(upbeat music) - Welcome to the Bogleheads Chapter Series. This episode was hosted by the Pre and Early Retirement Life States Chapter and recorded July 29th, 2021. It features Sean Mullaney, a CPA, financial planner, and president of Mullaney Financial and Tax Incorporated. He also blogs at fitaxguy.com. Bogleheads are investors who follow John Bogle's investing philosophy for attaining financial independence.

This recording is for informational purposes only and should not be construed as investment advice. - Then I'm gonna speak about tax topics relevant for the most part to those ages 50 to 70, those thinking about retirement and those beginning retirement. Now there's gonna be some nuggets in there for all ages, right?

Obviously all of us, even if we're under 50 years old are thinking about retirement. So we're hopefully gonna get to ages 50 to 70. And there will be some things in there for those who are a little further along in their retirement journey. Again, my name is Sean Mullaney.

Carol, Jim, thanks so much for the introduction. And I wanna, first of all, say it's an honor to be presenting tonight. Really glad to have this opportunity to be in front of the Bogleheads group. Real honor to be here. And thanks so much to Carol, Jim, Miriam, the entire team for putting this together.

I know there's a lot of work that goes on into it. So thank you so very much for that. Just a little bit about me and sort of my background there. Just, you know, we always do disclaimers, right? So this is for educational and hopefully entertainment purposes. It's not investment advice, tax advice, legal advice for any one person, but hopefully this gives you some knowledge.

This gives you some resources and some more information and some more power. Let's see here. So doing a tax presentation, every now and then it can be a little dry. So I wanted to think about, well, what's sort of in the news in the tax world, especially as it applies to pre-retirees, early retirees.

And to my mind in this investing environment, it's capital gains, right? There are so many people out there right now with an old dog or cat in their investment portfolio. It did well. They essentially have the good problem, right? They have the problem of years ago, I bought a stock or a mutual fund and that thing is shot through the roof.

Oh no, how do I access it, right? Because capital gains are subject to federal income tax rates of potentially 0%. We'll talk about that, 15% or 20%. And that's today's rates. You never know what the future is gonna hold. And then also for some of the higher income people, you're gonna add on to that a 3.8% net investment income tax, right?

If your AGI is over 200,000 for single people, 250,000 married filing joint, we've got this 3.8% net investment income tax to tackle. And then there's just the whole issue of AGI, right? As I'm sure most of you are aware. AGI is one of those things that really limits other benefits in the tax code.

So, maybe we're not even so much worried about this particular tax, but we're worried about spiking our AGI because of a potential capital gain. But we wanna access that money. And I just give you a very simple example. 1995, Candace purchased 200 shares of Acme Corp for $100 a share.

That means her stock basis for tax purposes is $20,000. Today, that stock has gone from $100 a share to $500 a share. So, we're talking about $100,000 of total value. And we're talking about an $80,000 capital gain, but Candace wants to access that. That's her money. How can she access that money in a tax efficient manner?

And so, there are exit strategies out there. I'm actually gonna just lead off before I get into the ones that I tend to favor. I'm gonna mention two quickly that I tend not to favor. And look, your mileage may vary, right? Just because it's not my favorite technique doesn't mean it couldn't work in your specific circumstances.

One of them is the like-kind exchange, right? 1031 exchange, like-kind exchange. However, it doesn't apply to Candace, right? Because it only applies today to rental real estate. 1031 exchanges can work out really well, but a couple of drawbacks. One is it's not really an exit, right? All it is is a deferral, right?

So, the idea behind a 1031 exchange is I have rental real estate property. I exchange it for another piece of rental real estate. It could even be something called a Delaware Statutory Trust. But all I've done is I've deferred the reckoning on that, right? So, now instead of rental property A, I either own rental property B or rental properties C and D, right?

It doesn't have to be one for one. It could be two for one or one for two. Or I own something called the Delaware Statutory Trust. There are issues with 1031 exchanges. And like I said, they only apply to rental real estate, right? So, limited subsection there. The other potential exit is something called a Qualified Opportunity Zone, right?

So, Candace could sell this stock and then roll the gain into something called a Qualified Opportunity Zone Fund. These are new to the tax law. They came in in late 2017. And to my mind, they're not optimal because they are an investment product that is very designed around tax rules, right?

They have to invest in certain assets in these Qualified Opportunity Zones. And it's a very tax-motivated investment. And it has a bunch of tax rules, right? So, I don't wanna spend any time on those. We could talk about those a little bit. Frankly, it's not something I believe I've ever recommended to a client.

So, you sort of see where I am on these Qualified Opportunity Zones. In the right set of circumstances, maybe it could work, but certainly not my go-to solution. But what are some things that I tend to favor? Well, the first one is something called tax gain harvesting. You'll see why I favor this in a second.

The idea here is that if Candace can keep her taxable income below $40,401 if she's single, $80,801 if she's married, filing joint, she can dispose of some of this stock and be in that 0% federal capital gains tax rate, right? So, capital gains tax rates right now are progressive and below these levels of taxable income, it's actually a 0% rate.

There is a drawback on that. One, she's gonna manage her taxable income, not gonna be available to everybody, but if she is otherwise low income, this could be a great way of slowly getting out of this stock in a tax-efficient manner. She does need to remember, though, she's subject to state income tax on that sale.

Now, look, if she lives in Florida, Texas, believe there are nine states without a capital gains tax, not a problem at all, and in many states, it's gonna only be a little bit of leakage, right? Because state income taxes tend to be progressive. So, tax gain harvesting, if she's got the right level of income, could be a great answer, maybe a little bit of state tax leakage, but no big deal there.

I like tax gain harvesting for two reasons, right? One would be, I'm sitting on some appreciated securities, I wanna reset the basis on them, right? So, it could be a mutual fund I like, it has a gain, I just wanna reset that basis, and if I can keep my income below these thresholds, fine, I just reset my basis.

The other one is maybe more like Candace's situation. She's been in ACME stock for 25 years, she doesn't like it from an investment perspective anymore, so she wants a tax-free exit, or at least a tax-efficient exit, so she starts dripping it out in terms of some taxable sales, does this tax gain harvesting, manages her income, and then she reallocates into her desired stocks, bonds, mutual funds, ETFs, whatever it is she likes.

So, to my mind, there's the tax angle to tax gain harvesting, just resetting basis, or it's, hey, I want to reallocate or get into cash in a tax-efficient manner. So, that's tax gain harvesting, a lot been written about that, I myself have written about that, but you need to keep that income low enough.

Another exit, and this exit is charitable gifting, this is for the otherwise charitably inclined, right? Charitable contributions are great, but they're a real expensive way to get a tax benefit if you aren't otherwise charitably inclined, and there are plenty of people, hey, you know, I go to mass every week, I donate to my church, or I have this charity I give to year in and year out, or maybe I'm just looking for a one-time donation, something really hit my heart, something really pulled at my heartstrings, I want to give some money to them.

This Acme stock, in Candice's case, could be a real win from a tax perspective, and so what am I talking about? There are plenty of 501(c)(3) charities today that will accept, appreciate securities as a donation. They have a brokerage account set up so they can accept them. I believe most of the common, most popular brokerage platforms facilitate this, I myself have done this, and what you do is you just go into that account and transfer a certain number of shares to the charitable organization, and so what you're doing is you're taking this appreciated stock and you're making it currency to do something you probably would have otherwise done, which is make this charitable donation, right?

So instead of sending $500 to her church, she just goes into her brokerage account, grabs one, says, all right, brokerage, send one share of Acme, which is worth $500, to that charity, right? So instead of having to go into her checking account, she gets to make that same donation with the appreciated stock.

What does she do from a tax perspective by doing that? One, the capital gain on that share of stock, forgiven, it's gone, it is never gonna be taxed, and that benefit is not income limited. So Candace could be making a billion dollars a year, maybe she's some big movie star or whatever, venture capital, I don't know what, but the capital gain is forgiven regardless of her taxable income, right?

No income limitation on that. And then the second potential benefit, which is income limited, is she could take an itemized deduction for that donation, right? So there is a limit, you can only take a current year itemized deduction of up to 30% of your so-called adjusted gross income for donations of appreciated stock.

And it may be that Candace, we're gonna talk about this in a second, in a little more detail, Candace may not be itemizing, right? That said, I think benefit number one is good enough, right? Who cares? Maybe she's taking the standard deduction, maybe she's married, right? So if she's married filing joint, her standard deduction is 25,100 this year, and it might be a little higher if she's over 65 and blind and those sorts of things.

But so maybe this is a $20,000 donation, maybe she doesn't have enough taxes, mortgage interest, other donations, so she doesn't itemize. Well, okay, that's fine. She avoided going into her checking account to make this substantial donation, and she avoided a big capital gains tax. So with or without benefit number two, I think benefit number one is powerful enough that she might wanna do this charitable gifting.

And like I said, in today's environment, I believe there are plenty of retirees that should just never donate cash to charities again. Maybe you do $10 at your grandchild's raffle or something, but for the most part, the serious charitable donations should be made with appreciated stock that you don't, for whatever reason, don't wanna have anymore.

One big caveat on this. Stock bonds, mutual funds, ETFs, securities with built-in losses, never donate those, right? What do you do, right? So, hey, I'm sitting on Acme stock, it's got a $10,000 loss. I want to donate some of that to charity. Don't do it. Sell the Acme stock first.

Pop that taxable loss. It may be limited, right? I'm sure everybody on this call is very familiar with the $3,000 per return limit on taking capital losses against ordinary income, right? So maybe you create a big loss, it's deferred, but that loss goes on for perpetuity, right? So for the rest of your life.

So you create a capital loss, maybe you can't use it this year 'cause of other losses, fine. You use it the next year or the following year, but a loss is a terrible thing to waste. So do not donate built-in loss stock or securities to a charity. Sell them first, donate the cash.

Well, all right. I don't wanna donate directly to my charity. Are there other charitable things I could do with this appreciated stock? I call this planning technique, the hyper-donor advised fund, because it essentially combines two planning techniques. Something called the donor advised fund, which I bet a lot of you are familiar with, with that first idea of skirting the capital gain by donating appreciated stock.

So now what I do is instead of donating appreciated stock to a charity, I donate it directly to my donor advised fund, right? And what I'm doing there is I'm sort of stepping up this game of charitable giving with a tax advantage, right? I'm avoiding the capital gain. So I transfer $1,000 worth of ACME stock to my donor advised fund.

First of all, subject to that 30% limitation, I get that deduction potentially, and I avoid the capital gain on whatever I put into the donor advised fund. The donor advised fund will sell off that stock in all likelihood, and then you can redirect it to invest in, usually donor advised funds are a little more conservatively invested, but each brokerage will have a different investment menu for the donor advised fund.

The donor advised fund is a great timing play. So what it does is it says, okay, I'm gonna transfer some assets to the so-called donor advised fund. I'm going to take a tax deduction for the fair market value of what I put in. I avoid capital gain, and then I can donate to charities on my schedule, right?

So maybe I have a big capital gain. There's, let's just say I have a stock position. It's worth, let's just say it's worth 20,000, and I have a basis of 10,000. I don't want to sell it and trip a $10,000 gain. So I just put it in donor advised fund.

It's gone, right? I can never use it again, right? It can't fix my roof. It can't install a pool, right? So I gotta be terribly inclined, but I might be saying, look, I donate 5,000 a year to charity. Well, why don't I do this? Why don't I do the donor advised fund for 20,000 in the year 2021, take that with other deductions as an itemized deduction this year.

So let's say my other itemized deductions are $20,000. So now I take a $40,000 itemized deduction in 2021, and then in 2022, 2023, 2024, I get the standard deduction at 25,000 plus if I'm married. And over the next four years, I donate 5,000 a year to the charity out of the donor advised fund.

The charity's experience with me is not different at all. They just get 5,000 a year every year from me, right? 'Cause people in real life, people rarely say, you know, I like to donate 5,000 a year to this charity. I'm just gonna front load, do 20,000 a year, and then not give them a penny for the next three or four years.

People don't wanna do that, right? So how do I optimize, right? In this environment where I've got such a high standard deduction, what I wanna do is I don't wanna be giving 5,000 a year and it just goes away and I get my standard deduction. Why not take a bunch of money now, put it in the donor advised fund, and then, you know, get a one-time tax benefit, and then rely back on those standard deductions every year after that.

That could be a great timing play and a great way to avoid capital gains. All right. Another one. So I had an AICPA conference this week, and I will say in the advisor world, and I'm sure in the client world, people are starting to get a little freaked out about future tax increases.

I think it's very speculative, and I certainly don't think it's gonna be retroactive if it happens. But there are people out there saying, look, you know, Sean had that slide, 15%, 20%, 3.8% surtax. Maybe these are the golden days. Maybe I should just sell now at 23.8% federal income tax rate and be happy I bailed out then before capital gains rates increase.

I think that's very speculative. So it is not my go-to technique. Look, every taxpayer needs to make their own decisions, and I don't have a perfect crystal ball of the future. So, you know, I'm not gonna speculate as to whether or not the tax plan is gonna pass or not, but I certainly don't think it's a slam dunk, right?

So this is definitely not my favorite way to go about it, but there are at least some people out there who are very worried about future capital gains tax rate increases and are looking to accelerate capital gains into the year 2021. Like I said, because it's so speculative, I don't like it, but there's a second reason.

You know, like I said, there are other planning techniques available, but there's a second reason that I don't like, and it has to do with this. That tax may never come due, right? Look, I get it. Candice has an $80,000 built-in gain in her Acme stock. If she doesn't mind Acme, then maybe that tax never comes due.

If she's staying up at night because she's worried Acme is gonna drop 50%, then yeah, maybe she should just sell, get out, pay some capital gains tax or do one of these other techniques. But if she's okay with Acme or whatever the built-in gain asset is as an asset, maybe she doesn't care, right?

So there is the ultimate planning technique. And I'm sure most of you are familiar with this. This is the step up of basis at death, right? So this is something in our tax law that I think administratively makes a lot of sense. And what it says is, okay, at death, generally speaking, your taxable assets get a basis reset, generally speaking on the day of your death.

And so what happens here is, let's say Candice dies and her heirs inherit the Acme stock, their basis when they go to sell it is the fair market value close of business, I believe on the date that Candice died. And so generally speaking, if Candice's heirs inherit this Acme stock, and let's just say it was worth 100,000 on the day she died, they get it, the estate closes out three months later, it's now worth like $102,000, they only have $2,000 of capital gains.

So this is a reason not to sell these assets because essentially this is not a tax that we ultimately know is due. It very well may be due, but it will, generally speaking, go away, it'll go away upon your death. And so that is the ultimate tax planning technique is, look, you've got this tax planning opportunity out there, you have to balance it with your other financial considerations, but if you're only motivated by tax, then maybe you just let it ride out and get that step-up basis.

A couple other comments on the step-up basis. One is it's great with rental real estate, 'cause your heirs get to redepreciate, so it's a reason to hold rental real estate in a taxable fashion. Two, IRAs do not get the step-up and basis at death, right? So in some ways, if the option is live on your IRA versus live on your taxable assets and you're older in life, oftentimes, hey, if I'm really concerned about my heirs, I might wanna live off my IRA instead of my taxable assets because the IRAs get no step-up and basis at death, but my taxable assets do.

And then three, apparently this is a little before my time, but in the year 1976, they actually got rid of the step-up and basis and they brought it back real quick. So there was a year, apparently, and I gotta do a little more research on my tax history, but in 1976, the step-up and basis went away upon death.

Now, back then, the computing power was much less, so it created nightmares because you would inherit stock or a house or whatever, and you'd have to reconstruct asset basis. Today, that's gonna be a lot easier, but still, there's so many assets out there, particularly real estate, where I still think that would be a real headache.

So we always have to think about, yeah, Washington's looking for some more money, but I think this one's a very popular and administratively sensible tax rule, so I think it's gonna be around for a while, but don't take my word for it. You have to make your own decision on those sorts of things.

So yeah, capital gains. There are ways, like I said, to get out, but it's gonna be an issue for folks right now, and then there's the ultimate out. This next one, I think it's a great opportunity. You do need to have a high-deductible health plan. So this high-deductible health plan is a type of medical insurance.

You need to be covered by one of these things, and it needs to be your only health insurance, generally speaking. For the healthy high-deductible health plan, I think it's a really good coverage option. Not everybody has it, right? So there are gonna be some in the audience where this is just not gonna be an option.

If you're on Medicare, no option, right? So you cannot have a high-deductible health plan once you turn 65. The planning technique here is while you're still working and you're relatively healthy, have your high-deductible health plan be your medical insurance, and then max out your HSA, and you're creating a tax-advantaged account that can really serve you later in life.

And that's, I actually, I've got a blog post, I say this all the time. You should generally be spending down your HSA in two situations, if you're in a dire medical situation or you are a elderly, dire or elderly, right? But we'll talk about, let's talk about building up our HSA and then spending it down, right?

How do we build it up, generally speaking, through our workplace, right? So we've got our medical insurance through our workplace. They offer a high-deductible health plan. We like that as insurance for us. We should then maximize our HSA through payroll tax withholding, right? So the money that we take out of our paycheck to put into the HSA, not tax, it's excluded, right?

That's fantastic. Not only is it excluded from our taxable income, it doesn't show up in our FICA income. So we don't pay FICA tax on that at all, right? We don't pay Social Security. We don't pay the Medicare tax on that. That's only, if we're well above that 142,800 FICA cap on the Social Security cap, this is only a minor benefit, but you still get that Medicare benefit.

And if we're below the 142.8, we get a big benefit because we don't have to pay the 6.2 on Social Security on what we put in to our HSA. That's really cool. One caveat about that though, it has to be through payroll withholding for this payroll tax benefit. You can just not do it through payroll withholding and write a check to your HSA.

You take a tax deduction on your tax return. That's perfectly fine. But if you can do it through your payroll withholding and get that FICA tax benefit, I say, why not? So it's tax excluded on the way in, right? So we get a tax benefit the year we put it in.

The tax, the investment income grows inside that HSA tax-free. So HSA is a great place to have investment growth. And then if we withdraw it for qualified medical expenses at any time, it's tax-free there. So it's tax-free on the way in, it's tax-free while it's in there, and then it's tax-free on the way out.

That's a really powerful tool. One thing for my fellow Californians, California does not recognize the HSA. Same thing with New Jersey. So in California and New Jersey, the HSA is a taxable account. No deduction on the way in and the interest and dividends and capital gains that are generated on your HSA, taxable in California.

So it's a little bit of a drawback for California and New Jersey residents, but again, you get this federal tax benefit, which is so powerful. So I still recommend them even for those in California and New Jersey. In most cases, right? Again, when I say recommend, I mean that in a general sense, not for anyone on this particular meeting.

Well, okay, great. We work, we have our high deductible health plan, we have our HSA, we're building up this money in this tax sheltered account. When the heck do I withdraw it, right? You're saying it's tax sheltered. I should keep it in there as long as possible. When do I withdraw it?

I would argue it's best to withdraw it at age 65 and later. A few reasons. One, we wanna keep it in there as long as possible to generate as much tax free wealth as possible. But the second thing is the HSA has a time limit and it's basically the later of your death or your spouse's death.

So let's talk about that for a second. An HSA can be left to a spouse, no problem, just becomes their HSA. But what if I leave my HSA to my parent, my sibling, my friend, anybody, not my spouse, they can inherit the HSA, they'll take the money, but the money becomes taxable income in the year of my death and it's also no longer an HSA.

So an HSA is a really bad asset to leave behind. So essentially there's this sort of pressure and we're talking about tax free estate planning a little later, or tax efficient, I should say, estate planning a little later, but there's a bit of a time clock there. And so it's this delicate balance of, okay, I'm 65 versus how long am I gonna live?

Am I only gonna live to age 70, in which case I probably should start spending it in my late 60s, or am I gonna live to 95? And why am I gonna start spending it down now, right? In my late 60s, if I'm gonna live to 95, I wanna have it enjoy tax free growth into my 80s and maybe even my 90s, and then I'll spend it down.

So there's a little bit of a tension there. One thing you should do though, is before age 65, pay your medical expenses out of your checking account, right? And then track it, right? Just track all your medical expenses. And then at age 65 and later, you reimburse yourself tax free for the weekend warrior injury you had at age 53.

You're playing Frisbee golf, sprained ankle, $300 medical bill. Keep that, Google Sheet, whatever you gotta do to keep a record of all that. And then bam, in your 60s, 70s, or 80s, reimburse yourself for that old medical expense. Fantastic tax-free distribution out of your HSA. That's some nice little tax planning.

And generally speaking, before age 65, if you're not in a dire situation, just let the money grow in that HSA. HSAs also can pay Medicare premiums. They generally, they can't pay Medigap premiums, but they can be used to pay Medicare premiums tax free. But then this becomes, well, wait a minute, do I really wanna pay my first and second and third premiums out of my HSA?

Maybe I wanna just keep records, right? So I pay my Medicare premiums in my 65, 66, 67, 68, just keep these records and then reimburse myself in my 70s or my 80s for my Medicare premiums from my late 60s and early 70s, right? This is a bit of an art and more than it is a science.

We don't, we neither know the time nor the place, right? So we gotta be a little artistic here. And then I've mentioned some of these concepts here. Definitely start at age 65 to let that tax-free growth accumulate. And then when exactly after age 65 is really gonna depend on your circumstances and just how long you think you're gonna be around.

And basically HSAs are great to leave to your spouse. They're actually a good asset to leave to a charity because the charity ain't gonna pay a dime of income tax on it, but it's not a good asset to leave to anybody else because anybody else, any other individual is gonna, your estate, a trust, they're gonna pay income tax like crazy on that thing.

So leave it, generally speaking, leave it to your spouse. If you don't have a spouse, well, look, if you have someone in your life you just need to leave money to, fine. But if there's a situation where there's some optionality and you're leaving it to an heir who perhaps doesn't need the money as much and you have a charitable intention, the HSA is sort of where I look first for where to leave money.

Okay, Roth conversions. This is a real hot topic. And we're gonna talk about Roth conversions while we're working and then Roth conversions once we've retired, right? So while we're working, to my mind, there are two big planning techniques, right? While we're working, the first planning technique is the so-called backdoor Roth IRA.

This is the two-step transaction, right? So we do two independent steps. The first step is a non-deductible contribution to a traditional IRA. And then the second step, I like to do this in the following month, the second step is we convert the money we contributed to that non-deductible traditional IRA to a Roth IRA.

And we do this though, generally speaking, only if we have no other traditional IRAs, SEP IRAs and simple IRAs. That's a big thing here, right? So I like to say the backdoor Roth IRA is a great planning technique, but it's profile dependent, right? For those of us who make too much to make a direct contribution to a Roth, we do this backdoor Roth IRA, but if and only if we have no other traditional IRAs, SEP IRAs and simple IRAs.

And when do we determine whether we have that? It's by 1231 of the year of that second step, the Roth conversion step. If we have other traditional IRAs, SEP IRAs or simple IRAs on that December 31st date, most likely our backdoor Roth was not a smart transaction. We're gonna pay some tax on it, not the end of the world.

And the big thing I like to say is get clean by 1231. So if we have other traditional IRAs and we wanna do a backdoor Roth, move those out in a direct trustee to trustee transfer to our workplace retirement plans or 401Ks, 403Bs. But we only do that if we like the investment options inside those plans.

If we do, great, it's a great way to get clean. The other thing is the trap for the unwary. I do my backdoor Roth in January, right? New Year's day, I make my 6,000 or 7,000 contribution into my non-deductible IRA. A few weeks or at the end of the month or beginning of the next month, February, I do my conversion step.

Great, backdoor Roth IRA, isn't this great? Oh, but wait a minute, in September, I left my job and in October, I rolled my old 401K to a traditional IRA. That creates a problem for your backdoor Roth because at 1231, you're gonna have another traditional IRA. I've blogged about this.

So you can go to my fitaxguy.com blog. I've written about it. So that's the first Roth conversion idea for the working. The second one is the so-called mega backdoor Roth. This is using your workplace retirement plan to make after-tax 401K contributions. And then shortly thereafter, could be automatic. What you do is you convert the after-tax contribution into the Roth 401K, or you roll it to a Roth IRA.

Great little planning technique. The thing about the backdoor Roth and the mega backdoor Roth, you need to think about it is that the choice is, I either invest that money in a taxable brokerage account or I invest it in a Roth account. This is not a deduction versus Roth, traditional versus Roth question.

This is, am I gonna invest that money into a brokerage account that'll have a 1099, that'll have interest dividends and later capital gains taxes, or can I get that money in the Roth, right? So generally speaking, for those who make too much, backdoor Roth IRA is a great thing.

The mega backdoor Roth has no AGI limits. So you can be at the lower end of the income spectrum, you can be Patrick Mahomes, you make whatever Patrick Mahomes makes, $40 million as the quarterback of the Kansas City Chiefs. If the Chiefs 401K has this option, he can do the mega backdoor.

Okay, well, all right. That's like the mostly non-taxable Roth conversions while working. If it works for you, great. What about while I'm working, right? So I'm working and I have an old traditional IRA, should I do Roth conversions? And I'd say in many cases for the "early retiree", I'd say no, right?

The idea would be, look, if you're gonna be an early retiree and I have an old traditional IRA and I'm gonna have to be fully taxable on the Roth conversion while I'm working, I probably should hold off. Now, your mileage may vary, but I would generally hold off because there's gonna be this opportunity, hopefully in early retirement, and I'll let you define that.

You're hopefully gonna have artificially low taxable income. And so why not do those Roth conversions while you have artificially low taxable income as opposed to now? So that's Roth versus traditional while working. Now, while we're retired, okay. Now we're retired, hopefully early, but we'll see. But if now, if we're retired, the planning changes in terms of, backdoor Roth isn't on the table anymore.

Mega backdoor Roth isn't on the table 'cause we don't have earned income. So don't worry about that. Those are off. But what we can do is we have old 401k, old IRA. We can do Roth conversions that are fully taxable. And we have two goals here, right? One of them is just the artificially low tax rates, right?

We're before age 70. So we don't have any, and maybe we're delaying social security hopefully, right? So we may not have much taxable income. We have a little bit of interest, but we know it's a low yield environment. So low dividends, low interest. So you look at our tax return and it looks like at least initially that we're poor.

All it is is that we're living off assets and we're not generating a lot of traditionally taxable income. So we take advantage of the progressive tax rates, right? So we do Roth conversions where our income is maybe only taxed at 10% or 12% for federal tax purposes, maybe even 22% or 24%, right?

So that's the first goal is just to take advantage of the luck of the draw before age 70. We're not getting social security. We're only getting a little bit of interest in dividends. Let's throw some Roth conversion income, move money from our traditional account to our Roth account where it's tax-free while we're at a low tax rate.

The second thing we're trying to do is at age 72, you're probably aware, you have to take taxable requirement distributions from your traditional IRAs, traditional 401Ks, 403Bs, et cetera. So we want those to be lower, right? Because if we can get that money from the traditional side of the ledger to the Roth side of the ledger, we're gonna have lower RMDs in our future.

We're happy with that outcome, right? The exercise here is to right-size those conversions. People sometimes don't understand this. You can convert a dollar or you can convert every dollar or anything in between, right? There's no income limit on the ability to do a Roth conversion. Everybody, every American with a traditional retirement account can do a Roth conversion regardless of their income, but you wanna right-size it, right?

And this is a subjective exercise, right? Because you have to coordinate, well, how much tax do I wanna pay now? 'Cause I'm gonna have to pay tax later, either me or my heirs. Somebody's paying tax on this IRA at some point. And I only wanna pay so much tax today.

Maybe I'm, you know, I might be thinking, boy, they're gonna raise tax rates and my RMDs as I get older are gonna start killing me. So what do I care? 24%, go for it, right? Other people are gonna be a little more conservative, right? This really does depend on your circumstances.

So that first bullet, marginal federal and state income taxes rates, so important to consider in terms of whether you're doing these Roth conversions. Could also be, hey, I live in California today and in three years, I'm moving to Florida. Well, maybe I wanna hold off a little bit because maybe I don't wanna hit California income tax.

I wanna hit Florida where there is no income tax, right? So there could be plenty of considerations in this regard. And then the other thing to think about is coordinating with tax gain harvesting, right? Tax gain harvesting, which we talked about earlier, is dependent on keeping my taxable income low.

Well, my Roth conversions could blow me out so now my capital gains are taxed at 15%. If I'm only motivated by tax and I can either do tax gain harvesting or Roth conversions, I'm generally gonna tell you to do Roth conversions. And here's why. The tax on the traditional IRA is coming due, period, end of discussion.

I might pay it during my lifetime or my heirs are gonna pay it. We'll talk about the inherited IRAs in a little bit. Somebody's paying that tax, right? The government's getting their piece. My tax gain harvesting, on the other hand, maybe that tax is gonna get forgiven with the step-up in basis, right?

So if my only consideration is tax, I'm gonna favor Roth conversions. Now, it might be that I have an investment allocation consideration. So I might have an old cat or dog. I invested in some tech startup years ago. It's got a huge capital gain. I want a tax gain harvest out versus in my traditional IRA, I've got mutual funds that I really like.

Maybe in that case, I say no, I'm gonna do my tax gain harvesting instead of my Roth conversions and get a 0% rate on the tax gain harvesting and get my old tech stock, which I'm a little leery about now, into mutual funds that I like better from an investment perspective, right?

So this is a tax planning presentation. Of course, no investment advice in this presentation, but we always have to consider all sides of our financial life, and this is where tax and investment really can intersect. Another thing to consider when we're doing Roth conversions is the Affordable Care Act premium tax credit.

This is if you're on an ACA plan, right? So maybe I'm on TRICARE or have other private insurance. I'm not on an ACA plan. Maybe I don't care about the premium tax credit. What you wanna do is think about without Roth conversions, do I qualify for a premium tax credit?

And where this really is gonna come into play for a lot of folks is in 2023, where you get a premium tax credit up to having adjusted gross income of 400% of your federal poverty level. And the second you're a dollar over it, you lose the entire credit. So this is, it's something to consider in terms of managing your taxable income so that you optimize the premium tax credit.

It only applies in those situations where you have an ACA plan. And by the way, once you go on Medicare, you're not gonna have an ACA plan. So this is not gonna be that big a deal for those already going on a Medicare. You do wanna think about IRMA, right?

So that's the increase in Medicare premiums that results from increasing your taxable income. This is a bit of a marginal concern because yes, this exists. And yes, if you blow through one of these, it's a little bit of a cliff, but it really only matters if you're right there.

I believe the first IRMA bend point is 176,000 of adjusted gross income for a married couple. So you don't want a Roth conversion to ever take you from $175,999 over the line, right? But before the line, and even within the line, it's a relatively modest increase. And it does go up progressively, but so it's something to consider, but I wouldn't be losing too much sleep over it.

And then qualified charitable distributions. Well, what the heck is a qualified charitable distribution, a QCD, and what does it have to do with Roth conversions? All right, qualified charitable distribution for the charitably inclined, another great planning technique. The idea here is you donate to charity up to $100,000 a year with your traditional IRA, instead of with your taxable accounts, your checking account, Roth IRA.

And why do we do this, right? If we're 70 and a half and older, we can transfer up to $100,000 every year from our traditional IRA, and the money is not taxed, right? The whole point of doing Roth conversions is to get money out of traditional IRAs, so it's taxed where we want it to be taxed, as opposed to later when we may not be able to afford that tax, or that tax might be very high, or whatever it is, okay?

The cool thing about the QCD is it's a way to bail money out of a traditional IRA and not pay tax. Now, look, you gotta be charitably inclined, right? But I might be saying, look, in my 70s, I'm gonna give a certain amount to my church, no matter what, might as well do it out of your traditional IRA, because what it does is it bails that money out of that traditional IRA fully tax-free, up to $100,000 a year.

You don't get charitable deduction for it, but who cares? You're getting that big standard deduction anyway. And, oh, by the way, QCDs do a couple things. They satisfy my RMD, right? So, starting at age 72, I'm gonna have requirement distributions. Guess what? If my RMD from my IRA is just, let's say, $50,000, and I do a qualified charitable distribution out of my IRA to my favorite charity for $50,000, I don't have to take my RMD.

That satisfies it, right? It's a way to bail money out of a traditional IRA without taxes, and if I'm gonna be giving that $50,000 to charity anyway, might as well do it out of my traditional IRA instead of taking my RMD myself, paying tax on it, and then giving money to the charity, right?

So, this is just a great idea. And, oh, by the way, so the reason I bring it up, if you're before age 70 and a half, you definitely wanna think about this in terms of right-sizing your Roth conversions. Why convert every last dollar to a Roth if I'm gonna be making some substantial charitable contributions in my 70s and 80s, right?

And then a little disclaimer, just don't accept any remuneration or trinket from the charity. That can blow QCD treatment. Very powerful planning technique. I'm very fond of it. Only applies if you are age 70 and a half, right? But you need to be thinking about it before you're age 70 and a half to right-size those Roth conversions.

All right, tax-efficient estate planning. What are we talking about? What are we not talking about? We are talking about mostly income tax here. For most people, the estate tax is not gonna bite. Now, that could change. I tend to doubt it. Right now, your lifetime exclusion is $11.7 million.

So, most of us are not gonna die with $11.7 million worth of wealth. Hate to break it to you. But that said, pretty much everybody with any sort of substantial assets needs an estate plan. And we'll talk about some reasons why. First thing is the elimination of the stretch IRA, right?

The whole, the idea in the past was, oh, I've got an IRA. My heirs have to take or require minimum distributions. I'm gonna leave it to the two-year-old grandchild. He or she has to take and require minimum distributions, but it's based on them being two years old and then three years old and then four years old.

So, they have to take a pittance out of it every year. And meanwhile, it grows either tax-deferred for an IRA or tax-free for a Roth IRA. They used to call that the stretch IRA. My grandchild could have like 90 years of tax-efficient income because of the stretch. Boy, isn't that powerful.

Congress, you know, this was all over the news. People knew about the stretch IRA. And Congress said, no, we want some more revenue. So, here's what we're gonna do. For most beneficiaries, we're gonna get rid of these RMBs other than this one rule. We're gonna say for most beneficiaries, you're gonna now have to take the money out over 10 years.

There's no required minimum distribution other than at the end of the 10th year following the original account owner's death. But otherwise, it has to come out in 10 years. So, there's no more stretch IRA. There's no more, I leave it to my grandchild and they get 90 years of tax deferral or tax-free growth.

Not doing that. You gotta take it out in 10 years, whether it's a traditional or a Roth. To my mind, this makes Roth conversion planning for those thinking about their heirs even more impactful. There's not a lot that could be done to avoid this. You should leave it to your spouse.

There are things that could be done. But if you happen to inherit an IRA, you now have a real financial planning issue that you either have to tackle or you need professional help because here's what you don't wanna do. You don't wanna inherit an IRA, a traditional IRA. Roth is different.

You don't wanna inherit a traditional IRA, do nothing, wait 10 years and then have to take out the entire amount. That's gonna be painful. You don't wanna plan your distributions every year. One little potential planning technique here is get the inherited IRA into a properly titled inherited IRA account in the year of the original owner's death.

That is the function of giving you, instead of 10 years, you actually have 11 years, the year of death plus the next 10 years to empty that thing out. It's a way to spread out the tax hit just a little more. But anyway, we'll talk about IRAs a little more in terms of who you wanted to leave them to.

Two important things from a tax and an estate planning perspective, beneficiary designation forms, payable on death forms, make sure at all times you have up to date, on file beneficiary designation forms, absolutely critical in terms of just the estate planning in general and tax efficient estate planning in particular and then revocable living trusts.

I've blogged about this. I'm a big fan of revocable living trusts in the right circumstances and they are great for real estate and they can be good for retirement accounts, but if and only if one of these two things applies, the intended beneficiary is a minor or the intended beneficiary has credit or protection issues, right?

So if I'm 70 years old and maybe I'm a widow, right? I'm 70, but I'm a widow and or widower and I have three adult children, right? And they're in their thirties and forties and they're just regular people. They're competent. They don't work in high risk occupations. They're just regular people.

I'm not gonna use, generally speaking, I'm gonna try to not use a revocable trust to leave the retirement accounts. I'm just gonna name them directly as the beneficiaries, but in certain cases using a revocable trust can be good. For the real estate though, the revocable trust can be very powerful.

Think about your beneficiaries. Is it my elderly parents? Is it an out-of-state beneficiary, right? 'Cause you could leave the house maybe through a will or through a trust. The trust can sort of provide a lot of benefit to your loved ones when you leave it through the trust. Let's just say, I'll just give you one example.

You own your house and maybe you're single and you leave it to your elderly parents. And maybe somehow you die early. Your elderly parents live out of state. Now your elderly parents have to come into your home state where they don't live. They have to get your will probated so that they can get the house and then get the house retitled all out of state.

That is not a recipe for success. It's gonna probably work a lot better if you put the house in the revocable trust and there are clear directions about how it should be disposed of. It's gonna make your beneficiary's life a lot easier. Gotta work with a lawyer, right? This is not a DIY type thing, but I definitely think there's some real advantages to the revocable living trust.

And then let's think about, let's think about our type of account and our beneficiary, right? So let's start off spouses, right? Spouses are the law's most favored beneficiaries. They can inherit these days all types of assets in a tax efficient manner, right? So for most people, leaving most assets to the spouse in today's environment, I think makes a lot of sense, right?

So, look for the ultra wealthy, yes, there can be absolutely be planning around spouses, but for most people who would not be stars of reality television, it's gonna generally be spouses the tax favored beneficiary and generally speaking how you might wanna go. Let's talk about Roths, right? Roths are great assets to leave to any non-charitable beneficiary, right?

Spouse, they're particularly good for your upper income beneficiaries. So, if you have a Roth IRA and a traditional IRA, and you've got one child who's a teacher and another child who's the quarterback of the Kansas City Chiefs, the Roth would be great to leave to the quarterback. The traditional would be great to leave to the teacher because the teacher's at a lower tax rate, right?

Just some little nickel dime planning like that. Roths are not great to leave to charities. Look, if you wanna be charitable, don't have me tell you not to be for tax reasons, but if you're looking to be charitable and tax efficient, why waste the benefit of a Roth on a charity, right?

Most beneficiaries today have 10 years of tax-free growth when they inherit a Roth IRA. Even without the stretch, that's pretty good, right? If I inherit a Roth IRA, I can leave that in there for 10 more years of tax-free growth, at the end of the 10th year, take it out, and now, yes, the money will now generate interest and dividends in my taxable brokerage account, but for 10 years, it grew tax-free, and I get a full step-up in basis when it comes out, right?

So, Roth is a great asset to leave to not, don't waste that tax attribute on a charity, right? Where you might wanna start thinking about charities, the traditional retirement accounts, right? So, if you're thinking about, I'm gonna leave a bunch of stuff to my adult child and a bunch of stuff to charity, and I have a Roth and a traditional, leave the Roth to the adult child, leave the traditional to the charity.

And traditionals are great for lower-income beneficiaries because they pay less tax than your higher-income beneficiaries. And then, like I said earlier on the HSA side, HSAs are great assets to leave to a spouse, and they're great assets to leave to charities because those are basically the only two categories of beneficiary that doesn't immediately pay tax on your HSA.

Everybody else is pretty much paying a lot of tax when they inherit your HSA. So, just some things to be thinking about from an estate tax plan. Basically, a lot of what you're thinking about is your beneficiary's income tax situation, that bites, in today's environment, that bites much, much, much harder than any estate tax is gonna bite for 99.9% of Americans.

But here's one thing that should be on your radar. And maybe in our audience, we have folks who are having parents now pass away, right? These things happen. Essentially, we all have one tax planning opportunity in our life. It's our death, and it's coming. But one thing you do wanna think about, if you or your parents, your spouse, dies with any sort of affluence, even though they don't owe any estate tax, right?

So, they owe much less than $11 million today. Today's exemption is 11.7 million. You still might want to, if they're married, you may wanna file an estate tax return. That's a Form 706. And the reason is this, portability. So, what the heck is portability? Portability means that if the first spouse dies, the second spouse can get their lifetime exemption, right?

So, spouse one dies in 2021. He or she has this 11.7 million estate tax exemption. They leave everything to the spouse, so they don't even use the estate tax exemption. The surviving spouse can get that 11.7 million from the first spouse, if the first spouse's estate files this Form 706.

So, and the Form 706 is just gonna report, hey, Joe Smith died in February, 2021. He had $3 million worth of assets. He left it all to his spouse. Check a box. The spouse inherits an $11.7 million estate tax exemption. 30 years from now, spouse two dies, right? This happened in my own life.

My grandparents on my father's side died 40 years, yeah, about 40 years apart, right? So, these things happen, right? Who knows what that $3 million is gonna grow to by the time the next spouse dies. Maybe it's 10 years, 15 years. And, oh, by the way, they're thinking about lowering the estate tax exemption.

It's actually in the law right now, I think in 2025 or six, it lowers. But it's only to the upside to leave the estate tax exemption to the surviving spouse. The way you do that, though, you can't do that unless the Form 706 is timely filed. So, just a little thought there.

And then the last slide I've got is just, when you approach your tax situation, I think more and more people are getting this, but it's just something that is sort of, people haven't really locked into this. There's a real distinction between tax planning and tax preparation. And I think some people go to their tax return preparer, they say, okay, I'm engaging you to prepare my federal and state tax return for 2021.

And they expect that they're gonna get all this tax planning. Well, I actually don't even think that's really that fair to the tax return preparer. It's just, they're distinct exercises, right? Preparing one's own tax return is, it should be done correctly, but it's not tax planning. And then I do have a blog post here that actually talks about, hey, I just did my tax return for 2020.

Could I use this as a tool to help facilitate my own tax planning? This little, this blog post has some tips and tricks to take out your old tax return and use it as a springboard to do some tax planning. So I think that's it. I hope, I'm gonna stop sharing.

So I hope we've got everybody still here. I hope that didn't, hope we didn't lose too many in the battle. So, Carol, I think there are some questions that have already come in. - Yeah, thank you so much for that presentation. That was very informative and just the kind of information we're looking for.

Yeah, I'm gonna read a few of the questions that we have pre-submitted from the RSVP survey. And then we'll have Jim and Miriam read a few of the questions from the chat. And then after about 15 minutes of that, we're gonna open up to interactive Q&A where people can raise their hands.

I think you did cover quite a few of the questions that people had pre-submitted, like with Roth conversions. Somebody did ask, discuss distribution strategies from inherited IRA subject to the 10-year rule. So as if you're the person that got the inherited IRA. - Great question. And let's start with, upon death, you wanna work with the executor, whoever's running the estate around properly tidying, and/or the financial institution around properly tidying an inherited IRA.

Generally speaking, there's a little magic language around, you know, it's, you know, Joe Smith, decedent, you know, decedent, deceased, you know, 12/31/2021, IRA for the benefit of beneficiary name, right? There's, don't use that exact language, but there are resources to find that. So you wanna get that inherited IRA properly titled as an inherited IRA, you know, sooner rather than later.

And then you wanna think about your distribution strategies. And basically what you need to do is you need to say, all right, you know, I have a 10-year spread on this. What was, what's my income this year? Did I sell a business? Did I have a big capital gain?

Are there things that happened in my life where I'm gonna have more or less income this year versus other years in that 10-year window? And by the end of the year, take that right size, that distribution, so that you get the distribution in those 10 years in the right, you know, marginal tax bracket.

So you need to be thinking, once you've inherited an IRA with this 10-year rule, you now have a lot more tax analysis to do than most Americans, 'cause you gotta say, oh, I sold a business this year. I had a big capital loss this year, whatever it is, and then take the right way.

The one thing you don't wanna do is just ignore the issue on a traditional IRA. And then in year 10, you gotta take all of it, 'cause that's gonna be a tax time bomb, so. - Okay, thank you for that. And now there are two questions on minimizing taxes that are kind of related, so I'm gonna read them together.

How to minimize taxes on a mostly fixed income stream during retirement, and how do you determine a tax-efficient order to withdraw assets in retirement? - Yes, great questions. So on our fixed income in retirement, there's not a whole lot you can do around, I'm assuming the fixed income's like a pension, right?

If that's true, there's not a whole lot we can do to minimize tax there. Where we need to then shift our focus is deduction planning, right? So that could be things like doing a donor-advised fund so that we maximize our itemized deductions in one year, and then go back to the standard deduction in later years as opposed to just only being in the standard deduction every year, right?

So deduction planning, that person might have a traditional IRA, so we might do like QCDs and those sorts of things. I will say fixed income is a little bit of a tough one because it's just a little more difficult. The other thing you could do is delay, right? So to the extent you can delay your pension, I tend to like that for clients because it does two things.

One, it buys us some early retirement years where we could do tax planning like Roth conversions, and two, it gives us more longevity insurance on the pension. Now, pension's gonna have credit risk, right? So the more you delay your pension, the more credit risk you take on, but there is the Pension Benefit Guarantee Corporation.

That's not gonna fully replace your pension. But anyway, so that's sort of my thoughts on fixed income. And then, oh, order of operations in terms of retirement distributions. To my mind, it depends on when you retire, right? If you're retiring early, I actually like taxable distribution. Living off the taxables early is something I tend to like because that limits us to interest dividends, capital gains from a tax perspective, and then we could do Roth conversions, right?

So we sort of use the taxable accounts early in an early retirement as our life raft while we're doing Roth conversions. And then we get, you know, maybe we spend down those taxable assets. And what we do at that point is we've got a lot more in Roths, and then we sort of toggle between Roth and traditional managing our tax rate.

So that, I will say, this is one of those, your mileage may vary. It really depends on your particular circumstances. I mean, it happens, and I would say it's gonna happen less and less, but it certainly happens that there are plenty of Americans who get to age 56. They're done with work mentally, maybe.

And, oh, what do you have? I have 2 million in IRA or 401(k), and I've got my house, and I've got 10,000 in my checking account. Well, you're basically gonna be taking taxable distributions. And we can talk about 72(t), we can talk about separation from service at age 55 or after.

I mean, there are things we can do, but definitely your planning landscape is a lot more limited. - Okay, thank you. Is there a better way to handle estimated income tax payments instead of just doing the 110%, especially when there's uneven investment returns, which makes planning difficult? - Yeah, so great question.

For the year 2021, I'm actually very fond of the 110%. Here's why, for retirees. So 110% for the uninitiated, right, is as long as I make equal estimated tax payments, get 110% of last year's tax, so the 2020 tax liability in for 2021, I can win the lottery, no problem.

I pay no, it doesn't matter. I can make all the money in the world in 2021. I make that 110% of 2020 estimated tax payment. I'm in, like, I'll have to write a big check in April. No penalties. I like that for this year. Here's why. Last year, think about it.

I've seen this on clients' tax returns. Dividends, interest, way, way down. Capital gain distributions, way, way down, and no RMDs. So we have a lot of taxpayers out there whose income was artificially low in the year 2020. So let's do that 110% in 2021, and then we write our big check in April of 2022 for 2021.

I will say, you know, outside of that, you have to go into that 90% safe harbor and you just have to be a little, you have to be a lot more precise because you have to estimate this year's taxable income as opposed to last year's, which I just grab off my tax return.

So 110% is not, especially in a low-yield environment where, all right, maybe I gave the government a little bit of an interest-free loan, but it's a low-yield environment. It's not that bad of an outcome. So for this year, I really like the 110%. And then in the future, the only alternative is the 90%, or if you have W-2 income, right, you can use your W-2 to get those payments in.

Yeah, there's no real magic bullet other than if I can really well estimate my 90%. Is there a second question that I missed? - No, no. Now let me do one more from the pre-submitted questions and we'll go on to the chat questions. The last one I have is, do you have any suggestions for retirement tax planning software for consumer use?

- I actually don't. So a couple of things on this piece, and I get it. Folks love analytical tools. So I believe projections are sort of a necessary evil of the financial planning world and the tax world. That said, if we're doing the right things, we don't need to worry about projections so much, right?

I just think about, you know, Bill Belichick, the New England Patriots. Now, yes, they have some analytics people predicting behavior and predicting what will happen on third down, but what they're doing is they're doing the right behaviors, the right preparation. You know, Bill Belichick's not in his office agonizing over whether the Patriots are gonna be 14-3 or 13-4, 12-5 this year.

Do the right things and the projections become a lot less meaningful. - Okay, thank you. Okay, now we're gonna move on to some of the questions that were submitted during the chat. Miriam, do you have any from the chat? - Yes, we have one question from Ben. He said, "I have a former employer, traditional 401(k), a personal Roth IRA, and also a simple IRA.

Can I partially convert my traditional 401(k) to the Roth IRA? Does the ownership of a separate simple IRA cause any issue?" - So if you're looking to convert a traditional IRA or traditional workplace plan, a 401(k) to a Roth IRA, it's possible, but you're gonna have to work with your plan administrator, right?

So one thing you could do is if the plan has a Roth 401(k) and you, you know, if it has a Roth 401(k) and allows Roth conversions, which I believe they generally do if they have a Roth 401(k), probably gonna be easier to do an in-plan conversion, right? The other option would be, right, so you could do an in-plan conversion.

You might be able to do a partial, all right, 401(k), send this to a Roth IRA. You'd have to look at your plan rules to see if they'll allow a partial withdrawal like that. Depends on your age, depends on their rules. The other option would be roll over the old 401(k) into a traditional IRA.

Now you wanna be careful about that, though. If you have employer stock in there, that may not be a good idea. If you're relying on the separation from service at age 55 exception, that may not be a good idea. So you wanna be careful about that. That's not just a slam dunk, but that could be an option as well.

And by the way, the simple, maybe the other option is convert the simple IRA to a Roth IRA. Don't do that if the simple is only two years old or younger. But once that simple is over two years old, generally speaking, you can convert the simple IRA without a penalty into the Roth IRA.

And to answer the question, no, having a simple IRA is no impediment to doing a Roth conversion. It's just a little tricky when you have traditional 401(k) into a separate Roth IRA. That's where it can get a little tricky, but maybe an in-plan conversion would be a potential answer there.

- Two points on that. Could you explain the two years on the simple for those who may want to know that? And second, what about the pro rata with the simple IRA? - Yep, so a couple of things on that. So simple IRAs have this nifty little rule that says if within two years of creation, you move it to any other account other than a simple IRA, you pay a 25% penalty.

It's just this onerous rule out there. It's a trap for the unwary. So it's just, oh, I don't like, that's just annoying. Look, if you had the simple for 10 years, don't worry about it. But yeah, so you don't want to be doing Roth conversions out of a simple if it's under two years old.

Be careful there. And then the other question was the pro rata rule. And the answer there is pro rata rule, if you have a simple IRA, you generally don't have non-deductible contributions inside a simple IRA. So there would be no pro rata only actually, well, I take that back.

So if we had a simple IRA and only a simple IRA, no SEP, no SEP and no traditional IRA, then there is no pro rata rule. Every dollar you convert or take out is just 100% taxable. But let's say we had an old IRA with non-deductible contributions. The simple IRA would actually attract some of that historic basis.

So I'll give you an example. You contributed 10 years, 5,000 a year to a non-deductible IRA. So you have 50,000 in basis in the non-deductible IRA. And that's now worth 100,000. And then you have a simple IRA that's worth 100,000. So 200,000 total. Every dollar that comes out of the simple IRA, 25 cents of it will be non-taxable under the pro rata rule.

So this illustrates how complicated this can get. But basically, if you only have a simple IRA, don't worry about the pro rata rule. It's just all taxable. But if you have other traditional IRAs or SEP IRAs, the pro rata rule could come into play, generally in a favorable way.

It'll attract some of that old basis and some of the simple IRA distribution or conversion will be non-taxable. - Could you explain in one or two sentences what a simple IRA is? That's not the same as a traditional IRA. - That's right. A simple IRA is a employer-sponsored plan, self-employed or actual worker, where it's an IRA that you can defer money into.

I believe the limit is 13,000 right now and then a 3,000 step-up or additional contribution, catch-up contribution if you're 50 years old. So it's almost like a hybrid between a 401(k) and a traditional IRA. You need an employer, whether it's self-employment or another employer, and it's 13,000 a year is, I believe, the current cap, and then 3,000 a year additional catch-up contributions.

It's only deductible, no raw simples, and it's for small employers where it's just an easy plan to maintain. - Okay, thank you. - Does Jim have any questions or do you have any more from the chat, Miriam? I'm not sure if Jim has any. - One just came up about what are your thoughts about using a non-qualified deferred compensation plan for high-income earners targeting an early retirement?

- Yeah, it can be a really good thing. I mean, those things usually have a 10-year payout. Sometimes I think I've seen a five-year payouts. So the idea is basically what you're doing is you're moving income from a high-earning year to what is hopefully a lower-earning year, right? I mean, it's really that, especially for the early retiree, hopefully that's what you're doing.

And generally speaking, I think for the very high earners, yeah, why not? Why not defer while you're very high-earning? I mean, you may then come into some not so pleasant surprises with things like premium tax credit, but it may be, I mean, I've done the analysis. I think premium tax credit is like a 13 or 14% tax.

That's what's coming to mind. If you blow through that, maybe you wouldn't have qualified anyway, and then it's not really a tax. So I have to look at any one particular deferred compensation arrangement and plan. The other thing you want to think about is creditor protection, right? So this is a bit of a, it's not that big a deal, but on the deferred comp, sometimes there could be some issues.

If your creditor, or I'm sorry, if your employer was to ever have a credit issue, they get sued for something. Theoretically, it depends on the nature of the plan. There are some plans where that could be an issue where the creditor could actually access it. So you just want to be a little careful with that, understand what you're getting into, but otherwise they can be good plans.

- We probably have time for one more question from the chat. Is there a good one? - Yes. - Okay, great. - There is. - This is from M.A.R. In the tax harvesting example, I guess that you gave, Sean, does the 40,000 taxable income include the income from the sales of the stock?

- Yeah, that's a great question. And generally speaking, yes, right? So it's not like, oh, I had no income, right? I have no interest, no dividends. I'm early retired. Oh, I'm in the 0% capital gains bracket. So what I'm going to do is I'm going to sell, I'm going to trip a $200,000 capital gain.

No, you've got to manage the gain with all your other income. And that's why, that is a bit of a governor on it. But look, if you're married and 80,000, you have $10,000 capital gain, you're looking to wash away, you know, it can be very powerful. But yes, it is not a mechanism to be washing away $500,000 worth of gain.

- Maybe time for one more? - One more. - Yeah. Any suggestions for a consumer version of tax forecasting software to use to optimize the Roth conversion and other tax planning issues? - Yeah, like I said, I don't endorse any particular product in that. You know, I think, I mean, some of it is quite mechanical, right?

I mean, literally what you do is you pull out the tax brackets for the year, and then you look at, are you in the itemized deduction or standard deduction? By the way, 90% of Americans are standard deduction, right? So that's a great guidepost. And then I just say like, be a little conservative.

The other thing too, is people sort of misunderstand this. This is an issue of degree, right? So what I mean by that is, let's say I've got $9,000 left in the 12% tax bracket. And I think I have 10 or 12,000 left. So I do a $10,000 Roth conversion.

Okay, the first nine is taxed at 12% federal. And then the last 1,000 is taxed at 22%. Yeah, to my mind, that's not that big of a miss, right? Okay, I went a little over. Some of it got into the 22%. By the way, I mean, this is another thing to keep in mind too, is your future self is never gonna be annoyed at you that you paid a little too much tax on a Roth conversion.

Your future self is gonna be thrilled that they have a ton of tax-free income to draw on retirement. And they are not going to be angry that, "Oh, you did some Roth conversions "that weren't 100% optimized. "You paid a little bit of tax in the 22% bracket. "How dare you?" (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) you