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Episode #495 - The Rules for Roth Contributions
Roger: "The economy didn't crater in the first half of 2023, and that means Wall Street was very wrong." -MarketWatch. com
INTRODUCTION
Hey there, welcome to the Retirement Answer Man show.
My name is Roger Whitney, and I am your host, and this is the show dedicated to helping you not just survive retirement, but to have the confidence because you're doing the work and you're focusing on the right things so you can lean in and rock retirement.
I am not beating up on Wall Street. I'm not beating up on the media. I just want to point out that when we focus too much in our planning on predictions, whether it's about the economy cratering in the first half of 2023, saw another article today. About I think a city group on don't need to be investing in U.S. stocks right now, this is where you should focus and then you had to click in the article to go see the emerging markets, real estate, etc.
Nobody has that kind of crystal ball. It's sort of an old joke now that we can't predict the future yet. We have this burning desire to see around the corners, whether it's about the economy, where the markets are going to go, what inflation's going to be, what kind of investment strategy you should use. There are plenty of people to share their predictions and opinions, and a lot of them are geniuses. Intellectual powerhouses with spreadsheets and financial forecasting models that would blow your brains, all presented in very attractive graphics. I'm not denying the intellectual capabilities of anybody that's in the prediction business.
All I am saying is that it's an educated guess, maybe more than the layman on the street, but it's still a guess, and it's not a good place to rest your process for managing your retirement. We have a question. It's in the queue. I don't think I'm answering it this month on using straight historical data for stock markets, interest rates, inflation, and " shouldn't we use predicted returns on those items because life is different right now?" I'm using air quotes there. I'm not arguing that historical data is great or accurate. I'm just arguing that's what we have, and I am questioning the practice of adding predictions on that, whether it's forecasts on any of the economic items or something else.
Does it add more accuracy or confidence in what we're doing? No, it just adds another layer of complexity that we have to manage what those predictions are over time.
The more we start to go down that road, the more we get distracted from things we actually have control over. So, I'm not beating up on any of the predictors out there. We have this desire to see around those corners. I have this desire to look around those corners and I have my predictions. I just try not to let them overly influence my process that we talk about, that I'm trying to teach you, empower you with. I try not to let it over influence our process and sound decision making. So, there's a little soapbox for today.
We're on this month-long theme of the Roth opportunity in retirement. And today we're just going to talk about not just, we're going to talk about How do you get money into Roths? And there are two ways of doing that. We're going to talk about contributions today. Next week, we're going to talk about conversions. The next week after that, we're going to talk about how we withdraw money from Roths and then when I get back from my vacation, my anniversary vacation, we're going to talk about a framework, the beginnings of a framework for how we determine whether we do conversions or not, because that's generally the big question for people of our vintage.
So, let's get started.
PRACTICAL PLANNING SEGMENT
This week, we're going to take a moment and talk about how we make Roth contributions, what are some of the rules around that? Because our vintage of humans generally has fewer assets in Roth accounts, because we grew up in an era where tax deferral was always the best option. This is an area that we may think, well, we've missed that bus. Maybe we shouldn't take advantage of that. I understand that from a complexity standpoint. If you don't feel like you have enough time to get money in Roth accounts now at least within contributions, I get that. You're going to have to balance that as to whether or not it's worth the effort in order to do that.
I will say though that incremental action done consistently, just like we teach our kids when it comes to them investing in their Roths, can have a difference over long periods of time. If you're 60 right now, you still have 30 years to be able to move money to tax free accounts within the scheme of Roth contributions, if you qualify for them or Roth conversions, which we'll talk about next week. So, I wouldn't discount these little actions, even if you feel like the bus is left. Maybe you can grab the tail end of it.
Alright, so how do we make Roth IRA contributions? We'll focus on IRA contributions and then we'll talk about Roth 401k contributions.
So, a couple keys to making a Roth IRA contribution.
One is you must have earned income. If you are retired and you have no earned income, you will not be able to make a traditional Roth IRA contribution. So, you have to have earned income. The maximum amount in 2023 that you can put into a Roth IRA as a contribution is 6, 500. And if you're over age 50, you can add another 1, 000 to that for a total of 7, 500.
Now, if you are married and you have one spouse working, as long as the working spouse has enough earned income to cover the contribution, you can make a 7, 500 contributions for the working spouse and a 7, 500 contributions, assuming you're over age 50, for the non-working spouse. The key there is there has to be enough earned income to justify both contributions. So those are the contribution limits and some of the rules around spousal contribution.
Now the IRS also has in place though that if you earn too much, you cannot make a Roth IRA contribution. So, for a single person in 2023, If you earn over 138, 000 they begin to diminish how much you can contribute to a Roth.
It's 153, 000 as a individual, if you earn over 153, 000. Then you're not eligible to contribute to a Roth IRA, and we'll talk about an option you might have there. If you're married, that phase out for contributing to a Roth IRA starts at 218, 000, ends at 228, 000. If you earn over those amounts, you're not eligible to make a Roth IRA contribution. So that's how you can get money into these the traditional way.
Now, there is something called a backdoor Roth contribution, which really is not a term in any regulation, it's just a planning term that was coined at some point in the time. So, let's assume you're in that era, or in that phase where you cannot make Roth contributions because you make too much.
What can you do? Is there any option to still get money into a Roth IRA from a contribution standpoint? Well, a backdoor Roth contribution might be a possibility. So, let's walk through how this would work.
You are always eligible to make a traditional pretax IRA contribution. We've known that and done that for a long time, and there are phase out limits for traditional pretax contributions related to whether it is deductible, that contribution is deductible or not. But even if you're over those income amounts, you can still make IRA contributions on a pretax level regardless of how much money you make. It's just not deductible on your taxes. It's an after-tax contribution to a pretax account sort of confusing there, I know.
A backdoor Roth contribution would have you make a nondeductible contribution to your traditional pretax individual retirement account, and then do a conversion of that same amount to your Roth IRA, because as you'll learn next week when we talk about conversions, there isn't an income limit where you can't do Roth conversions. It doesn't matter how much money you make; you can always do a Roth conversion. So, this gets around the income limit of the contribution to a Roth IRA by making a nondeductible contribution to a traditional IRA, that means that money was already taxed and then converting that money directly into a Roth, which should be tax neutral, shouldn't be any tax on that conversion. So that is what a backdoor Roth contribution is.
Now before you get excited, if you're in this situation, there's a couple of gotchas you got to pay attention to. The big one is something called the pro rata rule. If you already have an individual retirement account, say one that you contributed to on a pre-tax basis, or maybe you rolled over a 401k to an IRA, the IRS is going to look at the total amount in your pre-tax IRAs. It's not going to look at just the non-deductible contribution you made.
If you have money, pretax dollars in IRAs, the pro rata rule is going to apply. So, if you do this, you make a nondeductible contribution, and then, in your mind, you're converting, let's say, that 7, 500 over to the Roth, but in the IRS's eyes, no, no, no. It doesn't follow a thread that way. That 7, 500 goes into the entire pool of your IRA assets. And then the IRS is going to tell you, well, you're going to have to calculate it, but they're going to check it. What portion of that conversion is actually pretax or post tax. So, it could cause a tax event.
Are you confused? Let's look at a quick example. Let's assume you have a pretax IRA of 93, 000 and then you say, oh, I want to make a nondeductible IRA contribution and move that to a Roth, I want to do this backdoor contribution. So, you make a 7, 000 nondeductible contribution. So, after the contribution, you had 93 pretax, and now you have 7, 000 post tax within this IRA, and then you convert that to a Roth. So, you move that 7, 000 in your mind to the Roth thinking you're doing a backdoor contribution.
Well, the pro rata rule is going to apply when calculating how much of that 7, 000 conversion is actually taxable. So, you have a 7, 000 conversion to that Roth that represents 7% of the total IRA So if you do a 7, 000 conversion multiplied by 7% 490 will not be taxed and 6, 510 would be taxed.
If you have outside IRA monies, you got to be careful because this pro rata rule is going to come into play and you could potentially create a tax event where you thought you were getting around the income limits on Roth IRA contributions.
Now, how can you avoid this? Let's say you really want to do backdoor Roth contributions, but you have monies in IRAs.
The most common way is to roll your IRA assets into your current 401k plan, and we've done this with clients in the example. So, they had monies in a traditional IRA that came from an old employer, and we wanted to execute a annual backdoor Roth contribution. They checked their 401k at their current employer. They were willing to receive, and you got to check your plan, is it willing to receive rollover assets into the plan? In this case, it was. So, they rolled over their IRA into their 401k plan, and it had good options in this instance, and reasonable fees, etc. Now, we don't have money in an IRA, so we're able to do these backdoor Roth contributions. Because when the IRS is applying the Pro Rata Rule, they are not considering 401k assets.
So that's how you can make regular or backdoor contributions. What about a 401k rather than an IRA?
Since 2006, employers were allowed to offer their employees a 401k that had employee option to do post tax or Roth contributions for the employee portion of The 401k plan that's since 2006 now just because the IRS allows this to happen or the Department of Labor, just because they allow this to happen each individual 401k when they're designing their plan or company when they're designing their 401k plan can choose whether to make this an option for their employees or not they have a lot of things that they can choose based on eligibility and how these contributions go in the investment selections etc. So just because they were allowed within the design of a 401k doesn't mean many had them.
One thing you'd want to do here if you want to start building up Roth assets is check your summary plan description or your 401k provider and see if they allow you to make contributions under what's called a Roth option. In fact, when we designed our plan and our company a few years ago, we did it specifically so we could do this.
So, you have to check your plan. You still have to have earned income, but the cool thing about Roth 401ks is that there are no income limits. potentially limiting the amount that you can put into it. You can contribute as much as you can contribute into your pretax accounts within the 401k and for 2023, the maximum, if you're under 50, is 22, 500. If you're over 50, It's another 7, 500 for a total of 30, 000. So regardless of how much money you make, you can make an employee contribution into a Roth option of 30, 000 a year, assuming the company offers a plan.
Now, up until recently, if you had a company match, the employer contribution, the amount that they contribute to your plan, had to come in as pretax dollars, the traditional type of structure, but Secure Act 2. 0, which was passed a year or so ago, allows employers to offer match in Roth dollars rather than pretax dollars. So, you have to check your plan to see if they have this option.
Now, the big catch here, and I felt this pretty hard this year personally, is that if you contribute your 401k contribution, your employee contribution, as post tax Roth contribution, that is taxable income just like you would have received it in your paycheck, except you never see the money in your paycheck, you just see it go into your 401k account. So, you're taxed on it. That's a very unusual feeling because we're used to doing a 401k contribution and having it lower our taxable income for that year. That was the planning standard for decades.
Let's assume you're in the 24% bracket, as an example, and you make a pretax 401k contribution of 30, 000, where that 30, 000 isn't included in your taxable income, which saves you roughly 7, 200 in tax this year, and then those assets grow tax deferred, and then when you take them out, the earnings plus the contribution come out as taxable income, and we've talked about the impact of that.
Well, if you convert that contribution that you make, that 30, 000 contribution you make from a pretax contribution to a Roth contribution, and it's 30, 000, that means you just increased your tax bill by 7, 200. But your contribution and the growth on the contribution grow tax free forever, and that's what I did and have been doing in my 401k plan.
I'm telling you. You notice it because as you're doing your natural withholding, and for me, I'm doing quarterly payments. You have to calculate that into your quarterly payment scheme or have the withholding, make sure it matches. Otherwise, you're going to get a nasty surprise when you do your taxes because you're going to have all this income that you didn't think you were going to have because you don't see it because it's just going into the 401k.
So, what are some general rules on whether you should contribute as a Roth or not? Well, obviously, what are your long-term goals? That's key. What am I solving for here?
Another question is, can you afford to pay the taxes now? That was the calculation that I did. I was already doing after tax savings and building up cash reserves. So, being able to pay that extra tax, although it really hurt, it didn't impair my financial flexibility because I had the excess income to be able to do that. I was blessed with that.
Another factor that's going to come into that, are you over heavy in pretax assets? Do you feel like you need to have some balance because everything you have is in pretax assets? Another example, and I inferred it here a second ago, are you saving in after tax dollars? If it's yes, then do you have a meaningful emergency fund already accounted for?
If that's yes, then maybe a Roth IRA or a Roth 401k is going to make a lot of sense for you. But if you don't have a lot of after-tax assets, and you don't have a meaningful emergency fund yet, that is going to be a place that you might want to consider because that's going to give you a lot of flexibility.
So, there's a general overview of how to get money into a Roth IRA or 401k from a contribution standpoint. Next week, we're going to talk about Roth conversions, which are things that you can do really throughout your life.
LISTENER QUESTIONS
Alright, let's get to some of your questions. If you have a question for the show, you can go to askroger.me. and you can leave an audio question or type in a question, and we'll do our best to get it on the show so we can help you take a baby step towards rocking retirement.
INVISIONING FAMILY LEGACY OPTIONS
Alright, our first question comes from Steve related to the vision pillar.
Steve: Hi, Roger.
This is Steve, a listener for the last couple of years. I wanted to thank you and your team for providing insights and a sense of agency as I approach retirement.
I do have a question on the vision pillar. My wife and I are trying to get a grip on family legacy. We have two daughters, both great, and they’re in their late teens, and one is on the autism spectrum. We hope she will thrive and be self-supporting, but the jury is still out. Having an agile mindset helps, but do you have any guidance on family legacy?
I'm not looking for legal advice. I'm more curious if you have any observations from collective wisdom of your clients or other insights you've gained in your walk.
Thanks, Roger.
Roger: Steve, let's look at this from a couple different perspectives.
On the practical side, given what you know now, there could be some basic trust planning you do. It could be establishing a revocable trust and having your assets in that. That will convert to an irrevocable trust or trust for your daughters if the two of you, you and your spouse, were to pass.
That way, with the information you have today, you can make sure that there's money set aside in a structured way for both daughters. The nice thing about that is as you mature and as they mature and you can start to see around the corner relative to how financially independent your daughter is going to be able to be, then you can always change the terms of these trusts very easily, but still have peace of mind that with the knowledge you have today, you at least have something in place.
So that would be some practical stuff. Related to that, if you go down this route of trust planning, I would be careful, or at least cognizant of the dynamic that you would set up if you have one daughter be the trustee for the other daughter's irrevocable trust in the event that you and your spouse weren't here.
If you do that, one is, the daughter that is the trustee now has that responsibility as caretaker financially, not just emotionally and as a sister. But you also set up a dynamic where that one is approving money to be distributed to the other one and that could change their relationship. I've seen that happen numerous times where the relationship, because money was involved, one had to go to the other to ask for money.
Now they're not just sisters. It could destroy the sibling relationship, but it definitely can change the nature of it. Whereas if you had a corporate trustee or an outside trustee, other than the sister, you could preserve their relationship because that's going to be critical. So that's one thing to consider.
We will do at some point a month-long theme on planning for special needs, because that is a subspecialty of retirement planning and financial planning. This may be an area there that you want to go to somebody that does that a lot. Now, I don't have a lot of experience in planning for children with special needs, but on the month-long theme, we can at least think through it in an organized way.
But that may be a place where you want to at least get some financial planning help to structure that correctly.
Okay, let's look at it from another perspective. How do you leave a family legacy? Outside of this money stuff. What is it? I mean, we think of financial, but probably the best legacy you can leave is to help build a human of sound character that, as you mentioned, has agency. Always ask themselves, what can I do to fix this? Has extreme ownership over their life, rather than victim over their life. That can be very intentional, that can have sound moral values, both daughters, and that can have agency, can have control and self-determination as much as we're able to in this crazy world, and that's teaching them agency, that's teaching them vision, that's teaching them agility and ownership of things.
I think that the best legacy that we can leave our children, is to help grow them financially independent, morally sound. and feel like they have ownership over their own life, so they're not stepped on, or they don't fall into victimhood. I think that's the best legacy we can leave, and that can be multiplied through the people that they meet, through their children, through their spouses.
That's beautiful. That's how you improve the world. I'm guessing you're doing a lot of that, but you could focus and lean in on that as part of it.
When my son was in his teens, I used to call him a M.I.T., a man in training. So, you're just a M.I.T. Okay, let's go through this. I have failed in lots of ways, but we just got back from a vacation to Alaska and my kids came and they were hanging around 50 or so members of the club and my team and I was proud to have them there.
They represented well. They were articulate, maybe drank a little bit too much here and there, but I guess maybe I did too because we were on a cruise, but I was proud to have them around people. That's a legacy. That's a good legacy.
Now, let's look at it from a little bit different perspective. Because you can help these daughters mature into strong, independent women, given whatever capabilities they have to be that, but what else can you do for that?
I think another thing that you can do is start to seed and help them build a social network. of sisters and brothers that can help guide them and be there to help them make better decisions. And we all need that in life. People around us that we respect and that we like that we can lean on from time to time. When we're too high, they give us some perspective to keep us down a little bit, and if we're too low, they bring us up. They can help us stay buoyant. Not too high, not too low in all the stuff that life throws at us.
One thing that I saw a friend do who's actually currently my coach and has been for a couple years is when his kids were in their teens, Steve, he chose specific friends that were very close to him that had some relationship with the children on some level. At least they knew who each other was.
He held a dinner, a somewhat formal dinner. with the child, one of their children, he did this for both children, and these specific friends, maybe four or five, and he reintroduced the friends who this child already knew as their board of advisors, and presented these trusted friends that he knew, liked, and trusted to their son or their daughter and said, hey, this is Bob, Sally, and Bobby, you know them, but they're your foxhole buddies. They are here to help guide you in life. They are here for you to lean on. Then each one of them would talk about how they are willing to help. In this case, one was an attorney. One was a financial person. One was a businessperson. One was a mother. And talked about because each one had something to give this child and they were presenting themselves and creating a one on one relationship to where when the child needed somebody to reach out to, you can't always reach out to your parents, they could reach out to one of these people to help them think through something, to help bring them up when they were down to maybe check them on something they were considering doing.
You want to talk about leaving a family legacy in the event that the two of you pass, you may not know how the daughter with autism is, how she's going to turn out from becoming an adult standpoint. How beautiful would it be for both daughters to have a network of people that you've said, "These are smart people, they can be trusted. They are wise." Lean on them so those people can build a little bit of a relationship with the daughters. So, in the event that you or you and your spouse aren't there, that they have some other social network so they're not just doing this on their own. Because otherwise, they could turn to their friends who are 20 somethings or teens, and they're not any wiser than they are. They don't have that perspective. You don't know what they're going to turn to in terms of whether it's a safe place or not. So, I think those are three aspects of this family legacy question in this vision pillar that I've seen that have worked really well.
So hopefully that helps you a little bit on your journey there, Steve.
SPOUSAL SOCIAL SECURITY BENEFITS
Our next question comes from Kevin, related to spousal social security benefits. So, let's listen to Kevin's question.
Kevin: Hi, Roger.
This is Kevin. Thank you for all the insights over the years. This is a question about Social Security spousal benefits.
My partner and I are in our 60s, but we never got officially married. We are willing to get married to make sure that the spousal benefits kick in, my Social Security is much higher than hers. What does Social Security require in their definition of marriage? Is there a time matter or living together or any other qualities that they look at to confirm that you are indeed married?
Thank you very much for your help. Bye!
Roger: So, the intent here, Kevin, is to maximize your partner's social security benefit. It sounds like you have a relationship that's been working for a long time without marriage, and you have your own reasons for that. Before you go down this road, I would suggest that well, if she has an ex-spouse, to explore whether she will qualify for social security based off of her ex-spouse, because that may make the rest of this point because she can have a much higher benefit by claiming on her ex-spouses social security benefit. So that would be something I would explore first.
Now, when it comes to how does she qualify for spousal and survivor benefits on your benefit, Yeah, the starting point is definitely you want to have a legal marriage in your permanent state of residence. Definitely want to do that. That will make everything official.
You generally have to be married for at least a year to claim spousal or widow benefits. Some of that is dependent upon your eligibility and the timing of eligibility for Social Security in terms of full retirement age or claiming age of you and your now spouse. So that can get a little tricky there.
So, I'm going to refer you to the Code of Federal Regulations 404.34, the 345 and 346 and 330. We will have links to these in our 6-Shot Saturday email, which is our weekly email where we share links to things that are difficult to communicate, as well as give you a summary of the show, and I would explore those to understand what criteria that the Social Security Administration is going to look at to determine whether you are actually in a spousal relationship or not, but you have to have a legal marriage for that, and then it's got to be at least a year and then there can be some wiggle room on that based on some of this criteria. So that's something I would suggest checking out.
Another thing you could do is simply make an appointment with your local social security administrative office. That will help you and your partner at least hear from them. You have to be careful. They will tell you generally accurate information, but if they tell you something and it ends up not being accurate, you don't have recourse there, but that can help you ferret through this. So, have to have a legal marriage, at least one year and then if a spouse dies early in that marriage, there are some other things that could come into play, and you can explore these Federal Code of Regulations to help you a little bit further.
So hopefully that helps you and I wish you all the best.
OPTIMIZING TAXES AND ESTATE PLANNING
Our next question comes from Charlie, related to Roth conversions.
" Hey Roger,
I've been listening to your podcast for several years. I look forward to our walks together every Wednesday. My wife and I are both 62 and have recently retired. We are blessed to have a resilient plan in place with assets over 10 million.
Now that I have some spare time, I have started looking at optimizing our plan relative to taxes and estate planning. Like many baby boomers, I have a lot of money in pretax assets, about 3. 5 million. That will lead to some large required minimum distributions in the future and or to a large tax burden to our two children and seven grandchildren.
Due to some deferred compensation, I receive for the next five years, I don't see our tax rate dropping below 32%. We have a Donor Advised Fund that will meet all of our charitable plans for the future. My question is, given our tax rates, should we be doing Roth conversions or just wait until we start taking required minimum distributions?
My main concern is that I really would like to avoid leaving a big tax bill to the family, but also cringe at April tax time."
Hey, Charlie, well, it's nice that you're habit stacking, listening to a podcast and walking. That's a way to get two birds with one stone.
Now you said that you had your charitable intent covered with your donor advice fund. So, I'm going to assume that means that you've taken off the table doing qualified charitable distributions from your pretax assets. Where at age 70 and a half, you can contribute assets from your IRAs or 401ks to a charity, and that will help lower or diminish your required minimum distribution. So, I just wanted to mention that in case you hadn't thought of that. That might help you rethink some of your gifting strategy to incorporate that since you have these pretax assets.
Now, when we're looking at this, Charlie, we want to go to your intent here, right? And you said your intent is to avoid leaving a big tax bill to your family. Yeah, and you don't want to cringe, but we all have to take our medicine at some point. That's the intent. So, let's write that down someplace. Write down why you're even thinking about doing this, because that's important when you're going to get to your decision because your decision is not going to be crystal clear because this is going to be a judgment call like most things are.
The second thing I want you to make sure that you remember as you're thinking about this is we're not talking about avoiding taxes, we're talking about the timing of taxes. If you take your IRA distributions or do Roth conversions today, you're going to pay taxes. If you have RMDs and other withdrawals in the future, you're going to pay taxes.
If you leave these pretax assets to your children, they're going to have taxes within 10 years as they drain those inherited accounts that will be added on top of their already taxed income from whatever sources. We're not avoiding taxes. This is just simply a matter of timing. That's important to remember because there's a lot of things in play here.
We're currently under the current tax regime that's going to sunset in 2025, which means tax brackets are going to compress, which means we'll run up the tax brackets quicker, and I believe there's a higher bracket. We don't know what future tax policy holds, not just for yourself, in this case, Charlie, but for the children. We don't know what estate taxes are going to hold for the future.
There are a lot of unknowns here. But what we do know is that this year you're in a 32% bracket, and that you have some clarity over the next couple years. Now we have other things that come into play like required minimum distributions that we'll talk about in a second. But you still have IRMA surcharges and Social Security tax, etc. I think those things in your situation, since you're significantly overfunded, are more nuisances than material impacts. So I don't know if we necessarily need to consider those in a material way. Relative to, let's take your required minimum distribution situation.
So you have 3. 5 million in assets. Well, let's assume, Charlie, that those grow by 5% per year. I just did a simple spreadsheet, and I'm guessing you've done something like this. That means at age 75, you're going to have about 6. 6 million if it grows by 5% a year with no withdrawals. So, your first year required minimum distribution based on this year's tables would be about 268, 000. You're going to be in a high tax bracket. Next year, it would be 280, 000. Age 87, assuming that 5% linear growth rate, it'd be 435, 000. You'd have about 6. 1 million left in that IRA if we assume you pass at age 87.
Currently, you're probably thinking that you could do some calculations of what you're going to pay based on your joint return. But remember, if one of you predeceases the other, you're going to switch to a single taxpayer rate, which means you're going to move up even quicker whatever tax scheme happens in the year after that spouse dies. So, we have to consider this here too. That's the scary part. We can't see around the corner about tax rates, about estate taxes, about the taxes that your kids are going to have to pay, and the fact that your kids, assuming they're going to be the inheritors, can extend those distributions from the inherited IRAs for their lifetime.
It has to happen in 10 years. That's bringing a lot of money around the corner. So if your intent, go back to that initial intent, Charlie, is to not leave a big tax bill to your family, the fact that you are, I'm going to say, significantly overfunded, my words, not yours, that means you and your spouse are going to have a lot of money, not just in pretax assets, but in post-tax assets that are essentially going to go to the kids and the grandkids.
So, the question becomes, is it worth using some of that legacy money to prepay the taxes and lock in whether it's 32% or whatever the rate ends up being over a number of years or all in one year and go up the brackets big. So, my kids and I never have to worry about this again.
Mathematically, does it make sense or not? It all depends on your assumptions. We're all guessing on the future there. But what it does give you is, I know what my tax is today. I know what the bill is. I've locked in that rate. I'm never going to have to worry about that again. My kids are never going to have to worry about that again. There's a lot that can be of value there outside of math, and each of us is going to have to make a judgment call there.
I also want to remind you, Charlie, as you're dialing this in, and this is one reason why I brought up the charitable distributions, because you could reintroduce QCDs into your plan and look at gifting your children earlier after-tax assets or doing some other planning with after tax assets that complement and mitigate some of that required minimum distribution with qualified charitable distribution. So, I wouldn't necessarily take those off the table.
The last thing I'll point out here, Charlie, is remember now, you're going to have about a five-year window between the end of your deferred comp and when your RMDs are going to start. So that might be a window where you can do aggressive Roth conversions up to the 24, whatever the brackets are then, during that five-year window.
All of this is the timing question. It's not an avoidance question. The answer tends to lie somewhere in between and making a judgment call, and the math is only going to get you so far. So hopefully that gives you some perspective and some things to think about on that journey, and I wish you the best of luck.
With that, let's move on to our Bring It On segment and bring in Kevin Lyles to talk about a phased retirement.
TODAY’S SMART SPRINT SEGMENT
Now it's time to Bring It On and tackle the non-financial area of retirement. Today we're going to talk about passion and work with retirement coach Kevin Lyles. How are you doing, Kevin?
Kevin Lyles: Good, Roger. How are you?
Roger: Good! What is on deck today when it comes to having passion about things in retirement?
Kevin Lyles: Well, this is one that not everyone can do, but if you can it's maybe a great way to ease into that retirement transition and I'm talking about phased retirements.
That can mean several things. So obviously the one you think of is just cutting back on your hours, maybe the number of days of week you're working for a year or two before you leave your job. So that's the one way to do it, but there are some other ways.
I've heard you, Roger, talk about people who are institutionalized, and I think that's from Shawshank redemption.
Roger: It is. It is.
Kevin Lyles: So, one way to do it is just mentally a phased retirement and that is focusing less on your job, instead of giving your job 110% of your mind and your efforts. Maybe you cut it back to a hundred and you focus a little more on your future.
So that's a type of phased retirement. It's a mental approach.
Roger: Let's talk about that one for a moment because I don't think that's been highlighted enough, right? We've been on the treadmill of career advancement and pleasing for so long that work, especially our generation, it's so integrated with our life of just simply mentally saying, I stop at this time. You don't even have to tell anybody, right? You just compartmentalize it more than you maybe have in the past.
Kevin Lyles: Exactly. And it might not even mean quitting at a certain time. It might just mean when you get home, not thinking about the next day's work. I used to do that after dinner, grab a notebook and start planning the next day.
So, as you are getting ready to retire, going into that phase of life, maybe you need to spend that time planning what that next phase of life is going to look like and not thinking about your job. You don't need to get a new promotion at your job. You don't need to be the best employee. You just need to be really good.
Roger: It might not just be not thinking about it. But nowadays it would be, and this I think is a really difficult thing for people, putting your phone away.
Kevin Lyles: Yes, absolutely. Emails, right? Getting emails at all hours of the day. We joke about when we do that on vacation. But most people just think it's a normal thing to do emails all evening long on your job, and it's really not. A lot of societies don't do that at all, but we've sort of adopted that work ethic where we're always available for our job and so it's just a matter of saying, you know what, I'm going to turn that switch off and I'm going to start thinking more and planning for my future.
Roger: Two tactics around that, Kevin, I have a friend who does this, is he actually got a separate phone for personal. A lot of times we don't put our phone down because it's still our personal phone with kids texting and friends texting. So, what he did was he had his phone that had his work email and everything and then he bought a second phone.
So, when he comes home, he puts that phone away, and only keeps his personal phone, which I thought was that may cost a little bit of money, but it compartmentalizes it, so you don't have the emails pinging you on your personal phone.
Kevin Lyles: Yeah, so another way you can do a phased retirement, and this is one that I really like people to think about and it won't work for every role out there every job, but it will for a lot and that is move into perhaps a different position that's less stressful. Maybe it's consulting. Maybe it's mentoring younger folks at your company but figure out if there's a particular aspect of your job that is very stressful and you realize that, then maybe you figure out a way to get rid of those duties and shift to something else as you go into retirement.
Roger: Yeah, that can be hard. Usually what I hear is it's the obligation of managing a team and the stress related to managing people or being the one that's responsible for the project and not just participating in the project, right?
Kevin Lyles: You're right. And that's true. But I will tell you one thing I've found out through coaching some people through these kinds of things, a lot of us overestimate how important we are.
Roger: What are you talking about? Wait a second. I know I'm extremely important, Kevin. I don't know what you're talking about. You are important.
Kevin Lyles: So maybe you can back off a little bit and it'll be just fine. So that's it, and then finally the fourth type of phased retirement you can think about is actually leaving one job, but moving into something completely new that you find really fun or interesting and doing that, but on a lesser basis.
So that's a phased retirement, if you will. You're going from one job to another.
Roger: Two questions about that, Kevin. Maybe one, maybe more. One is, why would I do this if I'm going to end up doing roughly the same amount of work for likely substantially less money?
Kevin Lyles: Yeah, and that's the key, isn't it? You need to make sure you're doing a type of work that is more meaningful to you, that maybe gives you energy rather than saps energy out of you.
There are several benefits to these phased retirements, all these types that we've talked about. One, it keeps the money coming in, and a lot of people have under saved for retirement, so that's a good thing. But the two that are most important from the non-financial side, which is what we're talking about today, is stress reduction.
A lot of people have a lot of stress around their jobs, and frankly, the more important your job is, the more demanding it is, the more stress you feel. That can really create a lot of problems for you as you age, and then the next is physical demand, depending on your job. If your job has a lot of physical demands, as you enter your seventh decade into your sixties, that can become more and more important that you back off of that some so that you're able to enjoy the rest of your life and you're not destroying your body.
So those are two benefits. You say, why would you do it? Even if it means less money. That's why you might do it. The other thing though, as a retirement coach, I love, is it can keep you engaged and active, keeps your mind active as you explore options for the rest of your life. So, I think a dimmer switch is just a lot less abrupt than an on off switch.
Roger: It gets back to helping you compartmentalize more so you have more time freedom for the next season, right?
Kevin Lyles: It does. It does. Now, there are a couple of downsides that I want people to be sure they're thinking of. One i don't use phased retirement as an excuse for never retiring. It's that one more year syndrome.
Don't postpone things that you want to do in your retirement that maybe you need to do in this phase of life. Don't put them off so long that your go-go years are gone, and you never do them. So, make sure you're not doing that.
The second thing is make sure a phased retirement meets your spouse's idea for what retirement in that phase of life needs to look like.
If your spouse is ready to start traveling and you're not, then that can create an issue. So just make sure you talk about it together.
Roger: Yeah, it's definitely a good training wheel. Some people just don't know what they want, right? They know they're tired of the stress, but they can't imagine not working because they're institutionalized.
It creates compartmentalization, the purpose of that part is to have some time to create a different life.
Kevin Lyles: Exactly. It helps you through that period of fear. You're afraid of letting go and shutting off that income spigot and you don't know what you want to do. So, it gives you some time to sort of start planning.
Roger: Key message here is many of us don't think that these are even options. They are.
Kevin Lyles: Exactly. So, let's give people a smart sprint here. Go inquire at your work as to whether this is possible, whether others have done it. Maybe you don't want to ask your boss. Maybe you want to talk to coworkers who are a little bit older than you and may have done some things.
Just find out what's been done in your company and give it some thought. You may not want to do that, but it's a good option for a lot of people.
TODAY’S SMART SPRINT SEGMENT
On your marks, get set,
and we're off to take a little baby step you can take in the next seven days to not just rock retirement, but rock life.
All right, in the next seven days, pretty easy one. Examine whether it makes sense for you to make Roth contributions, and if you're over the limit, does it make sense for you to make backdoor Roth contributions or Roth 401k contributions?
The key here, and this is a good time to do it because we're right after the end of the year, you've just updated your net worth statement, is to simply make a decision. Take a look at it, look at your tax brackets for this year, whether it's your 401k or your Roth IRA, and does it make sense for you to make contributions to your Roth?
Just make a decision and close that loop so you can move on to other planning items.
CONCLUSION
One quick correction before we go. I think last week I was talking about required minimum distributions and had a fumble of words and said that once you start your RMDs, when you reach the age, you're required to make them every year until you retire. It's not until you retire, it's until you pass away. So quick correction there.
Well, thanks for listening to the show. Our pledge to you is always to focus on you and your journey and to try to be as authentic as possible with no pretense. Humble, respectful, curious about looking at things with fresh eyes and free from big finance products and gimmicks.
We're just trying to think through things logically and improve for, well, I'm trying to improve every day and I'm sure you are too. We also pledge to have you focus on taking incremental action. Action trumps intention all the time. I believe you can rock retirement regardless of what's going on in the world.
I'm here to think through this with you. We are all in with you. So, let's do this.
The opinions voiced in this podcast are for general information only and not intended to provide specific advice or recommendations for any individual. All performance references are historical and does not guarantee future results. All indices are unmanaged and cannot be invested in directly. Make sure you consult your legal tax or financial advisor before making any decisions.