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SEP IRA to Roth Conversions and Stretch Roth IRAs and RMDs - YMYW podcast - YouTube
Channel: Your Money, Your Wealth
[5]
We got Susan from San Diego.
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"Hi Joe and Al.
[9]
My husband has money in a SEP IRA that he
was able to save when he had a small business
[15]
years ago.
[16]
He no longer has that business, just his regular
income which is reported on a W-2.
[21]
As he cannot add any more savings to the SEP,
he was thinking about converting this to a
[25]
Roth IRA this year.
[26]
He will have to pay the taxes on the conversion
but is it possible for him to convert straight
[31]
from his SEP IRA to his Roth?
[34]
Susan, yes.
[36]
The answer is yes.
[39]
Absolutely.
[40]
But you would want to be careful, I guess.
[42]
I mean what's the balance of the SEP IRA?
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What tax bracket are you in?
[46]
Sure.
[47]
You've gotta ask a few more questions, and
I think that's a great question, because a
[51]
lot of times when you're reading or listening
to pundits that talk about, "you could do
[56]
an IRA to Roth conversion," you could also
do a SEP IRA to Roth conversion, you can do
[61]
a 401(k) balance to a Roth conversion.
[65]
You can take any retirement account and convert
it to a Roth IRA.
[70]
And now it used to be that you could recharacterize
if you converted too much.
[75]
You had until the filing date of your tax
return, and you had to recharacterize generally
[79]
back to an IRA, regardless of where it came
from.
[82]
But those rules are gone.
[85]
So it's very simple - whatever account you
have, it's a SEP IRA, you can convert that
[89]
directly to a Roth.
[91]
The question is should you?
[92]
What's your tax bracket now, what's it going
to be in the future?
[96]
Maybe you're in a low bracket, maybe you're
in a high bracket.
[99]
The lower the bracket you are, the more likely
you're going to want to do a conversion now
[103]
while tax rates are lower.
[105]
Maybe you want to fill up your current bracket,
so maybe you don't convert at all.
[108]
Maybe you convert part of it.
[109]
So those are things you've got to look at.
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Yeah.
[112]
So again, to refresh our listeners on what
the heck a conversion is, it's taking money
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- so a SEP IRA is just a self employment pension plan.
[121]
So her husband, Susan's husband, was self-employed
and set up a retirement plan for
[127]
his small business.
[128]
And so it was a pre-tax plan.
[130]
So he got the tax deduction for money going
into the SEP, the money grows tax deferred.
[134]
And then when he would pull the money out,
it's going to be taxed at
[137]
ordinary income rates.
[139]
Susan is a big fan of the show.
[141]
And so she's like, "well wait a minute, maybe
it might make sense for him or us to have
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tax-free money in retirement."
[148]
So strategies that we've talked about in the
past is taking retirement accounts, any accounts
[153]
for that matter, and moving some of that or
all of it into a Roth.
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The reason why you would want to do that is
that all future growth of that investment
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will grow 100% tax-free.
[165]
So you convert $10,000, that $10,000 grows
to $15,000.
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Let's say you need a pull of a few thousand
out to live on.
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That would be 100% tax free for you, as long
as you qualified for a tax free distribution,
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and that just means you have to be over 59
and a half or the Roth needs to be open for
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five years or longer.
[183]
So what we look at, and what we talk about,
is that yeah, tax rates are
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a little bit lower now.
[189]
We had the tax reform, so marginal rates have dropped.
[191]
And so, it could be a really good strategy
for a lot of people to look at.
[196]
So looking at your tax return is going to
determine how much that you convert.
[200]
You bet.
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And so what we're talking about, like for
example, a married couple, the 24% tax bracket
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goes all the way up to about $321,000 of taxable
income for 2019.
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Realize when you do a Roth conversion, you
have to do it in the tax year that you're in.
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In other words, it's not like a contribution
where you can do it April 15th.
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You have to do it by year end.
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So now we're talking 2019.
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And so for a lot of folks it's like, well
this is a lower bracket now than I'm going
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to be in retirement, because the old tax rates
are coming back and alternative minimum tax
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will be a bigger factor when it comes back.
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And so why not?
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And for single, that 24% bracket goes to about
$160,000, so that's pretty good to take a
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look at that.
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I think virtually everyone listening should
be considering it.
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Now, whether they should do it or not is based
upon their own circumstances.
[253]
And she goes on to write, "it would be very
beneficial for your listeners is you highly
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recommend everyone having a Roth IRA."
[262]
Susan, we do not highly recommend anything
on this show.
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We share ideas.
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We do not give advice.
[269]
That's compliance.
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"Thank you for all the great information you share."
[277]
OK, so she wants to learn a little bit about
a stretch Roth IRA.
[284]
So let's say that her husband then converts
the SEP IRA to a Roth IRA, and then the Roth
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IRA is growing tax-free and the husband dies.
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What happens to that money?
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So a few things can happen.
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Let's say Susan is still living.
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She could keep it in the deceased husband's
name and she has full access to the money
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like it's her own, because she is the beneficiary.
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As long as she's the beneficiary on the account.
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So she can keep it in his name.
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And let's say Susan's under 59 and a half,
she can have full access to the dollars.
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That's the only real reason why you would
want to keep it in the deceased spouse's name
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is that if you're under 59 and a half and
you need access to it.
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Because if you are a beneficial owner of a
retirement account, you have access to those
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dollars without that 10% penalty.
[327]
So it would still be tax-free to you Susan,
as long as that account was open for five years.
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If it wasn't, you would still have to wait
for the five year clock to get any type of
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interest out of that account.
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Maybe you're wondering what happens to that
account, and both of you are spouses, and
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let's say you have a son or daughter that
is going to be the beneficiary of that account.
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So if it's after the second spouse passes,
how it works is that it would still be in
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the deceased's name.
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So to make this easy, let's say her husband
passes, Susan puts the Roth IRA into her own
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Roth IRA, which she can, because they're spouses.
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Now she passes away and it goes to her child.
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Now the child cannot put the Roth IRA into
the child's account.
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It will blow the thing up.
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It would unravel everything and 100% of that
Roth IRA would be distributed.
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Then any future growth of those dollars are
going to be taxed at either a capital gains
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interest or dividend.
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So you don't want to do that, especially if
you're converting them and paying tax.
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You want to have it parlayed tax-deferred
as long as you possibly can.
[393]
So you pass, Susan, it goes to your heir.
[398]
And so what happens then is that it still
stays in your name though.
[401]
That's the biggest tricky part about all retirement
accounts going to the next generation, or
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any non-spouse beneficiary, I should say.
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So it would stay in Susan's name for the benefit
of her issue.
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Which is "kid."
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Which is child.
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(laughs) Or any beneficiary.
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Well he's probably caused some "issues" in
Susan's life. (laughs)
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Yeah. Just clarifying. (laughs) You got legal on us.
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(laughs) I read a book over the weekend.
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But here's the catch with Roth IRAs.
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You don't have to take a required distribution.
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If it's your account, you do not have to take
a required distribution.
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What that is is that it's a mandatory distribution,
age 70 and a half, thereafter you have to
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start taking money out of the account.
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In a Roth IRA you do not, as long as you're
the owner of the account.
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Once you pass away though, you're still the
owner of the account, the beneficiary is a
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beneficial owner.
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So it's not a true ownership of that account.
[461]
So that non-spouse beneficiary will have to
take a required distribution from the Roth
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IRA based on that child's life expectancy.
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The distribution is tax-free, but they do
have to pull money out of the account based
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on their life expectancy.
[476]
Yeah I think that bears a little repeating.
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So it's still tax-free - when you do the Roth
conversion, what's in that account is tax-free
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for whoever inherits it.
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But if it's a non-spouse, if it's a child
or nephew or friend, a non-spouse, then they
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have to take a required distribution.
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They could be eight years old and still have
to take a distribution based upon the eight
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year old's life expectancy.
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And the reason is because the IRS doesn't
want these accounts to grow generation after
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generation tax-free.
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And so in recent tax law, that did not pass,
what they want to do is eliminate, basically,
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the stretch IRA.
[514]
Right. And we thought they would, because both the
Democrats and the Republicans wanted that.
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So they were saying, "No, this is a retirement account.
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We want you to distribute in your lifetime,
because it's for your retirement, not your
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child's retirement."
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That's right.
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Or if you die early, it's got to come out
in five years.
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Right.
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Get the whole thing out.
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We want our tax money, let's recycle the money.
[536]
And so what the latest proposal was is that
you could pass about $450,000 - 400 or 450.
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That would be able to stretch.
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Everything else has to come out within five
years or that year.
[549]
Yeah. And that was the proposal, which did not pass.
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Right.
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It didn't pass so we still have the stretch.
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We still have the full stretch on regular
IRAs and Roth IRAs.
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And I mean, there have been rumors of, maybe
you can pass a million dollars.
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Maybe it's 200, and maybe it's 4, whatever.
[563]
so stay tuned on that.
[566]
But just know that if you ever inherit a retirement
account, you have to take a required distribution.
[571]
We just had an individual that came in, inherited
an account, never took a required distribution
[578]
for like three or four years.
[580]
And they were with a broker, we're like, "well
what did you tell the broker?"
[583]
And then they're like, "oh yeah, they're gonna
run some numbers for me."
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And I was like, "Well when did you inherit
this thing?"
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"Well, four or five years ago."
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"And you've never taken an RMD??"
[590]
I looked at the tax return - nothing.
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So that's a 50% tax penalty each year that
you don't take the RMD.
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When you're looking at beneficial IRAs, it's
completely different than a regular IRA.
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Most custodians, iIf you've got your money
at TD Ameritrade, Fidelity, Merrill Lynch,
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whatever, they usually will send you a letter
saying, "hey, we have your birth date here,
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you're 75 years old.
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You need to take money out of this account.
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And here's the amount, roughly, that you need
to take out."
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And they're just going to give you the number
on the accounts that they hold.
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So maybe you have an account at Fidelity.
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You have an account at TD Ameritrade and Charles Schwab?
[631]
Maybe Charles Schwab doesn't do it or forgets .
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And then you get the number from TD Ameritrade
and you only take that RMD?
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You're gonna be short the RMD.
[639]
Be careful with that.
[640]
But non-spouse beneficiaries, a lot of them
don't even calculate that - they don't even
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know, they're like, "Screw it.
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I don't even know how much," that's on you.
[649]
You are the taxpayer, you are responsible
for taking the required distribution.
[653]
The custodian is not.
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They're doing it as a service - as a customer
service perk.
[660]
The IRS does not mandate Fidelity to send
you out a statement, for what I know.
[666]
Right.
[667]
Wow, you got pretty fired up.
[668]
Well, I just don't want people to lose money.
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I got a big heart, Al.
[672]
(laughs) Apparently.
[673]
You've got a big wallet. I've got a big… heart.
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