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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Welcome to How to Retire On Time, a show that answers your retirement questions. My name is Mike Decker. I'm a licensed financial advisor and fiduciary. And with me in the studio today is my colleague, David Franson, who will be reading your retirement questions. As always, you can submit those questions to (913) 363-1234.
Mike:Again, that's (913) 363-1234. David, what do we have for today?
David:Hey, Mike. What's the best way to get funds into a Roth IRA? And do you just click a button and they move over?
Mike:Yeah. So I wanna open up the conversation more than just Roth. Okay. But let's just talk about tax free in general. So there's kind of a couple of categories that I would consider the tax free category to be in, and they're slightly nuanced.
Mike:So you've got a Roth IRA. Roth IRAs or the after tax part of your four zero one k or four zero three b or whatever. Basically, it grows tax free, as in it grows without being subject to capital gains tax. K. And then when you take it out, it's tax free.
Mike:It doesn't hurt your provisional income or your Social Security calculations. It doesn't hurt your income taxes and so on. So that's one way that you can operate tax free, and people love it because it's the easiest to do. It is difficult though to get funds into a Roth because you have to be working, and you have to make within a certain threshold, and you may not qualify for Roth, and then you've got these other things to get money into Roth, and let's just briefly go through those. You've got your Roth contribution.
Mike:You've got your IRA, your backdoor IRA to Roth, so you can put funds into an IRA, and then do an IRA to Roth conversion. And then you've got your backdoor or your mega backdoor, which is through your four zero one K, which is kind of another way you could do this. Okay?
David:Okay. I've never heard mega backdoor before.
Mike:Yeah. It's not really common. I don't wanna spend too much time on it. If you wanted me to talk about it more, just text us that question. Hey, Mike.
Mike:Explain the mega backdoor Roth. That's that's a pretty black and white definition that you could probably ask chat GPT to or whoever you use. Yeah. But let's just generally speaking, when you're working, you should be able to get funds into a Roth in one way or the other. Now retirement accounts or qualified accounts, these are accounts that are not subject to capital gains, whether you're getting money into a Roth or an IRA, it's it's very beneficial.
Mike:There's a huge benefit to these accounts, but you have to ask yourself at what cost? So we get many very successful people that are earning 250 to $400,000 household income that are saying, everyone says I should get money into the Roth, or I should do the backdoor Roth or the IRA Roth. The Roth is where funds need to go. And I say, okay. What's your adjusted gross income or your modified adjusted gross income, depending on the situation?
Mike:Yeah. And then what is your what's your tax bracket? And they'll tell me. I'll say, okay. Would you like to pay that or potentially more, depending on where they are, just to get funds into a Roth right now?
Mike:Or let's look at your adjusted gross income when you retire. Would you rather pay that percentage on the conversions? And almost every time they sober up and say, what? It's like they they let go of this FOMO, the fear of missing out, because everyone else is putting funds in the Roth, and they're just they're deferring their income tax, put it into their IRA, and then they're gonna put funds in the Roth later. So there's an important understanding of the environment in your tax situation and the sequence of how to get funds into the Roth.
David:Yeah. Because anytime you put what do I wanna say? It it's income. Right? When you're moving from a traditional IRA to a Roth, that's income.
David:You're paying income taxes.
Mike:Yes. So at what tax bracket or, in my opinion, a more appropriate measurement, what's the effective tax rate of you moving those funds over?
David:Okay.
Mike:How does that change your dynamic environment? Does that affect your health care? If you're on Medicare, is that gonna put you into IRMAA? Are you okay with that? Are you gonna do it for a limited period of time?
Mike:Are you not gonna do it for a limited period of time? Are you on affordable care act because you retired before 65 years old? All these questions matter. So you don't wanna be like I don't know what is are those lemmings that just run off a cliff because other lemmings fell off a cliff or whatever? Is that the right expression?
David:Yeah. That's
Mike:right. You wanna go online, this would be a fun webinar to do. I don't know if we'll do it or not. But just going on Reddit, and just finding threads, and then explaining why they're idiots. Now I wanna defend Reddit.
Mike:Yeah. Half them are self proclaimed philosophers that believe they're financial wizards, and the other half are brilliant financial advisors. Like, they actually know their stuff. But to the uninitiated, they both probably look the same, And that's the problem. How do you differentiate?
Mike:I mean, that's like me going on the medical forums and trying to figure out what is right. Let's step on a landmine right now. Let's talk about vaccines for a second. Can we talk about that?
David:Can't wait. Yep. Let's talk it.
Mike:Not a medical professional. Do you think I could properly sort through the medical research on if that's good or not?
David:Yeah. That'd be tough.
Mike:I'm not qualified to do that. Weird. That's that's kind of how I like to envision someone who doesn't have a financial background trying to figure out how to proceed with all of this. You have no idea how to differentiate the the differences, and you could put it in the chat GPT, but chat GPT is gonna give you the most predictable answer it believes it's supposed to give you. Yeah.
Mike:It's not actually doing research, and for all those who don't know, large language models take the information that's in there, and whoever has the loudest voice or the most popular form, it's going to influence the answer that it gives you. So it's a tricky one. So when you have this idea, how do you get funds into a Roth? You have to first ask yourself, is Roth the next step, or should you be putting funds to do with IRA, and then put the funds in the Roth later? Can you even put funds to a Roth?
Mike:And by the way, this is an important distinction on Roth contributions versus conversions.
David:Okay.
Mike:So a contribution is when you take after tax funds, like your checking and savings account, and you add it to a Roth account. If you're able to do that and you add to a Roth account, there's around a five year holding period. You can't take the funds out.
David:Okay.
Mike:If you do a conversion, dollar for dollar, you can take those funds out. Oh. The five year holding period is only based on the gains of those assets. You have to do a proper accounting of how the funds are moving, but people misunderstand that as well. So there's different ways to move the funds over to the Roth.
Mike:Now there's other tax free ways that you could also consider. One of them being municipal bonds. You're not gonna make as much money probably with municipal bonds for the growth potential, but you probably won't lose as much money, but that's a tax free source that there's no limit. The sky's the limit, so the ultra wealthy might use municipal bonds just to try and lower all their overall cash or taxable situations for a period of time. Should someone with twenty to thirty million dollars just go all in on municipal bonds to avoid taxes?
Mike:I don't think that's prudent. I see a lot of people do it, but I just don't think it's prudent. Because what's the end goal? To send in municipal bonds and just call it good and to suspend critical thought, or is it to be industrious with your money, and prudent with your money, and grow your money in different ways? Got some heartburn with that.
Mike:Now the insurance industry is is going to propose what's called an index universal life insurance policy. All life insurance, technically, it grows tax deferred or tax free because you're not creating a taxable situation as the money grows.
David:Okay.
Mike:You can borrow against the policy tax free because you're not taking income out. You're not taking cash out, you're borrowing against the policy tax free. That is a true statement, and then whenever you pass, the death benefit will then pay back the loans on the policy, and then beneficiaries allegedly tax free. Now that depends on your estate, and does the benefit go to your estate, and does that cross over an estate tax exemption? I mean, there there's different ways that that could create a taxable situation or not, so be very careful with how you structure your estate plan and any life insurance benefits.
Mike:It's not as cut and dry as people assume. But going back to the life insurance side, insurance is not an investment.
David:Think I've heard your say that before on the show.
Mike:Insurance is not an investment, but there is a cash vehicle associated with these policies. It's not like term life insurance. And so when you get people online or on TikTok or on the radio saying, this is how you cheat the IRS is through index universal life insurance, and that's how the Rockefellers did it, and that's how you should do it too, and this is how the wealthy do it. It's not. I'll tell you right now.
Mike:When I work with someone that has 20,000,000 plus, and we're talking about their planning, I will jokingly say, alright. We can talk about life insurance. Do you feel that you need to get a death benefit? Then they laugh. And I say, I thought so.
Mike:And then we move on. K? Maybe they do it because there there's some sort of risks they wanna pay for to hedge against. I see that. But the rich aren't cheating the IRS by growing their cash through life insurance.
Mike:If they buy life insurance, it's for a certain specific time frame that if they died sooner than they expected, that's going to help cover some potential illiquidity or other issues on passing their estate. You don't cheat the market. You don't get more money by just buying life insurance and then dying soon. If you're on your deathbed, they're not gonna insure you. So the odds have to be against you for the death benefit to work out.
Mike:K? And this is I cannot say this emphatically enough. I get probably the most pushback from insurance agents, whom I am an insurance agent technically speaking, and from the ultra wealthy who were sold this idea that life insurance is how they solve their estate planning issues and their estate planning tax issues, and there's this visceral resistance. I mean, almost like they're foaming at the mouth. It's like, no.
Mike:I wasn't lied to. Well, let's just run the numbers. Here's the different times where it would make sense, and here's when it wouldn't have made sense based on these average projections. The insurance company isn't printing money to give you a larger death benefit. They're not cheating the stock market, and you aren't either.
Mike:Life insurance is paying for a death benefit so that if you die sooner than expected, knowing that the odds are in the insurance company's favor, yeah, you might get a nice ROI. Yeah. That can bridge the gap when it comes to businesses being illiquid or maybe things aren't settled in the right way for the estate tax purposes, whatever it is, and you're willing to pay to hedge against that risk. But you're not getting rich off of life insurance. Life insurance is a great way to hedge against that, to hedge against spousal risk if a spouse were to pass sooner than expected, hoping that your spouse doesn't pass, or maybe I'm going out on a limb here.
Mike:Maybe you're taking the bond fund component or the lower risk part of your overall plan in the portfolio, because most people aren't all in stocks. They've got some lesser risk assets that aren't growing as much as the S and P, but they're not losing when the S and P goes down. Maybe you take some of those assets and you structure an appropriate index universal life insurance policy so that the cash value hopefully advances at an equal or near rate as the cash value would have done with bond funds, depending on how the portfolio was done, and you get the death benefit. That is a reasonable possibility. That is a reasonable, in my opinion, thing to look for.
Mike:As long as you're okay paying for the death benefit, as long as the insurance policy is structured, as long as it makes sense from a funding standpoint, because you're probably not gonna make much money for ten years in doing this. This is a long term play. There's a lot of as long as you're okay with fill in the blank situations. Sometimes it makes sense. Sometimes it doesn't.
Mike:But let's not tell everyone that everyone should do the same thing. Let's get into the details and understand what's going on. But that is another vehicle that you could funnel money into that would grow tax free and help shelter potential tax issues. It just depends on your situation. That's all the time we've got for the show today.
Mike:If you enjoyed the show, consider subscribing to it wherever you get your podcasts. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis.
Mike:Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date, go to www.yourwealthanalysis.com today to learn more and get started.