Back to the basics on Roth
November 1, 2023
Welcome to The Retirement Tax Podcast, where hosts Steven Jarvis, CPA, and Benjamin Brandt, CFP, work together to bridge the gap between tax professionals, financial advisors, and their mutual clients to help reduce most people’s largest expense in retirement: taxes. Each week, they will dive into conversations around taxes, focusing on what you can truly control (instead of what you cannot) and how to set yourself up financially for your future.
Thanks in part to an article that kept being sent to Steven, he and Ben share their thoughts on what the true value of Roth accounts can be and how to sift through the “noise” on the internet (that Steven refers to as garbage at one point in the episode). Tax planning is situation specific so Ben and Steven talk about the clients they typically work with and how it is going to make the most sense to look into Roth options. Stay to the end for their thoughts on what Congress might do in the future with Roth rules.
What You’ll Learn In Today’s Episode:
Read The Transcript Below:
Hello everyone and welcome back to the Least Boring Tax Podcast, AKA, the Retirement Tax podcast. I’m one of your co-hosts, Steven Jarvis, CPA, and with me the much more illustrious Benjamin Brandt.
Always happy to be here, Steven.
Well, Ben, I love getting together to be able to record these episodes, and quite often you and I get pretty excited about whatever topic that we are discussing. We just dive straight in. There’s some recurring themes that come up on this podcast. Roth conversions is certainly one of them. None of our listeners will be surprised by that. An article that I was recently sent a couple of times kind of reminded me that sometimes it might be good for us to take a step back and maybe cover a couple of things at a more basic level and really talk about who it is we think we’re speaking to because we do mention all the time in this podcast that tax planning has to be situation specific. The answer almost always starts with, it depends, and we are serious about that. There isn’t a wink and a nod that, hey, everyone should do the exact same thing in every situation. Roth is not something that we personally get a commission on, but we want to make sure that people listening understand when it applies to them and when it doesn’t, and that sometimes even just as importantly, that they can sort through all of the noise that’s out there on the internet and on social media that might feel distracted or even demoralizing at times.
Well, that’s why we call it personal finance. Not everybody finance, right? As much as we love the Roth IRA or many other things that we talk about frequently, it doesn’t mean that it applies to everyone. You’ve got to do your own due diligence. We’ve surveyed our audience. We just, I think, put the cap on our sixth annual listener survey and something around 70% of people listening have no intention of ever hiring a financial advisor because they like to do it themselves, which we’re in full support of because we know that the 30% that will hire an advisor are going to hire somebody that we’re affiliated with or us directly or something like that, and everybody wins. So we encourage people knowing that 70% of our audience is going to do it themselves. We really encourage people to do their due diligence, read these articles, listen to the podcasts, attend to the webinars like the one we had just a few days ago.
Do all those things to educate yourself, but know that this is personal finance, not everybody finance. You’ve got to run that through your filters and say, I know that that thing that Steven was talking about doesn’t apply to me and here’s why. So that’s why every once in a while we’ve got to rewind and go back to the basics and say, here’s what a Roth is, here’s where it applies, and based on the people that we work with on a day-to-day basis, here’s why we recommend it. And then you can look for your own similarities to that situation, say, I think that does apply or doesn’t. So some of that we’re limited by the medium in that this is kind of one-way traffic when it comes to us talking into the ether, but we serve enough people to know that it’s super helpful. So that’s why we want to keep doing it. But yeah, that’s why everyone once in a while we want to rewind and talk about the basics.
Well, and you can go out to retirementtaxpodcast.com and you actually can send us a message. We love hearing from our listeners. We do our best to explain the assumptions that we’re using and why we think that what we’re recommending is reasonable for the situations we’re recommending in. But if we ever say something on this podcast and you think, geez, guys, you are so far off base because you didn’t think about this one other thing, Hey, send it to us. I will gladly answer those questions because in part that’s what we’re going to do today is, I won’t mention the author by name, but I again was sent this article a few times. That was this claim that the person who wrote the article, the self-proclaimed financial expert, had lost $400,000 by contributing to a Roth account, and as a huge proponent of Roth as a user of Roth myself, that did catch my attention.
My antenna immediately went up of, there’s got to be something off here. This sounds like clickbait, but there was definitely an article behind it. There were some spreadsheets behind it. There was a lot of numbers behind it, but as I dug into it, it’s like, okay, this is why we have a podcast like this, because there’s so much will nicely say fluff. The thought that more comes to mind is garbage that’s out there that it can be. If you’re not doing your due diligence, it can be really easy to be distracted or demoralized if you’ve been converting to Roth because you did your assessment. You said, Hey, you know what? After I retire and before I start social security, there’s going to be a couple of years where I have a lower tax rate and absolutely I should be getting things into Roth. And then you see this article by someone claiming to be a financial expert saying that. I want to say that in there he said that less than 1% of people would ever benefit from having a Roth and then makes up some math as to why that’s supported. Again, I’m kind of a numbers nerd. So I started digging through his spreadsheets and started to realize that yes, you can make two plus two equal anything you want it to be, but that doesn’t mean it’s going to apply to your situation.
So maybe we should start by, let’s maybe describe Steven since we share a lot of clients and you work with advisors that you share clients with that I have no affiliation with. Maybe describe what the average person that you work with is. So for me, we work with investors that have been super savers. They’ve saved up at least a million dollars and their income, what they want from that asset is generally in the six figure range. So social security pension, IRA withdrawals, everything in a bucket, million dollars, and then they want something. Some people have five, $6 million and they want a couple hundred thousand dollars a year, but there’s a certain income tax and investment complexity that allows our skills to shine, and thus we charge a fee for that service. I will acknowledge that if you’ve saved up a million dollars, you are in the top 10%.
I think it might even be in the top 5% of all savers if your 401k balance is over a million dollars. So we recognize that we’re not talking to everybody. We’re talking to a fairly narrow swath of the American super saving public, but we do that because we work with these people on a daily basis and we feel like we can speak unique value to their unique situations. Now Steven, I know you work with dozens of advisors and then through them, hundreds of clients, but maybe you could describe a little bit about what your average client looks like.
Yeah. I work with a larger variety of clients than you do just because, like you said, I work with a variety of advisors and they all have their own areas of specialty, but I would say a common theme amongst all of them is that if they are already in retirement, they are looking at six figures of income a year or more, or if they’re, I’ve worked with a lot of mid-career professionals as well, but they’re setting themselves up for that kind of retirement. So yes, these are people who are in that top five, 10% of earners for sure. Yeah, you make a really good point. The strategies we talk about here aren’t for everyone. If you expect that your retirement is going to just be social security or just social security and a few thousand extra off of an investment portfolio, then a lot of things we talk about probably aren’t worth your time, you’re probably going to be just fine because at that level, a lot of social security is not going to be taxable.
There’s just not as much that you need to be doing. But the thing that I think gets glossed over quite often, and maybe it’s something we should speak to more often as well, is I think people get in their heads that they’re going to earn all this money, have this lifestyle through their earning years, and then suddenly in retirement, they’re just going to stop. They’re just going to cut back. They’re going to have half as much expenses a quarter of the expenses. And in reality, especially for people who have worked hard and done a good job being super savers, that’s just not what we see in reality. You don’t just magically get to 65 or whatever age you decide to retire and think, you know what? My life is now going to cost a fraction of what it did before.
Sure. Even if you are the rare case that says, I’m going to stop spending a money in retirement, our hands are forced after a certain age where depending your retirement savings, if we’re not really diligent about how we manage that, it becomes less about how much you want to spend and how much you have to spend because our hand is forced through required minimum distributions. So while the article author talks about only 1% of people might need a Roth, everybody that has an IRA is going to be subject to required minimum distributions, and do we want to be in the driver’s seat on those distributions or do we want to be reactive and told 20 years from now what our income is going to be? If we want to be proactive, then we want to try to have what we call the perfect RMD where we intentionally from the first day of retirement, we structure our income intentionally every year to fill up the friendly parts of the tax brackets so that when we get to that required minimum distribution age, what we see as a perfect RMD is the amount that we’re going to take out for our lifestyle automatically satisfies that required minimum distribution.
So we’re actually taking out more than is mandated. For many people that don’t listen to our podcasts or aren’t interested in Roth IRAs, they do the opposite is they only take out what they need and never a penny more. And because that’s what worked during their working years and this amount in their IRA 401K accounts keeps building and deferring over time so that when they do hit age 72, 73, when they have to take out distributions, they have to take out significantly more than what is needed for their lifestyle. And that is what gets people hammered with income taxes. So I think what the author is talking about is during the accumulation phase and saving into a Roth, I’ve encouraged many clients over the last few years to stop doing that.
Because their income is going to be lower in retirement. You only knew that through plan. You can’t really learn that from a podcast because you need some kind of back and forth feedback on that. But that’s who we are helping with a Roth is someone that we’re intentionally spending more money now by doing Roth conversions with the strong likelihood of spending significantly less later. Now, we only know that through a comprehensive plan. We only know that through taking advantage of our number one advantage over the IRS looking at a 30 year opportunity to spend taxes versus the IRS is looking at one year over year. So there’s a lot of nuance that goes there, and it does matter who we’re visiting with as clients, but we just want to give you that perspective to know to just give a different lens and who we’re talking to and who we’re giving advice to, and then how you can use your own situation and due diligence to say, does this make sense for me?
Yeah, great points in there, Ben. The other thing that comes to mind that I think we’re hitting on here is whether you’re reading it or listening into it or however you’re consuming information, especially when something seems like it’s on an extreme, you really got to take a step back and just ask some questions. Is this person talking to people like me? Where is this credibility coming from? Does this pass the straight face test? Because again, I’m probably more of a numbers nerd than a lot, but as I dug into this article in particular, one of the things that was done to get to these giant numbers of why everyone’s going to lose so much money in Roth is that when they did the comparison of how much distributing pre-tax dollars in retirement was going to cost in taxes, they just assumed that there were no other sources of income.
There was no social security, there were no pensions, there was no taxable accounts. That was your only source of income. And again, they were looking at people who made $70,000 in their peak earning years and were only taking $30,000 in retirement. And so yes, I can make the math work against any situation if I puzzle through it enough. I think more important though, Ben, is to your point that you’re taking the information you learn, you’re applying it to your own situation, and especially when it comes to Roth, I also like to remind myself, remind my clients that part of the reason we do this is for the potential tax savings for the real money we can save if tax rates go up in the future. The other piece is to create flexibility. You mentioned the fact that the IRS only has so much patience, and at some point we will start having required minimum distributions, but it also creates a lot of flexibility by having a tax-free bucket. That’s what Roth is, a tax-free bucket. Now we’re better able to deal with the unexpected in life, whether we get into retirement and decide, you know what? I want to buy that RV or I want to travel around the world, or we’ve got to replace our roof or deal with an unexpected medical bill. Having a large tax-free bucket creates a ton of flexibility for us.
Flexibility, yeah. That’s where we’re going to save a lot of money on taxes is just looking at every year looking at taxes over 30 years, but looking at each year individually and saying, I need $30,000. I’ve got my taxable account. I’ve got my savings account after taxes, I’ve got my IRA, I’ve got my Roth IRA, I’ve got two or three or five or six different ways to get this money that I need. And those options are where we save a lot of money on income taxes.
Yeah, so the simplest version of Roth versus pre-tax is in my peak earning years, I would rather be contributing pre-tax in my relatively lower earning years I would either like to be contributing Roth or converting to Roth. But to your point, Ben, it’s so much more nuanced than that in the individual years and how we make those decisions. And really that’s only going to happen in an effective way if we have a comprehensive plan, whether we want to take the time to figure out that comprehensive plan ourselves or work with a professional who does that.
Well, Steven, I hope that gives some background on why we love a Roth IRA so much, and then just some of the basics about how they work at different net worth or income levels. I think we could pivot onto a listener question. Listener writes in, “are you worried that Congress will change the rules on Roth and will suddenly become taxable? So this is something that does come up in planning from time to time. We’re playing baseball with the government and they decide to change the rules in the seventh inning. How can we pivot? Should we be worried about this? Is this something that keeps us up at night? Should we plan for it?” So I’ll let you answer, but for our team, we can’t operate on possibilities. We want to operate on probabilities. It’s possible that the government could change these rules in the middle of the baseball game.
The likelihood is not. We want to focus on the probabilities. If we look at recent legislation like Secure Act 2.0, maybe even some tax cut in Jobs Act, if we’re reading the tea leaves, if we’re reading between the lines and appropriately mixing our metaphors, the government loves the Roth IRA because the government would rather have some money today than more money tomorrow. I dunno if you’re sitting down or not, Steven and our federal fellow listeners, but the government is short on cash. They want cash. They want you to do Roth conversions. They want you to do all these sorts of things because they want that tax money now, and of course the government’s going to be broke 20 years from now, but that’s a different set of politicians’ problems, not theirs. So in order to balance the books, they want that revenue today. So that’s why I’m not worried about it.
I know that people are worried, oftentimes on the internet, people that are worried have ulterior motives. They want to sell you life insurance or gold or annuities or something else. So they want you to be worried, but we’re not worried. We don’t have a crystal ball, but we don’t think the government’s going to make any changes to Roth right now because there is no long-term incentive for them to do. So the incentive that they’re focused on is the short-term of I want that new, fresh, juicy revenue now. So you should do all the conversions. We’re going to set up rules to incentivize that. That’s the first rule of economics for anybody that has read the Freakonomics books is that human beings are motivated by incentives, and that also goes through the government as well. So the incentives are lined up for the government to get that revenue now, which is very Roth friendly.
Ben, I dunno what you’re doing. I have a crystal ball. It’s just broken, but I do have one that sits on my desk as you went through that. I don’t know that I have anything particularly salient to add other than what you covered, because I think that really hits on those different really key points of Yes, absolutely. We need to remember that tax code is written in pencil. Congress can change it anytime they want to, but we can only make decisions based on the information we have today. The other thing that I take comfort in personally is that I am recommending to my clients the same things that I do in my own situation. So if 10 years from now it comes out that Congress is going to tax every Roth dollar, that’s going to be some uncomfortable conversations, but it’s, Hey, we did the best we could and we were all in this together. And to your point, I don’t see how that happens when it’s such a direct impact to voters. But you’re welcome to keep this recording if it changes in the future. Unfortunately, the IRS is not going to take, while Steven and Ben said, this wouldn’t change as a legal argument for not paying your taxes.
Well, and I’ll even give a selfish plug now. Human beings are motivated by incentives. Of course, laws are made based on the size of voting blocks, right? Politicians bring home the bacon and so on and so forth. So if you want your Roth IRA to be preserved from adverse judgment against the Roth, convince your friends to listen to this podcast. Then we will convince them to put more in a Roth. Then they will become a larger voting block, and thus your Roth will become more safe as a result. See, human beings are motivated by incentives, even for your humble podcast hosts. So the more of your friends that listen to the show, the more Roth they’ll be and the safer they’ll be. So not so humble plug. Get your friends to listen to the show.
I listen to a lot of podcasts, that is my new favorite call to action for people to refer a podcast to their friends. Let’s make a bigger voting block around Roth IRAs.
Can the show improve from here, Steven, or are we calling it today?
I think we should probably wrap it up there. We just got to make sure that we remind everyone that as they’re going about their lives and enjoying everything, just remember to not let the tax man hit you where the good Lord split you.