In this month’s edition of “Money Matters,” Scott discusses how Roth IRA conversions can be a successful financial strategy for some people, depending on their situation and financial goals.

Money Matters: Roth IRA Conversions & Financial Planning Transcript

0:00:00.4 Mark: WTIP is pleased to have a monthly feature intended to help us understand about managing our finances, and it's called Money Matters. Scott Oeth is a certified financial planner and adjunct professor. He's taught hundreds of financial professionals' retirement planning and wealth management strategies. Scott joins us now by phone. Good morning, Scott.

0:00:21.0 Scott Oeth: Good morning, Mark.

0:00:23.8 Mark: So are you working from home these days, Scott?

0:00:26.7 SO: I am. I am indeed. Been doing that for almost two months now, I guess.

0:00:32.7 Mark: And how is that working for you?

0:00:35.1 SO: You know, it's not bad. I've worked from home partially for a long time, the better part of 15 years, so I had... I'm very lucky and fortunate that I had a little bit of a home office setup where I can go lock myself away and bury my head in paperwork and get things done, but we have three kids at home and dog barking. And it does get a little extra trying at times.

0:00:58.5 Mark: Alright, just in general, we're gonna talk about Roth IRAs today, but just in general, any suggestions about navigating these financial times?

0:01:09.9 SO: Well, in general, I'd say be wary that emotions, fear, panic, those things can really cloud long-term decision making, and we have a lot of that going on right now. And so I think this is a very good time to take a few deep breaths before you make any moves, seek expert advice, talk to other folks, do your research. There's a lot of rules of thumb and off-hand statements being thrown around, but I think it's more important than ever to really make sure you're getting some qualified, experienced advice and doing your research before you act on things, whether it's managing investments or making tax moves or insurance or anything in those matters. You wanna make sure it's well thought out.

0:01:57.9 Mark: I think for a lot of us that have had some of these decision-making things now about financial planning thrust upon us, need to just take a step back and talk to somebody that knows what they're talking about, instead of just consulting relatives and friends. This is the time for talking with an expert, possibly.

0:02:17.6 SO: I would agree. Yeah, I would agree.

0:02:19.2 Mark: Alright, now talk about Roth IRA conversions, and this is where my head starts to spin when we talk about Roth IRAs. You're gonna explain it for us really well.

0:02:30.2 SO: Well, first of all, you're not alone, Mark. Don't feel bad. So this is a planning opportunity that has been around for quite a while, but the stars have aligned to make this look extra important or appealing in 2020. It's not something for everyone. Individual listeners really do need to sharpen the pencil, run the numbers in their own situation, seek advice from an accountant, a certified financial planner and make sure it makes sense. So we're gonna talk about some things that make this sound like it's an important or a powerful move, and it can be for certain individuals, but not everyone. So do your homework. But Roth IRAs, there's this whole alphabet soup of steps and SIMPLEs and 401k' s and 403b's and 457s, and this whole litany of retirement, tax-advantaged retirement plans named after code sections that the IRS has put out there. Almost all of them, they're all funded with dollars that you don't pay taxes on. They're pre-tax dollars that go into these plans. You can choose investments. Investments grow tax deferred until you take the money out in retirement is the idea and you pay tax on them at that point.

0:03:43.6 SO: So wonderful tools for building up a retirement nest egg. There is one type of retirement account where you pay the tax on the dollars now, income tax. It goes into a retirement account. It can be invested. The investments are tax sheltered as they grow, and as long as a few criteria are met, their earnings can come out tax free. And that's the Roth IRA, and we now have Roth 401k provisions. So it's a different flavor. It's choosing to voluntarily decide, "I'm gonna pay the income tax on these dollars now, put them in this account for the long haul thinking that it'll be better off having tax-free growth as opposed to tax-deferred income." So that's kind of the big picture of the difference between all the traditional retirement plans and the Roth IRAs, Roth plans.

0:04:36.6 Mark: At the point in people's lives, is this something that people would be doing pre-retirement or is this something that people can even consider after retirement?

0:04:45.8 SO: Yes, both. So while you're working to putting dollars away, you can choose through our income limit, and this is where you need to double check and make sure, see what fits in your situation. But you can choose between investing as you're packing money away between pre-tax accounts and Roth accounts, that's one thing. And then the unique feature that we're... We wanted to talk about this morning is you have the ability to say, "Oh, I have balances built up in my 401k or my SIMPLE plan or my 403b plan." You can choose to pay income tax on those with restrictions and convert those to a Roth IRA. So that decision to say, "I've built up some balance and retirement savings, gee, doesn't make sense now to take some or all that money, pay income tax on it and shift it over to a Roth IRA account." So that decision could be made while you're in your working years or when you're in retirement. There's a couple of things that are going on right now that make it appealing, I think, for almost everyone to consider, "Is this something that makes sense for me?" And that is asset values are down.

0:05:53.4 SO: Now, we've had a nice comeback since the big drop a couple of months ago, but certain areas of the market are still quite a bit down, smaller company stocks, international stocks. Some areas that are probably worthwhile for most investors to have in a long-term portfolio are still down 20% or so. So you pay the income tax on the fair market value. It's like they're compressed, and possibly you might be able to pay the income tax now, shift those investments to a Roth IRA, and then when they recover at some point down the road, it's like a jack in the box, and you capture that growth on a tax-free basis. So that's one thing. It's the potential to pay tax, uncompressed dollar amounts. The other thing is we had a big tax cut in 2017, and for a lot of people that are in a lower tax rate now, those tax cuts are scheduled to sunset in 2026 and go back to a higher level. We have lots of federal stimulus. We have big deficits. Very likely that a lot of people will be paying tax at a higher rate later, that's a bit of a guessing game, but it seems very likely, so that choice ain't cheap. Maybe I pay tax now at a lower rate than later, that's the big decision point.

0:07:05.6 Mark: You know what, I'm actually getting this. I'm actually understanding very well.

0:07:10.9 SO: Okay, well, good. Well, good.

0:07:12.1 Mark: Now... Go ahead.

0:07:13.1 SO: Just one other thing I throw out there, Mark. It's kinda a unique situation too because for a lot of retirees, there's no sort of a golden window. We have values that are down, tax rates that are down, tax rates that seem likely to climb in the future. But there was a couple of Tax Acts that came through this year, the SECURE Act and the CARES Act, and they changed some of the rules. There's a thing called Required Minimum Distributions for retirees where they have to take money out on the back end of retirement, on the retirement accounts. That's waived for 2020 now as part of the CARES Act that just went through. And the SECURE Act that started January 1, pushed that beginning date to age 72. So this is getting way into the weeds of this stuff, but the short story is, it's created a window of opportunity here where the... A lot of retirees are not forced to take dollars out of retirement accounts. And the way our tax scale works is kinda like filling up a measuring cup. You're pouring water. You've got the marks at the side 10%, 12%, 22. So if you don't have any water coming in from required distribution, you have the potential to start filling up those lower rates, and they're getting paid tax on these conversions at a low rate and get it over to that Roth side.

0:08:30.9 Mark: Alright. Now, are there downsides to doing this Roth IRA conversion?

0:08:35.5 SO: Yes, potentially many. And here again, is not, this is not a one-size-all thing at all. It's complex transaction. You really need to think it through with your professionals on your team. There's a number. The biggest one is you might be wrong. Tax rates might be lower later on or even flat, and you chose to pay income tax earlier than you had to. You could have let that money still work for you, to still be invested. That's the biggest downside, I think. It's just getting it wrong. But also, you are pulling more income into this year when you do a conversion, and that can have a whole number of things. It could potentially change the way your Social Security benefits are taxed or your Medicare premiums. There's a 3.8% net investment income surtax. There's a whole sort of list of little things that could get you if this is a great strategy.

0:09:27.0 Mark: We are talking with Scott Oeth. We'll be talking finances with Scott on the first Wednesday of the month on North Shore Morning. Scott, anything else you wanna add this morning? Thank you very much for explaining this 'cause I do have it in my head now. I think I understand a little better.

0:09:42.3 SO: Well, good, good, good. I'm glad I helped at least get one person to sort it out here. I'd say it's worth taking a look and it's worth taking a look whether you're working and you have just a bit of money that you're setting aside. Should it go into a Roth IRA versus say your 401k or a traditional IRA? That's an important decision. And then further, folks, if you have a bit of a balance built up, think through this opportunity. Does it make sense to convert some or all that traditional IRA or 401k to a Roth IRA? It could be a very good long-term financial plan strategy.

0:10:15.5 Mark: Alright. Well, my takeaway from this is, learn about it, talk to somebody that knows what they're talking about, not your uncle Joe, talk to maybe somebody with some financial background and a financial advisor. So thank you very much for talking with us today, Scott.

0:10:30.5 SO: Thanks, Mark. Appreciate the opportunity.

0:10:32.5 Mark: Alright, have a great day.

0:10:34.5 SO: You as well.