that you're going to go ahead and pay taxes.
00:10:39.100 | And so this would only be intelligent for you to do if you felt that your paying taxes
00:10:43.500 | today was on a lower amount of income than paying taxes in the future.
00:10:49.500 | You're paying at a lower rate.
00:10:51.020 | So you want to be very careful in when you do this because it's silly to pay more money
00:10:55.060 | in taxes just to put the money into a Roth.
00:10:58.020 | However, this is a way that many people can use to get large amounts of money into a Roth.
00:11:05.900 | See, the rules for contributing to a Roth IRA have everything to do with how much money
00:11:11.280 | you're earning and high-income earners aren't able to contribute.
00:11:17.820 | As I record this in 2017, the rule is that if you are single or head of household or
00:11:23.220 | married filing separately and you're earning more than $118,000 as your modified adjusted
00:11:29.620 | gross income, then you cannot contribute – you can't – excuse me, $133,000.
00:11:36.660 | See, what I talked about with making mistakes.
00:11:40.460 | If your income is over $133,000 in 2017, you can't contribute to a Roth IRA.
00:11:48.240 | If you are married filing jointly and your household income, your modified adjusted gross
00:11:52.500 | income is over $196,000, then you can't contribute to a Roth IRA.
00:11:58.920 | So if your income is, either whether you're single or married, over $200,000, you can't
00:12:05.020 | contribute to a Roth IRA.
00:12:06.500 | But you might like to have money in those Roth amounts.
00:12:09.620 | Well, because of the ability to do a conversion, you can take money from your 401(k) or an
00:12:16.500 | IRA or traditional IRA, any kind of – you can take money from an IRA, which – the
00:12:22.860 | source of which could have been a 401(k) or a 403(b) or it could have just been accumulated
00:12:27.340 | little by little over time, and you can convert that into a Roth.
00:12:31.380 | And so if you have a high household income in excess of, say, $200,000, this would be
00:12:36.540 | the way that you would get money into a Roth IRA, which can be very helpful for the reasons
00:12:41.620 | that I described.
00:12:43.020 | Now, you have to pay taxes on the full amount.
00:12:46.280 | You don't get to just roll the contributions in and have the gains flow in without taxes.
00:12:52.140 | No, you pay taxes on the full amount.
00:12:54.220 | So if you're converting $50,000 of a $100,000 account over, then you're going to pay taxes
00:12:59.740 | on the full $50,000.
00:13:02.580 | But the question is this, what happens if you are 72 years old and now you're subject
00:13:08.140 | to required minimum distributions?
00:13:10.060 | Well, if the IRA is requiring you to do required minimum distributions, the answer is it depends.
00:13:18.700 | Assume for a moment that our 72-year-old is earning income.
00:13:22.180 | Well, in this case, it's fairly simple.
00:13:25.500 | Why is this important?
00:13:27.620 | Because in order for you to contribute to a Roth IRA, you have to be earning wages.
00:13:36.100 | You have to be earning wages.
00:13:38.760 | The amount of the wages matters, depending on your filing status, single versus married,
00:13:43.380 | but you have to be earning wages.
00:13:46.380 | So if our 72-year-old retiree still has some wages, maybe they're working part-time somewhere
00:13:53.660 | or they have a business out of which they take some wages.
00:13:57.460 | Notice I'm saying wages, not profits.
00:13:59.180 | There's a distinction.
00:14:00.180 | Wages.
00:14:01.180 | If they're earning some wages from somewhere, then they could contribute to a Roth IRA.
00:14:04.700 | Here's how that would work.
00:14:06.980 | Example.
00:14:09.020 | If somebody is earning income, they have the opportunity to make contributions to the retirement
00:14:14.020 | accounts depending on their age.
00:14:17.060 | Generally, if somebody is under the age of 50, then that number is limited at $5,500
00:14:23.700 | in 2017 for their annual contribution to a retirement account.
00:14:28.740 | If they're older than 50, they have a special $1,000 catch-up contribution.
00:14:32.780 | So our 72-year-old could contribute $6,500 into a retirement account or specifically
00:14:40.940 | into a Roth retirement account.
00:14:43.780 | After the age of 70 and a half, you can no longer make any regular contributions to a
00:14:50.860 | traditional IRA.
00:14:53.380 | So you can't make regular contributions to a traditional IRA after the age of 70 and
00:14:57.660 | a half, but you can still contribute to a Roth IRA.
00:15:02.260 | So the simplest scenario for our retiree, our 72-year-old retiree, is if they have some
00:15:09.380 | wages to just simply go ahead and make a contribution to the Roth IRA.
00:15:15.580 | Assume for a moment that our 72-year-old is married, filing jointly, and our 72-year-old
00:15:20.660 | has at least $13,000 of wages.
00:15:23.500 | Well, in this case, they could make a $6,500 contribution to Roth IRA for the husband and
00:15:28.860 | $6,500 contribution for Roth IRA to the wife, totaling $13,000.
00:15:35.500 | If their required minimum distributions from the traditional IRA were $13,000, then this
00:15:41.760 | would work very, very well.
00:15:43.260 | They had a $13,000 required minimum distribution from the traditional IRA.
00:15:48.160 | That means they're going to receive $13,000 of income from the traditional IRA.
00:15:53.300 | They're going to record that $13,000 of income on their tax return and pay taxes on it, but
00:15:59.420 | then they're going to make a separate $13,000 contribution to a Roth IRA, and now they're
00:16:04.700 | funding the Roth IRA.
00:16:06.540 | Now, why would they want to do that?
00:16:08.980 | We'll talk in a moment that the most powerful reason is so that they can start to build
00:16:13.340 | a stretch IRA.
00:16:14.340 | But for right now, recognize that this allows them to buy more tax deferral on these Roth
00:16:18.980 | IRA contributions.
00:16:20.900 | And this can be helpful because they can put the money in at 72 and 73 and continue putting
00:16:25.140 | in, and they never have to take the money out of the Roth IRA.
00:16:29.740 | The trick here is that they have to have wages, and if they don't have wages, then they can't
00:16:38.700 | make that contribution to the Roth IRA.
00:16:43.700 | In order to contribute money to a Roth IRA, you have to have wages and then fit in under
00:16:49.460 | the earning amounts.
00:16:51.340 | Now what I found out in the discussion over this question was that this particular retiree
00:16:58.580 | that had our questions here, this particular retiree doesn't have any wages, and so that
00:17:03.460 | messes up this plan.
00:17:06.500 | Basically what it means is there's not going to be a tax-efficient way for them to move
00:17:10.660 | the money from a traditional IRA into a Roth IRA.
00:17:16.540 | They can't make contributions to a Roth IRA if they don't have an appropriate level of
00:17:21.620 | wages, and that's the problem here.
00:17:24.340 | Now what could they do in order to get the money into a Roth IRA?
00:17:27.980 | Well they can't do anything with their required minimum distributions.
00:17:31.260 | They have to take the required minimum distributions out and pay the tax on them now.
00:17:36.660 | They could convert money from a traditional IRA into a Roth IRA, but that's now going
00:17:43.380 | to be a separate calculation from the required minimum distributions.
00:17:47.940 | They would have to go ahead and pay the tax on the required minimum distributions and
00:17:52.260 | then separately make a conversion of the traditional IRA assets into the Roth IRA assets and pay
00:17:59.020 | the tax on that.
00:18:00.580 | And now we start to pick up a significant amount of tax.
00:18:03.540 | Is that in their best interest to do?
00:18:05.460 | Well it's hard to say.
00:18:07.580 | Probably not from a tax perspective.
00:18:11.420 | Probably not.
00:18:12.420 | And the reason would be because you're picking up the income, and the whole goal is we're
00:18:14.860 | trying to keep the money in the account for tax efficiency, but now you're picking up
00:18:19.060 | more income quickly and you're just paying a whole bunch of tax now instead of stretching
00:18:23.820 | the tax efficiency out for the future.
00:18:26.500 | So there's not really any easy solution or tax efficient way for them to get the money
00:18:31.120 | into a Roth IRA.
00:18:32.660 | Now you would have to sit down and think about your plans.
00:18:35.420 | And let me talk about the inheritance of the IRAs here and what's so powerful about having
00:18:40.620 | an IRA as an asset.
00:18:42.700 | IRA assets and Roth IRA assets are wonderful assets to have into old age, into retirement,
00:18:50.300 | and at death.
00:18:51.300 | They're really wonderful assets to own.
00:18:53.940 | Some of the benefits of Roth IRAs and traditional IRAs is they're very protected money from
00:19:00.580 | the claims of creditors, which is very valuable.
00:19:03.380 | They are assets that you can own excellent investments in.
00:19:07.540 | They're very inexpensive to own.
00:19:09.060 | You can hold an IRA just about anywhere without – it's a lot cheaper than say managing
00:19:13.700 | a trust that's going to hold assets.
00:19:16.100 | So they're very, very inexpensive.
00:19:17.980 | And these assets are nonprobate assets.
00:19:22.620 | So they're assets that you can adjust the beneficiaries of in a very easy and flexible
00:19:28.500 | way.
00:19:29.500 | You don't have to go and update your will when you want to change the beneficiary of
00:19:31.660 | the asset.
00:19:32.660 | You can just simply change it at the website.
00:19:35.420 | If you have a million dollars in an IRA or $100,000 in an IRA and you want to leave it
00:19:40.380 | to the grandkids, just tell the grandkids, "Listen, I change the IRA beneficiary every
00:19:45.200 | single day."
00:19:46.200 | Right online, I change the beneficiary.
00:19:48.460 | So whoever calls me the most and whoever I like the most, that's who I put that day
00:19:52.620 | or some version of that joke.
00:19:54.700 | The point is it's very simple and easy for you to change the beneficiary of the IRA asset.
00:19:59.820 | You don't have to go and file new paperwork with an attorney and update your will, get
00:20:03.420 | it notarized and signed.
00:20:04.500 | You just sign a few papers.
00:20:06.060 | So an IRA is a very flexible asset.
00:20:08.020 | So is a Roth IRA, same thing, very flexible assets.
00:20:10.240 | They have beneficiary designations.
00:20:12.680 | One of the benefits though of an IRA and a Roth IRA is they can be inherited by people
00:20:20.040 | and your, what do they call it, inheritees, the person that inherits the account has the
00:20:25.580 | ability to also continue with some of the tax benefits.
00:20:31.580 | And this is what we call colloquially a stretch IRA.
00:20:35.980 | Now there's no such thing legally as a so-called stretch IRA.
00:20:39.580 | What a stretch IRA is, it's just a word that we use to describe the rule of or describe
00:20:46.120 | the practice of trying to defer contributions, sorry, trying to defer distributions from
00:20:52.040 | the account to a future time so that we can continue to maintain the tax efficiency.
00:21:00.860 | So let's say that I am an 80-year-old person and I have a 40-year-old child.
00:21:09.060 | Well my 40-year-old child, if I leave them as the beneficiary of my IRA, they can take
00:21:14.380 | that, they can receive that IRA and of course they can take the money out right away.
00:21:19.140 | But let's say it's a traditional IRA.
00:21:20.980 | Well in that case they're going to take the money out and they're going to pay the taxes.
00:21:24.740 | If it's a Roth IRA, they're going to take the money out and the money's going to come
00:21:27.620 | to them income tax free.
00:21:29.620 | That's very valuable.
00:21:31.460 | But what if they don't need the money?
00:21:34.020 | Well under the IRS rules, they can take the money out over a much longer schedule.
00:21:41.740 | There are required minimum distributions for somebody who inherits an IRA account.
00:21:47.140 | If my 40-year-old child inherits my IRA, they're going to be required to take distributions
00:21:53.100 | from that account, whether it's a Roth IRA or whether it's a traditional IRA.
00:21:58.300 | And they're going to be required to take it out whether they need it or not.
00:22:00.580 | The government doesn't allow the assets to stay in the IRA into perpetuity.
00:22:05.740 | But they can take it out using a chart, a calculation chart that goes over their life
00:22:12.140 | expectancy.
00:22:13.140 | They use what the IRS calls their single life expectancy table, which means that if somebody
00:22:17.420 | is very young, they possibly have many years at which they can keep the money in the account
00:22:24.260 | and only take out small amounts.
00:22:26.260 | This allows an IRA or a Roth IRA to accumulate over time more and more and more while still
00:22:32.140 | staying free of taxes.
00:22:33.940 | Really valuable.
00:22:35.500 | The challenge of course is winding up at death with assets in the account.
00:22:41.900 | And this is where a Roth IRA really shines.
00:22:45.460 | Remember that at the age of 70 and a half, about 70, you're going to be taking distributions
00:22:49.660 | from a traditional IRA every year of your life.
00:22:53.420 | Now if you die early, great, you get to leave behind a big IRA.
00:22:58.460 | But if you die late, you're going to have taken a lot of money out of the account whether
00:23:01.900 | you need it or not.
00:23:04.060 | Not so with a Roth IRA.
00:23:05.840 | With that Roth IRA, you can keep the money in there.
00:23:09.140 | And in fact, if you have wages, as long as you have wages, you can continue making contributions
00:23:12.860 | to the account.
00:23:14.300 | So if you're working into your old age, like I recommend at 70 and 75 and 80 and 85 and
00:23:19.100 | 90 and 95, and you're still working and earning wages as you probably should be and probably
00:23:23.300 | will want to be, in that situation you can still fund that Roth IRA and you never have
00:23:28.100 | to take the money out.
00:23:29.540 | You die at age 100, you can leave that behind to your spouse or you can leave that behind
00:23:34.060 | to your children.
00:23:36.060 | Or you could leave it behind to your grandchildren.
00:23:40.340 | Now you just imagine for a moment, if you had a nice, fat Roth IRA at retirement age,
00:23:49.820 | and whether you could contribute or not, you just left it alone and it continued growing
00:23:55.700 | for 30 years from 60 to 90 or from 65 to 95 or 70 to 100.
00:24:02.380 | Let me give you an idea of the numbers that would be involved.
00:24:04.740 | Let's say that you had a $500,000 – that would be a lot.
00:24:07.780 | Let's say we had a $100,000 Roth IRA at the age of 60.
00:24:12.940 | So let's put this in.
00:24:14.180 | Hold on, clear the register.
00:24:17.540 | This as our present value starting at the age of 60.
00:24:22.780 | Okay, you got 35 years from 60 to 95.
00:24:29.300 | Life expectancies are going up, you're a healthy person, rich people live longer.
00:24:33.220 | You got 35 years.
00:24:34.860 | Let's say that you keep that money invested in equities and you are able to earn a 9%
00:24:41.020 | investment return and you don't put any more money into it.
00:24:44.060 | After 35 years, your $100,000 IRA – there must be a problem.
00:24:48.660 | Hold on.
00:24:49.660 | That can't be right.
00:24:52.660 | $100,000, present value.
00:24:56.180 | 35 years, 9% rate of return, no payments.
00:25:03.500 | Future value after 35 years, $2 million.
00:25:07.820 | $2 million in that Roth IRA.
00:25:11.460 | Is that right?
00:25:13.460 | Can that be right?
00:25:15.540 | Make sure I don't mess everything up when I'm doing live math.
00:25:18.620 | Let's see here.
00:25:21.060 | $2 million.
00:25:22.780 | I've got to check myself.
00:25:24.860 | I have to work it backwards and make sure I didn't mess anything up.
00:25:28.460 | 35 years, annualized interest.
00:25:33.060 | Yeah, I'm right.
00:25:35.540 | $100,000 at the age of 60 invested for 35 years at 9% interest equals $2 million in
00:25:41.540 | a Roth IRA at the age of 100.
00:25:45.340 | I just felt really high and I don't think I'm making a dumb error somewhere.
00:25:49.820 | Talk about a dumb error, I'll tell on myself.
00:25:51.700 | I gave a recent speech and at that recent speech, I was talking about percentages.
00:25:58.660 | I did the math and I forgot to change my final decimals to percentages in my presentation.
00:26:05.100 | I put the numbers in and I said that 0.24% of an audience does such and such or 0.57%
00:26:13.980 | does such and such.
00:26:14.980 | Then I went back and afterwards, somebody said, "Didn't you mean you forgot to multiply
00:26:18.900 | by 100?"
00:26:19.900 | I had completely messed up my numbers in my presentation.
00:26:22.340 | It's recorded on video, very embarrassing.
00:26:24.900 | We all make math mistakes.
00:26:28.060 | Just imagine this Roth IRA that's left alone and this Roth IRA grows over time.
00:26:35.660 | You leave that as an asset to your grandchild.
00:26:38.100 | Let me give you an idea here of how much money that could be.
00:26:45.380 | If you die and leave your $2 million at your death, you leave your $2 million Roth IRA
00:26:51.540 | asset to your 20-year-old grandchild, your 20-year-old grandchild would have to start
00:26:57.300 | taking out required minimum distributions.
00:27:00.340 | But it's not all that much.
00:27:01.860 | If we did the math real quick on the single life expectancy for a beneficiary who's 20
00:27:06.660 | years old, their life expectancy would be 63 years.
00:27:10.260 | The way it would work is they would take the $2 million balance of the account and you
00:27:14.860 | would divide that in by 63 and you would get your required minimum distribution in the
00:27:18.940 | first year is $31,746.
00:27:23.340 | Your grandchild would receive that money income tax-free.
00:27:27.340 | Remember it's a Roth IRA asset and so that money would come to them income tax-free.
00:27:33.200 | You put $100,000 into the account, you left it alone, it was never taxed, you leave it,
00:27:38.340 | your grandchild starts to receive that money income tax-free.
00:27:42.260 | Then they would have basically 63 years over the course of their life expectancy during
00:27:47.780 | which they could take distributions.
00:27:49.380 | Now there would be a bit of a scale here that I can't do for you live to show you exactly
00:27:54.740 | how much of an amount this would be just based upon required minimum distributions.
00:28:01.160 | But let's just talk about what it would be, how much your annual payments would be if
00:28:06.100 | we were going to take level payments and deplete the account over time.
00:28:10.000 | So let's say that our 20-year-old, our goal is to take payments out over 63 years of their
00:28:15.100 | life expectancy which takes them to 83.
00:28:17.880 | So we've got a $2 million, clear the register, $2 million starting balance.
00:28:22.920 | So that's our present value.
00:28:24.220 | Our starting balance for them is $2 million.
00:28:27.700 | We've got a 63-year time horizon in which we're going to take distributions.
00:28:33.220 | We're going to keep it at that 9% investment interest rate or that investment return, 9%
00:28:38.060 | investment return.
00:28:39.060 | We're assuming you keep the money well invested at equities and we're able to earn 9% net
00:28:42.940 | of fees.
00:28:43.940 | We don't have to worry about taxes here, net of fees.
00:28:46.300 | And our closing value, our future value is going to be zero on this account.
00:28:51.060 | What would be the payments out of this account?
00:28:52.860 | Well, in that situation, if we were able to earn that amount of income, hold on, that
00:29:00.380 | cannot be right.
00:29:01.380 | Man, I double-checked it again and it works.
00:29:04.380 | Man, I just double-checked it again.
00:29:06.780 | I get so scared when I say these numbers because they sound unbelievable and yet they are technically
00:29:11.540 | accurate under the assumptions that I said.
00:29:14.780 | Old grandchild taking money out over 63 years, if they just took out a level payment over
00:29:21.740 | 63 years, starting with $2 million, earning 9% annually on the money, that would be an
00:29:29.300 | annual flow into their pocket of $180,793.
00:29:34.900 | $180,793.
00:29:37.100 | I checked it three times.
00:29:41.740 | That's the power of assets sheltered from tax.
00:29:47.020 | Now, go ahead and get your financial calculator and you run any scenario that you want.
00:29:52.700 | But when you're talking about a very, very simple and powerful way to leave money behind
00:29:59.000 | for heirs, Roth IRA is a wonderful way to do that.
00:30:03.660 | And remember those required minimum distributions, they're adjusted based upon the value of the
00:30:08.020 | account at the end of the year, which means that when the account value goes down, then
00:30:11.820 | they naturally wind up taking less.
00:30:13.500 | When the account value goes up, they take out more.
00:30:17.060 | And that money's coming in tax-free.
00:30:18.540 | So just imagine yourself.
00:30:20.780 | You at 60 years old accumulate $100,000 in a Roth IRA.
00:30:26.620 | You leave it alone for 35 years until you die.
00:30:31.420 | And then your grandchild inherits it and takes it out over the course of a little over 60
00:30:37.980 | years.
00:30:40.580 | If that money can be intelligently invested, we're talking huge amounts of money received
00:30:46.900 | income tax-free.
00:30:47.900 | Now, is this a perfect solution for all scenarios?
00:30:52.060 | No, of course not.
00:30:53.780 | One of the disadvantages, for example, with just doing this in a simple Roth IRA is you
00:30:58.620 | have no control over the money.
00:30:59.940 | You can't force your 20-year-old grandchild to not take all the money out in the first
00:31:04.460 | year and go and buy a bunch of fun stuff.
00:31:08.620 | You can't force them to—you can't exert control over it.
00:31:13.580 | You would have to write a trust and leave this as an asset of the trust, which has its
00:31:17.100 | own benefits and disadvantages in it.
00:31:20.180 | But this is simple.
00:31:21.760 | This is easy.
00:31:23.200 | And it continues to get huge benefits for your grandchild.
00:31:26.180 | For example, one of the things that people would want—that people want with their children
00:31:32.260 | and their grandchildren, they want asset protection.
00:31:34.700 | Roth IRA, basically ironclad, governed by state law, but basically most states have
00:31:39.900 | put in place protections for it, protections from the claim of creditors.
00:31:43.500 | Now, the big concern is what about in the case of divorce?
00:31:46.500 | Well, an IRA asset that is received as a gift from a grandfather, whether you're in a community
00:31:51.660 | property state or a non-community property state, is generally considered to be individual
00:31:56.580 | property.
00:31:57.580 | It's not generally considered to be a marital asset.
00:31:59.460 | It's protected.
00:32:01.340 | So there are tremendous benefits to this, and it's simple.
00:32:04.700 | You can open a Roth IRA with just about anybody.
00:32:08.820 | So I hope these ideas give you an idea of how valuable a Roth IRA is.
00:32:13.620 | Of course, you're subject to potential danger of changing tax laws.
00:32:18.060 | Can the IRS and can the U.S. federal government change their tax laws?
00:32:22.740 | Absolutely.
00:32:23.740 | Will they?
00:32:24.740 | Absolutely.
00:32:25.740 | What will they change it to?
00:32:26.740 | Who knows?
00:32:27.740 | I don't know.
00:32:28.740 | But it's a powerful, powerful, simple tool.
00:32:35.180 | Now back to the original question.
00:32:37.860 | Unfortunately, for this retiree, they can't really efficiently get the money from their
00:32:45.620 | traditional IRA into a Roth IRA because they don't have wages.
00:32:49.660 | They don't have wages.
00:32:51.580 | They can't do a Roth.
00:32:52.860 | Yes, they could convert it, and that's worth considering for the reasons that I described.
00:32:58.780 | But they should acknowledge the fact that it's not necessarily tax-efficient to do that.
00:33:03.100 | It may be useful, but it's not necessarily tax-efficient.
00:33:06.940 | What I would do if I woke up or if I were giving advice to this particular 72-year-old
00:33:10.660 | person, I wouldn't recommend that they convert the money necessarily.
00:33:15.220 | What I would probably do is I would have them just take those required minimum distributions,
00:33:20.060 | and if they're going to go for the kids or for the grandkids, just write checks to the
00:33:23.820 | kids or the grandkids, or figure out a way to make sure the kids and the grandkids get
00:33:28.580 | income, have their own wages, and then go ahead and make a Roth IRA contribution for
00:33:35.740 | them.
00:33:36.940 | If this 72-year-old has a 10-year-old grandchild, and if that 10-year-old grandchild can earn
00:33:43.340 | $5,000 of wages, the grandparent here can make a gift to the grandchild of $5,000, and
00:33:52.940 | the grandchild can make a $5,000 contribution to their Roth IRA while also having $5,000
00:34:01.180 | that they can spend.
00:34:03.020 | Because they earned $5,000 and they received $5,000 from the grandparent, $5,000 of that
00:34:07.780 | total of 10 is in the Roth IRA, and then $5,000 is spendable income.
00:34:13.740 | That would be very powerful.
00:34:14.740 | Now, the grandchild, if they can leave it alone, can also have the money grow over time.
00:34:20.060 | It can grow tax-protected for a very long period of time, but also the grandchild has
00:34:24.260 | the benefit, and I believe it's a benefit, of being able to withdraw the money, because
00:34:28.180 | of course with a Roth IRA, you can always withdraw your contribution to the account
00:34:33.100 | without penalty.
00:34:34.260 | If they contributed $5,000 to the account, and the account has grown in value from $5,000
00:34:39.620 | to $5,500, they can always make that $5,000 withdrawal from the account.
00:34:46.420 | So as long as the grandchild, as long as somebody can earn wages, we have opportunities.
00:34:52.140 | Hope you enjoy thinking those scenarios through.
00:34:54.540 | IRAs and Roth IRAs are powerful tools.
00:34:57.980 | They're really, really powerful.
00:34:59.540 | They're very, very useful in the hands of a competent financial planner, aka you.
00:35:05.700 | I want you to use these tools and look at them and think about how they can be used
00:35:09.700 | to their maximum advantage.
00:35:11.740 | And this particular benefit of a traditional IRA and a Roth IRA, to be able to take the
00:35:16.660 | money out over an extended period of time, and thus protect the money from taxes, is
00:35:21.660 | valuable.
00:35:22.660 | Remember, you have this benefit in both traditional IRAs and Roth IRAs, as the tax law currently
00:35:28.500 | stands.
00:35:29.500 | The recent tax proposal had some proposed changes, but to my knowledge, as things go
00:35:34.300 | at the moment, those proposals to change the stretch IRA rules are not included in the
00:35:41.220 | current debates over tax law changes.
00:35:44.980 | But they both have those benefits.
00:35:46.780 | It's just a lot harder to arrive at death with a nice fat IRA than it is with a nice
00:35:51.540 | fat Roth IRA.
00:35:53.100 | I hope this is useful for you.
00:35:54.700 | If it's not useful for you, talk with your parents.
00:35:57.340 | Talk with a friend.
00:35:59.020 | Try to help someone else with these ideas.
00:36:01.140 | These ideas are available to the common man.
00:36:04.660 | You don't have to go and spend thousands of dollars on fancy documents.
00:36:08.340 | You do have to sit down and look at your situation and understand it.
00:36:12.300 | And that's your job and my job, to sit down and look at our situations and look at other
00:36:17.020 | people's situations and try to help people to do smart stuff with their money.
00:36:20.300 | If we can do that, my hope is we'll keep a lot more of it.
00:36:26.740 | This show is part of the Radical Life Media network of podcasts and resources.
00:36:32.380 | Find out more at RadicalLifeMedia.com.
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