IRA vs. Roth IRA Pt. 2 with JoAnn Huber
IRA vs. Roth IRA Show Notes
In the last episode, CERTIFIED FINANCIAL PLANNER® and CPA JoAnn Huber and I kicked off the podcast with a discussion about the differences between the IRA and the Roth IRA.
However, we barely scratched the surface, and if you’re feeling confused after listening to Part 1 of our conversation, that’s okay. This is one of the most important financial decisions you will make on the road to retirement. It’s also a complicated one to answer, and there’s no clear one-size-fits-all plan that works perfectly for everyone.
In today’s episode, JoAnn and I continue discussing this important topic. You’ll hear the importance of working with an independent professional with no product to sell – someone who can assess your financial situation and create a plan every time you have a major life transition.
In this podcast interview, you’ll learn:
- How the new tax code changed the rules of retirement for small business owners – and why you need to be even more careful to ensure you qualify for deductions.
- Circumstances under which you can’t receive a tax deduction when making a contribution to an IRA – and why you may want to create a “backdoor Roth” to work around this.
- Why understanding the rules of the tax code is key to never paying more tax than you have to.
- “If you make the wrong choice, it can be the difference between thousands of dollars in spendable income in retirement.”
– Dean Barber
- “Websites with IRA calculators don’t care what you do. They just want your money.”
– Dean Barber
[00:00:11] Dean: Welcome to the Guided Retirement Show. I’m Dean Barber, Managing Director at Modern Wealth Management in Kansas City. This is Part 2 of IRAs vs Roth IRAs. The guided retirement show is here to guide you through all of the things that are out there that can be opportunities or potential pitfalls that could impact either positively or negatively your retirement. We take deep dives into subjects and really get down to the nitty-gritty so that you’re not having to listen to just a few soundbites from a television station or even a regular radio program. We’re going to take you in depth so that you will have much more knowledge to make better decisions. We want to be your retirement guide. This week we’re going to talk more about the Roth IRA versus the IRA.
And trust me when I tell you this, JoAnn and I spent a ton of time talking about Roth IRAs versus traditional IRAs and you know what, we’re scratching the surface here. This is so complicated. There’s so many things that you need to know before you make the decision of whether you use a traditional or a Roth whether it’s an IRA or a 401(k). Enjoy today’s show. Take lots of notes.
[00:01:31] Dean: So, if you’re more confused now than when you started listening to JoAnn talk and I talk about this whole Roth IRA or traditional IRA which one should I do, you’re probably not alone and the thing is that, I think, in every scenario there is an exact answer that can be given. Am I correct there?
[00:01:56] JoAnn: There is but it’s going to be unique to each person. It’s not just one of those things where you read the latest article on money magazine or hear something on CNBC or something. You really got to look at your own individual situation and say, “How does this apply to me and what do I have and what do I want to do?” And I see and talk to people all the time just like you do. I mean, between the two of us we’re seeing 100 people a month and we’re talking to them about their financial situation, their tax situation and this question is probably one of the driving questions of what do I do? Should I do the Roth? Should I do the traditional? Should I do a conversion? Should I not? I even heard something really, really crazy from some radio show host here within the last couple of weeks where he made a comment that I couldn’t believe this is actually coming from a proposed financial advisor.
I’m not sure what his designations were, what the situation was, but he said up until the tax law change under Trump’s Tax Act, the Roth IRA didn’t make any sense, but now it does. And I’m going, “Wait a minute. We’ve been using the Roth IRA for 21 years now and I’ve seen hundreds upon hundreds of scenarios where the Roth IRA made a ton of sense.” I think the biggest thing is that even though I said that the Roth IRA is the best portion of the tax code that’s ever been written and the reason it’s the best tax code ever written is because it’s got a zero tax rate and there’s no better tax rate than zero.
[00:03:40] JoAnn: Right.
[00:03:41] Dean: Right? But it doesn’t mean that you just blindly say, “Well, the Roth IRAs, the best version of tax codes that’s ever been written I should put everything into a Roth because that might not be the right answer.
[00:03:54] JoAnn: Right. With the new tax law with the qualified business income deduction, if you have a small business owner, they’ve got to really be careful about where they’re putting their money because it might make the difference between being able to deduct that qualified business income and not being able to. And so, there’s a lot of planning and that’s beyond the scope of what we want to get into here but there’s so many questions that people need to be asking themselves when they’re deciding where do I put that money.
[00:04:27] Dean: I think that that decision on whether you choose the traditional or the Roth, especially if you’re, I mean, I guess it doesn’t really matter. If you’re getting started saving early or even if you’re later in your career, if you make the wrong choice, it can equate to tens of thousands of dollars of either more spendable income in retirement or less spendable income in retirement. So, you make the wrong choice, it’s going to be less spendable income. If you make the right choice, it’s going to be more spendable income in retirement. So, why in the world would our industry try to oversimplify how you make that decision? That doesn’t make any sense to me at all.
[00:05:12] JoAnn: I’m not sure if they’re just shortsighted or if this is the easy approach so we’ll just say this because it is a lot of work to go through and figure out what is the right place for people to be saving.
[00:05:23] Dean: Well, you know, the interesting thing and I have a theory and I don’t know that my theory is a correct theory or not, but most of the websites that you’ll find that have these calculators on them of whether you should do a traditional or Roth, the honest answer is they don’t really care which you do. They just want your money.
[00:05:47] JoAnn: I think there’s a lot of truth to that.
[00:05:49] Dean: They just want to make sure that if you land on their website, do that conversion, “Oh, you can open your IRA right here.” “Oh well, that’s easy. Let me just open my IRA right here.” So, I think that it does a great disservice to oversimplify this whole idea of a person can choose whether they should use traditional or Roth without really going into all of the mechanics that you and I have been talking about today.
[00:06:14] JoAnn: Yeah. I think it does but I agree with your theory that it is a lot of just making it simple so they can get that money. But what we want to do at least for the people that we talk with is make sure that they’re making the best decision for them.
[00:06:27] Dean: Right. And so, there are ways that you can do this. So, as an example, let’s just say that you wanted an unbiased opinion. You wanted someone who didn’t care if you invested your Roth IRA or your 401(k) with them or not. You just want somebody to perform an analysis for you that’s unbiased, that doesn’t have a financial product to sell just to tell you based on your personal situation should you be doing a traditional IRA versus a Roth IRA? Now, there are plenty of people out there including JoAnn right here that can do that calculation for you for an hourly rate where you’ll sit down, gather the applicable data and charge by the hour to give the right answer.
And depending upon the complexity of your situation I think your minimum fee, JoAnn, to do this is like $350 or something like that but in a lot of cases, if it’s a more complex scenario, that bill could rise above that. But I think the key thing to take into consideration here if you’re going to think about, “Well, should I really pay somebody to make this calculation for me?” I think the answer is absolutely 100% yes. You’re better off doing that than using one of these silly online calculators that really doesn’t give you the right answer because like I said before, the difference could be it could be $5,000 to $10,000 every year of additional income by making the right choice. And if I got to pay somebody to make sure that I’m making the right choice because that’s their expertise and I’m going to pay a few hundred dollars to get myself an additional $5,000 to $10,000 a year in retirement, that’s a no-brainer for me.
[00:08:23] JoAnn: That’s a pretty good return on your investment.
[00:08:25] Dean: Yeah.
[00:08:26] JoAnn: And the thing is this isn’t just a one-time thing that you look at because your situation is going to change from year to year. So, in one year, it may make sense to contribute to a Roth. Another year the traditional might make sense.
[00:08:39] Dean: Right. But I don’t want people to think that, “Oh, if I do this, if I have JoAnn calculate this for me one time then I’m going to have to go back and have her calculate it for me every year.” Look, if you’re in a scenario where you’re earning money, you’re in your 40s, you’re in your 50s, you don’t think your income is going to change, we can do a good long-term looking forecast that say, “Okay. For the next five years, unless something changes, you should do X.”
[00:08:59] JoAnn: Right. So, what I was talking about is say you’re working and then maybe you get laid off and so you’re out of work for most of the year and then you go back to work. Well, we might want to put things in at Roth IRA or formulating. So, there’s different situations to look at.
[00:09:17] Dean: Play that game with me for a minute.
[00:09:18] JoAnn: Okay.
[00:09:19] Dean: Right now, we’ve got full employment in the United States. Everybody’s working that wants to work. There are more job openings than there are applicants and some of the people that are unemployed probably should be unemployed or not. You don’t want a worker where they don’t fit the skill sets that are available for them to go get a job. So, let’s just say the recession hits and all the sudden employment goes from 3.7% to 10% or higher like it did back in the Great Recession. We run into somebody then that has done a good job of saving. They got money in their traditional 401(k). They got money in their traditional IRA. They’ve saved a good amount of money in an account that is their what we’ll their emergency funds, their liquid money that they can use in case of emergencies. They lose their job. They get unemployment but that’s their only source of income and they’re using their savings then on top of their unemployment income to sustain their lifestyle. First of all, is that unemployment taxable income?
[00:10:28] JoAnn: It is taxable income.
[00:10:30] Dean: Okay. So, we had to take that into consideration that employment is taxable income, but that might be an area where that person could’ve been in a 32% tax bracket while they were working and now all the sudden, they find themselves in a 12% bracket. So, are you saying that that’s when a person would want to sit down and say, “Gosh, okay, that might be an opportunity for me to get some of that money out of my traditional that I got to deduct the 32%? Maybe I can take it out of 12?”
[00:10:56] JoAnn: Or maybe they have enough saved that we can look at that Roth conversion that we talked a little bit about earlier. So, there’s a lot of things we’re looking at. So, when I say it’s something you need to revisit, it’s really when you have those transitions in life that that’s the time where you need to reevaluate and say, “Okay. What do I do now?”
[00:11:14] Dean: Okay. Let’s take a quick break. This is the Guided Retirement Show. I’m Dean Barber. We’ll be right back.
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[00:12:37] Dean: Most of the websites that you’ll find that have these calculators on them of whether you should do a traditional or Roth, the honest answer is they don’t really care which you do. They just want your money.
[00:12:50] JoAnn: I think there’s a lot of truth to that.
[00:12:52] Dean: They just want to make sure that if you land on their website do that conversion, “Oh, you can open your IRA right here. Oh, well, that’s easy. Let me just open my IRA right here.”
[00:13:16] Dean: We’re back. So, I think the simple answer to a very complicated question of Roth or traditional, the simple answer is it’s your personal situation and the only way that you’re going to know that you’re making the right decision is by getting some unbiased advice, somebody that’s just looking at your situation, but doesn’t have a financial product to sell you, that doesn’t care where the money is invested and just pay that person by the hour to do the work and say what should I do?
[00:13:59] JoAnn: Right. And one thing I want to point out you mentioned earlier about people saving into a 401(k) and getting a match. Well, even if you’re contributing to a Roth 401(k), the employer match piece is going to be going into a traditional 401(k).
[00:14:14] Dean: And that gets split out on the person’s statement. So, when they get their statement, they’ll see this was my contribution to traditional and, by the way, you could do a portion to traditional, a portion to Roth and then you get your employer match. So, you see how all those break out.
[00:14:30] JoAnn: And so, even if you think that everything you’re putting in is going into the Roth, chances are pretty good that you’re getting that employer match and it’s going into the traditional piece.
[00:14:40] Dean: And so, it gets pretty tricky and we could do it. We will do a whole podcast, JoAnn, on rollovers and so the IRA rollovers, get money out of that 401(k), and some of the traps and snares that are there that can get in a person’s way that can really cost you dearly if you don’t follow all the right rules. I don’t want to get into that today because that’s…
[00:15:01] JoAnn: No. It’s a whole different podcast.
[00:15:03] Dean: That’s a whole another discussion. Anything else on the Roth IRA that you think is critical that we talk about today that we haven’t touched on yet?
[00:15:12] JoAnn: Well, one thing that I think is important when we’re looking at the traditional versus the Roth is a lot of times people may not be eligible to even make a contribution to a traditional IRA because if they’re covered by a 401(k) plan at work, then there’s income limits on being able to contribute to both the traditional and the Roth IRA.
[00:15:33] Dean: Well, hold on because you can contribute to an IRA no matter how much money you make.
[00:15:39] JoAnn: Right. You can.
[00:15:40] Dean: That doesn’t matter.
[00:15:41] JoAnn: So, a lot of times people will say, “Well, I’m putting money into a traditional IRA,” but if they exceed the earning limits then all a sudden that money they’re putting into the traditional IRA is no longer tax deductible and so they’ve lost the benefit of it.
[00:15:55] Dean: Well, they got the money in the IRA. It’s going to go tax-deferred, right? But they just didn’t get the deduction.
[00:16:02] JoAnn: Right. So, now they have to keep track of basis because it’s considered. So, what it is, is it’s considered an after-tax contribution to an IRA. So, you don’t get the deduction for it which a lot of times people are putting it into that traditional IRA, trying to get that tax deduction but if their income is over I think it’s about $80,000 and they’re covered by an employer plan, they’re not eligible.
[00:16:29] Dean: That’s a single individual?
[00:16:30] JoAnn: Yeah. They’re not eligible to take a tax deduction for it.
[00:16:34] Dean: Okay. But they can still put it in?
[00:16:35] JoAnn: You can put it in but are you putting it in to get the tax deduction and if somebody…
[00:16:41] Dean: Well, maybe they’re just putting it in to get tax-deferred growth?
[00:16:44] JoAnn: And that’s a possibility, but that’s another complication that comes into it. Now, the Roth IRA has a higher contribution limit. So, if you’re not going to get the deduction for putting it in, all of the growth that happens on that traditional IRA, that after-tax contribution, you still have to pay tax on that growth when it comes out.
[00:17:04] Dean: So, what’s my income limit to contribute to a Roth IRA?
[00:17:06] JoAnn: Let me look and see. So, the phase-out for deducting…
[00:17:10] Dean: Let’s go to the top of it, just so I can’t deduct anything.
[00:17:13] JoAnn: Okay. You can’t deduct anything if your adjusted gross income exceeds 121,000 and that’s married filing joint and 73,000 if you’re single or head of household and if you’re covered by an employer plan.
[00:17:26] Dean: So, I can’t deduct any of my IRA contributions if I’m single and I exceed what?
[00:17:31] JoAnn: 73,000.
[00:17:32] Dean: And if I’m married?
[00:17:34] JoAnn: 121,000.
[00:17:35] Dean: Okay. So, I can make a contribution to a traditional IRA then no deduction.
[00:17:39] JoAnn: Right.
[00:17:39] Dean: Now, what’s my Roth earnings?
[00:17:41] JoAnn: So, the Roth for a single taxpayer is 135,000.
[00:17:46] Dean: So, I can make a Roth contribution after taxes all the way up to 135,000.
[00:17:51] JoAnn: Right. And for a joint couple, it’s 199,000. And so, people might say, “Well, really, what’s the difference?”
[00:17:58] Dean: But what if I’m earning 250,000? What do I do?
[00:18:02] JoAnn: Well, that you can put money into traditional IRA. You just don’t get the tax deduction.
[00:18:06] Dean: Well, what if I just put in a traditional today and then I want to move it to a Roth next week?
[00:18:12] JoAnn: You can and that’s what one thing we want to look at is a backdoor Roth is what we kind of call that because if you’re putting it in to the traditional IRA and you don’t get a deduction for it, that’s when you get what is considered basis. And under the tax code, you can then go and do that Roth conversion of it.
[00:18:31] Dean: Okay. I want to be really clear. All right. You say basis and if somebody has real estate, their idea of basis is different than the definition that you gave. If someone has a stock in a dividend reinvestment plan, their idea of basis is different than the basis that you’re talking about here. So, I want you to be really clear of what the basis is in this after-tax contribution.
[00:18:57] JoAnn: So, the basis is the amount that you contributed to that IRA account on that after-tax basis.
[00:19:03] Dean: So, if any dividends reinvest or whatever, that does not add to your basis inside of your IRA?
[00:19:09] JoAnn: So, if you maximize it and put in a $5,500 that would be your basis.
[00:19:14] Dean: So, why don’t we just call it contributions as opposed to basis?
[00:16:18] JoAnn: Because that’s not how the tax code was written. I don’t know.
[00:19:21] Dean: But they have different definitions for basis.
[00:19:24] JoAnn: Right. So, I mean, well, you think about it and really is basis is what you put into it on all of those things, the real estate and the stock. It just gets a little confusing because if people are reinvesting that you’ve kind of forget that they’re really buying new shares and they’re putting that back in because it’s like they got the dividend paid out to them and then they put it in. But anyway, let’s just go on the example to the back-door Roth. So, you have that contribution.
[00:19:51] Dean: So, I put $5,500 into my IRA on an after-tax basis because I made too much money to do a Roth or a traditional. I couldn’t get the deduction for the traditional. I made too much money to put into a Roth. So, I put $5,500 into a traditional IRA, nondeductible. I want to move that now to a Roth.
[00:20:08] JoAnn: And that’s where it gets a little bit complicated.
[00:20:11] Dean: Everything I talk about you say it gets complicated.
[00:20:13] JoAnn: That’s the tax code, and that’s not my fault. I didn’t write it. So, if that’s the only IRA you have and that’s the only money that you have in it, then it’s simple. You just move it over to the Roth and you’ll pay tax on whatever earnings occur between the time you make the contribution and you roll it over.
[00:20:33] Dean: So, if I did it next week and I put the money in today and it’s just in the money market there are no earnings on that.
[00:20:38] JoAnn: There’s going to be very little and there are some disagreement between professionals on how long do you have to wait from when you put it into the traditional IRA before you can convert it to that Roth.
[00:20:48] Dean: A day? A week?
[00:20:50] JoAnn: Some people will say you can do it at the same time. Others say you really need to wait a year or so before you do that.
[00:20:56] Dean: Why?
[00:20:58] Joanne: It has to do with what’s called this step transaction doctrine at which is an IRS thing. So, it’s probably not really but basically what that means…
[00:21:05] Dean: Now, what was the step transaction doctrine written for?
[00:21:10] JoAnn: Well, I don’t even know the answer to that, but I can tell you what…
[00:21:14] Dean: Was it written for the IRA to convert to a Roth?
[00:21:16] JoAnn: No, it wasn’t. It’s just a general tax code and they’re basically saying if you’re trying to get from A to C, but you throw B in kind of a set intermediary to throw things off, you really didn’t just do A to C. And so, in this situation they’re saying if all you’re doing is putting it in and moving that the next day you really just were making that Roth contribution which wasn’t allowed.
[00:21:42] Dean: But is there anything in the tax code, though that says that if I put money into a nondeductible traditional IRA today and I want to move it over to a Roth tomorrow that I can’t?
[00:21:51] JoAnn: No. Which is what would be really nice is if they gave some guidance instead of saying, “Well, it might not.”
[00:21:55] Dean: So, if it doesn’t say that I can’t, then why is your argument…
[00:22:00] JoAnn: But it doesn’t say you can and so that’s why there’s so much difference between different people who are a lot smarter than I am on when you can do it.
[00:22:07] Dean: But it says you can move it from a traditional to a Roth but that doesn’t say that you can’t do within a specified period of time. So, if I were looking at that as a simple person I’d say, “Well, there’s no specified period of time so I can do it anytime I want to.”
[00:22:20] JoAnn: Right. And so, it really just depends on how risk-averse you are or how…
[00:22:25] Dean: I don’t know where the risk would be in that but…
[00:22:28] JoAnn: Well, because they could come back and say, “You really did just make an ineligible contribution to a Roth IRA.”
[00:22:33] Dean: But where does it say in the tax code in here?
[00:22:34] JoAnn: I don’t know. I’m going to debate this with you because I don’t know the answer.
[00:22:36] Dean: I’m just saying. So, every time I say something you go, “It’s complicated.” Well, here’s the deal. It is.
[00:22:41] JoAnn: It is.
[00:22:42] Dean: Every single aspect of the tax code is complicated because in order to do this you got to refer back to this code section, that code section, refers to another code section, and all of a sudden, the normal person trying to decipher what is it that the IRS is trying to tell me or the guidelines here gets confused. So much so, JoAnn, that I can take my tax situation to five different CPAs with identical data and I’m going to get five different answers on how much I owe.
[00:23:12] JoAnn: You’re right.
[00:23:13] Dean: That’s crazy.
[00:23:16] JoAnn: You know, and you would think that it would be simple in the whole Trump Tax Bill. It was supposed to simplify things and it made it more complicated.
[00:23:23] Dean: It did. It made it more complicated, but I think the moral of the story is, and we can kind of wrap up here, the moral of the story is that the tax code is complex. It’s over 76,000 pages long, but if you understand the rules well enough, you should never pay any more tax than what you absolutely have to. And if you can understand the rules well enough to never pay any more tax than you absolutely have to, well, guess what that does. That keeps more money in your pocket that you could spend for the things that you want as opposed to sending off to Uncle Sam and letting them spend it in what I’ll consider many cases to be very wasteful fashion.
[00:24:07] JoAnn: Right. So, it’s all about you having the control on how you want to spend your money.
[00:24:13] Dean: Right. This was fun. I think that we’re going to get together again shortly and do another podcast. We’ll kind of do some polls with some of our clients to figure out what’s the next hottest topic, what is it you want to hear us discussed, and we probably will come back and revisit this whole idea of Roth IRA versus traditional IRA. And I think you and I could probably spend quite some time talking not just about the Roth versus traditional but really go into some more detail on Roth conversions and how to really impact your retirement income, net of taxes by doing Roth conversions after you retire, but that’s a whole another very lengthy discussion.
[00:25:00] JoAnn: It is but it’s an important one because that’s where so many people can really impact their taxes and minimize it for the long-term.
[00:25:08] Dean: Thanks for spending some time with me today.
[00:25:10] JoAnn: You’re welcome.
[00:25:11] Dean: Thanks for taking the time to listen to the Guided Retirement Show. I’m Dean Barber, Managing Director at Modern Wealth Management in Kansas City. There are thousands of podcasts out there. Thank you for choosing to listen to ours. Thanks for taking the time. On next program will be with a lady by the name of Bree Williams and she’s going to talk about the psychological effects of retiring and how sometimes as you get a little older, your cognitive abilities change and things that you need to have in place and things that you need to be speaking with your adult children about so that they can help you through what could be some difficult times in your older years.
I want to make sure that you understand that you can go out and get a copy of our retirement plan checklist and a great piece of JoAnn Huber, CPA, and CERTIFIED FINANCIAL PLANNER® authored called Tax Reduction Strategies. All you have to do is go to the show notes here of your favorite podcast or go directly to the website and the website is GuidedRetirementShow.com/2. Make sure you subscribe to the podcast, share it with a friend who may be getting ready to retire even if they’re already retired and make sure to rate our podcast and I look forward to engaging you more and guiding you through retirement on our next episode.
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