Bonus Mailbag #26: The Ultimate Guide To IRAs 

Ed Slott: (01:03)
Okay. Sounds good.

Jean Chatzky: (01:05)
All right. Question number one comes from Libby. And Libby writes, hi there. Should I convert my traditional IRA to a Roth IRA? I’m 64 years old and already retired. I have a traditional IRA with Vanguard. The current value is $613,000. It’s got $597,000 in stock funds and $16,000 in bond funds. I also have $487,000 in a 457 plan, all stock funds. I don’t expect to need this money or social security until I’m 70. Current expenses are covered by a small pension and taxable savings. Thanks for your thoughts on this. So, Ed, I think, you know, in terms of her question, does everybody always go with a Roth? Are there certain situations where a Roth isn’t the right move and what would you say to her specifically?

Ed Slott: (02:01)
Well, specifically, it sounds like she’s doing fine and she should probably have a plan to, over time, convert at least a 600,000 to a Roth IRA. Because you know how in investments, I’m sure you say this all the time. Everybody says it. Don’t put all your eggs in one basket, always diversify. But it’s the same thing with tax risk. You need to diversify your tax risk. It sounds like she has a lot of her eggs in one big taxable basket. I think she said she had an IRA or a 457 or both. That’s all taxable money. At some point she should start converting that because can you imagine, she said she’s 65 or 66?

Jean Chatzky: (02:44)
She said she is 64 years old and already retired.

Ed Slott: (02:49)
All right, let’s take it from the point of view, if she does nothing, can you imagine how much that account, or both of those retirement accounts will grow by the time she is forced to take it out at age 72. She’ll have massive tax bills for the rest of her life because of required minimum distributions. She’s in a good spot now, because she has the ability to convert before required minimum distributions begin. She can do an amount each year, maybe 50,000, whatever she can afford to pay tax on. Now that’s a big issue too. We didn’t cover this in the other segment. We talked all about Roth conversions and you actually made sure right up front, you said you have to have the money, and I prefer outside, which she said she does, to pay the tax. But you must have money to pay the tax, because after the tax cuts and jobs act, it changed the way we look at Roth conversions. Once you convert now, it’s permanent. You can’t go back. There’s no backsies. There’s no do-overs. The next year you will owe the tax. Now I wouldn’t have that deter you from converting to a Roth, but make sure you have the money to pay the tax. So I think in her case, she should probably do, if she can afford it, 50 to a hundred thousand a year of Roth conversions each year to empty that IRA I think she said she had. So that will lower her tax bill come age 72 and she’ll have more diversification. It seems like, if she does that, she’ll have half a funds in taxable accounts and the other half of her retirement funds in all tax-free accounts that require no RMDs.

Jean Chatzky: (04:26)
Yeah, I think that makes sense. And again, a point you made earlier in the other show was if she doesn’t have enough money to convert that much each year, you can convert less. You don’t have to convert such a sizable chunk. But I agree with you. I think that’s a good move. Next question is from somebody at the other age end of the spectrum. Hi Jean and the HerMoney team. My name is Cheyenne. I’m 23 years old and I’ve been an active listener to your show for about a year and a half. Kudos to you, Cheyenne, for getting on the money bandwagon so young. As a 2020 college grad, your advice has really helped me prepare for my adult life. So thank you. Thank you again for listening, Cheyenne. Okay. Here’s the question. With all the knowledge I have now, I can definitely see how my parents have not prepared for retirement at all. My parents, age 54 and 50, currently work jobs as independent contractors. They have no 401k plans and benefits. And from my understanding have exhausted all funds from previous 401ks through a plethora of bad financial decisions. I planned on helping them set up Schwab Roth IRAs and invest in the same low-maintenance mutual fund I’m currently investing in. They both seem open to the idea, but I’m not sure I can count on them to consistently add funds and invest them. How do I create some sense of urgency for retirement savings when they’re still young and active? Is there a way to automate these investments? I’m sure if I had to, I could log into their accounts and do it for them, but I want them to have some independence and I don’t want to babysit their money. My dad really enjoys his job and will work past the average retirement age, but I want to make sure they’re well taken care of. Once I pay off my student loans, I also plan on setting up some kind of brokerage account to contribute as well since I’m sure I will have to help take care of them eventually. Thank you for your advice. Oh my gosh, Cheyenne, you are wise beyond your years. And I don’t think I’ve ever seen Ed Slott’s eyes so big.

Ed Slott: (06:31)
Yeah. Well, I mean the first saying that comes to my mind, you can lead a horse to water, but you can’t make them drink. I don’t know how you’re going to force a change in behavior, somebody in their fifties. It’s nice you’re doing that and you’re worried, but they have to want to do it themselves. They may do it for, you know, to get you off their back, but it doesn’t seem like they’re in that mode.

Jean Chatzky: (06:56)
It doesn’t to me either but I think, Cheyenne, that automation is the key.

Ed Slott: (07:00)
Right.

Jean Chatzky: (07:00)
And if you can sit with them and you can get them to set up an account wherever you want to set it up and just arrange so that a certain amount of money is withdrawn from each of their accounts and moved into a Roth IRA every single month, then that money will continue to just go there and hopefully grow. And what I hope will happen is that your parents will have the same sort of eye–opening moment that you’ve had and that I saw that my son had. So my son, when he got his first job did not have a job with benefits. He’s five years in now. He still does not have a job where they’re contributing for him. But very early on, we opened a Roth for him and he started making monthly contributions and has been watching, for the last five years of this bull market, his money adding up. And he actually turned to me about two years in and said, oh my God, mom, why didn’t we do this sooner? And that’s what I hope happens with your parents. So encourage them to open the account. And then when you’re with your parents, go with them and visit their money. Make sure that you are watching them look at the growth. Make sure you are helping them revel in their progress. And I think that, if anything, has a chance of changing their mind.

Ed Slott: (08:25)
Yeah. I liked the idea of doing it with them. She mentioned going to wherever she’s going to go, .Schwab, Fidelity, wherever she’s going. And go there with them. And everybody do it together as a family thing.

Jean Chatzky: (08:36)
Yeah. Love that. All right. Next question. This one is from Brenda. She writes, hi. IRA question. Hubby and I have solid retirement planning status. We’re 45 and 46, have two long-funded Roths, one pension and one 401k, and investments in an HSA. We’re probably halfway to a million I believe, with a decent time period before considering official retirement. The Roths and HSA are maxed out, but I choose not to supplement the pension because it’s totally out of my control to manage. The 401k is good, but I’m content with staying at the company match for it. Fees are a little high. It also gets safe harbor contributions, occasionally, which add up impressively. I assume you’re familiar with safe harbor, she writes, I’m still a little fuzzy on it. Safe harbor, just FYI for all of you, is a fairness mechanism to make sure that your company contributes for you while they’re contributing a lot for the highest paid employees.

Ed Slott: (09:40)
Right. It’s meant to prevent discrimination of the top people just to say it. You can’t have the people at the top loading their pockets and not give something similar percentage-wise to the other employees.

Jean Chatzky: (09:52)
So basically she writes, my question is this. Am I correct that we’re doing enough for retirement or should we be considering a traditional IRA? We truly have free funds this year that I’m not sure how to allocate best. We have significant short-term savings available, hello vacation, when safe to do so, and our two kids have long-term investments in their names as well. So far I’ve been investing in an individual account. We are long time Fidelity customers. Yay. But is that the wisest? Thanks. Your info is very valuable. So where would you send her? First of all, let me just say, Brenda, it sounds like you’re completely on track. I don’t know what your income is, but if you listen to this show, then you know the benchmarks that we like to cite and I’ll just lay them out here for people who haven’t heard them. That by the time you’re 30, you should have about one times your annual income put aside for retirement, at 40, 3 times at 50, 6 times, at 60, 8 times. And by the time you retire, 10 times. And if you’re contributing generally about 15% a year, that can include matching dollars, you should be getting there. But where would you put that next dollar for her, Ed?

Ed Slott: (11:07)
If she qualifies, she didn’t say anything about having, she said, Roths.

Jean Chatzky: (11:12)
She maxes out a Roth IRA. Can she also do a traditional IRA?

Ed Slott: (11:17)
No, no, no. It’s a one limit for both. But it doesn’t mean, she said she sort of stopped after the match on the 401k. Why not see if your company has a Roth 401k and start maxing that out to build tax-free dollars. At your age, based on 45, 46 years old, you’re going to be in a very high bracket at retirement, and you should be doing all you can to push to Roth IRA. You’re the perfect candidate for a Roth, because you can see where you’re going. Look where you are now at 40. You know, in 20, 30 years, if you even retire by then, you’ll be at probably the highest tax bracket in the land. And that’s when you’ll wish you had a Roth IRA. So why don’t you start it? You have it now, but maybe you can add the Roth 401k element in your company, if they offer it.

Jean Chatzky: (12:07)
I agree. And I would say if they don’t offer it, I would just max out your regular 401k and get the tax benefits that way, and know that down the road, you’ll roll some of that money into an IRA or convert to a Roth IRA. And you’ll have an opportunity to do that if you ever change jobs.

Ed Slott: (12:26)
Yeah. She’s got everything else covered.

Jean Chatzky: (12:27)
Yeah, for sure. We’ve got more questions here, but before we get to them, let me just remind everyone that HerMoney is brought to you by Fidelity investments. Mom, you work hard all year long and your money should work just as hard for you. Join us for a special Women Talk Money event. In this candid conversation, we talk about the challenges of this past year and share stories to inspire other families. Also take advantage of access to articles, tools, and resources that can help you create a roadmap for your family’s financial future. Visit Fidelity.com/HerMoney to learn more. Ed Slott and I are tackling your IRA questions. Thank you so much for filling up our mailbag.

Jean Chatzky: (13:11)
Our next one comes from Joanna and she writes, hi Jean and Kathryn. Thanks for all you do to ensure women have access to so many helpful financial resources. Your show is a favorite of mine. I’ve listened to every single episode. And even when I don’t think the topic will be relevant to my particular circumstances, I end up learning something new. Thank you for saying all of that Joanna. And just so you know, I have just usurped Kathryn’s chair for this podcast, but she will be back with us next time. Joanna writes, I’m a 38 year old married mom who stays on top of our family’s finances on a regular basis. Back in January, my financial advisor and I decided 2021 would be the year when I rolled over an annuity valued at $22,000 from an old employer into my Roth IRA since the surrender fees and term had finally expired. Knowing that the money will be considered taxable income. I’m now trying to come up with as many different ways to bring down our adjusted gross income as possible, so that we can avoid a hefty tax bill in 2021. I’ve increased both my and my husband’s 403B contributions to $500 per paycheck, which is the most that we can afford really. And I’m maxing out our dependent and healthcare FSA accounts as well. I’ve also increased our charitable donations as much as possible, but we don’t have an HSA account to contribute to. Our health plan isn’t eligible. Do you have other suggestions we should consider? Based on our 2020 tax filing, we are eligible for the monthly child tax credit payments of $600 in July, but I recently read that if we opt out of those payments, we may not have to owe taxes as much come next April. Is that accurate? I’m feeling pretty confident in our financial future, despite the rollercoaster ride of the last year, and I have you and this podcast to thank for that. Thanks in advance for any suggestions you might have. Boy oh boy, Ed, I am happy to have a CPA on this podcast with me.

Ed Slott: (15:19)
I want to back to the beginning. She said she had an annuity she’s rolling into a Roth. I have to assume she’s doing a conversion and that annuity is in an IRA, because you just can’t take an annuity and put it in a Roth. I mean, you can take the money out, pay tax and do a Roth contribution. You can use any money for a Roth contribution for the six, well in her case, only 6,000, cause she’s in her thirties. So I don’t know which way she meant, but let’s assume, she said she cashed it.

Jean Chatzky: (15:48)
She said she’s rolling it in from an old employer.

Ed Slott: (15:52)
Then it has to be in like a 403B or some kind of like a TIAA-CREF, something like that. There’s the tax on the conversion. So that’s what she’s talking about. So she has the typical problem that sometimes steers people away from conversions, a one year spike in income. Like we said in the other segment, you can’t be short-sighted. You’re getting something for your money. Yes. For that one year, your income goes up and other things fall by the wayside. You don’t qualify for certain things, but over the long haul, that money will grow tax-free.

Jean Chatzky: (16:28)
Absolutely. Absolutely. But are there any other ways, I mean, I know that the increase in the standard deduction has just made it hard for people who don’t itemize to take advantage of abilities to reduce their adjusted gross income. And it sounds like she does itemize cause she mentioned charitable deductions. Are there other things that she should be doing?

Ed Slott: (16:52)
Well, I don’t know if she itemizes because she said she couldn’t afford this and that. And you know, you’d have to contribute a lot of money to go over the threshold to itemize. Remember about 90% of taxpayers now use the new higher standard deduction because they don’t come anywhere near the amount to itemize. So she says she keeps putting money in charity and gets no benefit. That may be what she means. You’d have to contribute, you know, let’s say they have a home mortgage, probably like 10,000 extra in charity just to get over that threshold. So it doesn’t sound like she’s getting any benefit for a charitable gifts tax benefit.

Jean Chatzky: (17:33)
Yeah. So basically you’re saying this may just be a pill that you have to swallow.

Ed Slott: (17:38)
Right. She’s doing everything else. I mean, she’s loading up on the 401k to have lower income maybe to offset that Roth conversion income. But the Roth conversion income. Yes. It’s uh, like you said. That’s a good way to put it. A pill to swallow one year. It’s like getting a vaccine or something. You know, it hurts the one time, but then it builds over time. So yeah, it’s like the medicine, that’s a good way to put it, for bigger benefits later on, especially in her 30s, she should be really picking up a Roth. And once she gets over this hump year, again, it sounds like I’m saying the same thing over and over again. She should look to switch a 401k to a Roth 401k. That’s true for anyone in their twenties and thirties, like Joanna is here. Why? Because the greatest money-making asset any individual can possess is time. And young people have more of it than anyone else. And this is the time to capitalize on it by pushing it into Roth. I think that, if there’s any group that it’s a no brainer, it’s a slam dunk to go all Roth, it’s younger people.

Jean Chatzky: (18:45)
Hundred percent. Our next question comes from Wendy from Colorado. She writes, I’ve been enjoying the podcast, as well as the HerMoney Facebook group, for well over two years now. I can honestly say it’s because of you all that I’m making a career pivot. After working for a major financial institution in various sales roles for 25 years, I just announced I’m taking early retirement and enrolled at the American College for Financial Services to become a chartered financial consultant. Woo-hoo I want to help young professionals in their financial journey, accumulate wealth, and those about to embark on retirement de-accumulate wealth. My question is, do I roll my 401k to my IRA this year and do a backdoor IRA conversion? I believe my husband and I will still be in a higher tax bracket this year and upon completion of my financial consultant program at the end of next year. I will begin to look for a new position then, and I’m unsure what our tax bracket will be in 2022. I’m turning 54 next month. My husband is 55 and wants to work another five years. Thanks for all you do. So she’s a yes, right? If she can afford to pay the taxes.

Ed Slott: (20:01)
Well, if she can wait till next year. See, here’s the thing. We don’t know what taxes will be next year. See, I like certainty. First of all, let me back up. She’s with the American College. I don’t know if you know this Jean, but I’m a professor of practice at the American College. So I’m glad to have her aboard. We actually have just created this year, for any financial advisors listening or watching the program, an on-demand training program I partnered with the American College with. It’s a fantastic program. She’ll probably be taking that program.

Jean Chatzky: (20:32)
She’s going to take your class, Ed. This is amazing.

Ed Slott: (20:36)
So it’s on there. It’s called IRA Success, the program. So just for others. But you like certainty. This is a big point I don’t think we made earlier. We know what 2021 tax rates are. I did say that they’re lowest rates we’ll ever see in our lifetime. But they are here now. We know what they are now. And we don’t know what future legislation will bring but one thing, and I don’t have any inside information, but my gut feeling is every day that goes by that there’s not a new tax bill passed, maybe there will be something later in the year, means it’s more likely that whatever they pass will not be retroactive to the first of the year, more likely be effective January 1, 2022. So we know what the rates are this year. If you can use up this year’s rates, it pays to do it this year. But if you truly think, no matter what they do with the tax law, you’ll be in a lower bracket next year, maybe save the Roth conversion for next year.

Jean Chatzky: (21:33)
There you go. Thank you for that. And thanks for writing. Our next question comes from an anonymous listener. We are cool with that, by the way. Hi Jean. Thanks so much for the wonderful podcast. Does it ever make sense to contribute to an IRA if you’re above the income limit to receive a tax deduction? Due to a recent compensation increase, my income now falls into this category. However, I’m still a bit behind in retirement funding. I’m maxing my 401k contribution this year at $26,000, but I want and need to save more. Last year. I also opened a Roth IRA and made the maximum contribution. However, this year I believe my income will disqualify me from a Roth contribution and I would not get a tax deduction for contributing to my existing IRA. Is there any case to be made to contribute to the traditional IRA without an available tax deduction or is that a bad choice? And if not an IRA, where else can I put these savings to grow my retirement funds. An HSA is not an option for me. I’m 55 years old, divorced, and my only child will be entering college this year. So I also want to make sure my investment strategy does not negatively impact financial aid awards during the next three years. Thank you. What do you think?

Ed Slott: (22:54)
Well, first of all, the answer, I know where we’re going is a backdoor Roth. She doesn’t qualify for the traditional IRA. Just to make things clear for other listeners, she said she was over the limit to take a tax deduction for a traditional IRA, but there was no income limit to have a traditional IRA. She could have a non-deductible IRA. So that’s the issue. She gets no tax deduction. So she said, should I just do a non-deductible IRA and forego the tax deduction? Well, if you’re going to do that, then you’re better off doing the non-deductible IRA. Yes. But then converting it to a Roth. Now, if you want to wait to convert it, because you don’t want high income this year because of financial aid, then do the traditional non-deductible IRA. Don’t convert it yet until you know what your situation is for 2021, as far as financial aid will be.

Jean Chatzky: (23:49)
Yeah. And just stash some cash to pay the taxes. So you know that you’ll be doing it down the road and just put some money in a separate account where you know that you’re not going to touch it so it’s there to do the conversion and until you have a clearer picture of what your financial aid is going to look like. And by the way, you’re really, really smart to recognize that your income is a factor in this, and that you’ve got to look at the whole picture of your financial landscape, because believe me, the colleges certainly do. So that was really smart. Last question. Ed, this one comes from Ann and she writes, what are the main benefits of investing in an IRA over a 401k? Most of my retirement is in a defined benefit plan. But I still try to save some extra in my employer’s 401k. Because of the pension, there is no employer match for the 401k. Just FYI for people, when we talk about defined benefit plans, we are talking about pensions. Because of the pension, there is no employer match for the 401k, but it does have both Roth and self-directed options. I opted into the self-directed account through Schwab and have the same diversified portfolio that I could build in any brokerage account. Is the primary benefit of an IRA the extra options of funds to invest in. Is there another reason I’m missing why you should go with an IRA over a 401k? Thank you. I’m so glad that actually we’re ending on this question because it’s one that we get all the time. And for me, yes. The company match is a huge benefit if you are able to get your hands on that. But the other big, big benefit is automation. The other benefit is that it comes out of your paycheck. If you don’t see it. You don’t touch it. You don’t spend it. And there’s research that shows when savings happens automatically, you save 15 times more than when it doesn’t. So I like that. But from your perspective, what’s the calculus?

Ed Slott: (25:51)
Well, you know, it’s interesting she mentioned that. I have a whole chapter on that in my book dedicated to the difference between a 401k and an IRA. And it depends on your particular facts and circumstances. First of all, generally with your IRA, you have the universe of investments, but lots of 401ks have a large menu of investments. And then you look at the fees. 401ks sometimes say their fees are lower. IRA people say their fees are lower. So you have to compare. I don’t believe either one of them, because you can never really get to what the real fees are, if you ever try and go through some of this stuff. But the big benefit of the IRA over the 401k, you have absolute control. You can take money out whenever you want. You can split it up for estate planning, separate accounts, different beneficiaries. Most company plans are not going to that for you. Many plans have their own rules. This is one of the areas of the tax law, where the actual tax law is more liberal than the plan’s own rules. So you get everything the tax law offers in your IRA, but the plan may have restrictions. Let’s say you want to convert to a Roth IRA from the plan. You may not be eligible for a distribution. Let’s say you want to convert within the plan to a Roth 401k. You have to find out when that’s available. You want to take certain distributions early. You may not be able to. You can take distributions. Let’s say you needed the money early in your IRA. You can take it whenever you want. Now you might pay a penalty before 59 and a half.

Jean Chatzky: (27:25)
And taxes.

Ed Slott: (27:26)
Of course taxes, but you’re in control. You don’t have to ask anybody and go through the bureaucracy of your company plan, especially if you’re in a big company,

Jean Chatzky: (27:36)
On the flip side, you can’t borrow from an IRA, right? And you can borrow from a 401k. And we know that a lot of people, it’s not something that we encourage, but it is something that people do.

Ed Slott: (27:49)
Right.

Jean Chatzky: (27:49)
And it’s beneficial.

Ed Slott: (27:50)
Yeah, that’s an option and a plan that’s not available in IRAs, if you want to go down that road, for people that have plan life insurance. You can’t have life insurance in an IRA. You can in a plan. Also, if you’re worried about credit or protection, if it’s an ERISA, one of the Employee Retirement Income Security Act, that’s what they call the ERISA plan. If your company is an ERISA plan, it has the gold standard of creditor protection, both in bankruptcy and other judgements, except if you owe taxes, no, there’s no protection against that. Or if you commit a crime, believe it or not. Restitution can pierce an ERISA plan. But in your IRAs, there’s no such overall credit or protection for judgments other than bankruptcy. IRAs are protected under federal law for bankruptcy, but not other judgements where somebody sues you. That goes based on your own state law. So if that’s an issue, let’s say you’re a doctor. You’re worried about malpractice or a business executive. Maybe you like to keep your money in a 401k to get more protection. So there are issues on both sides. But generally all that being said, if those other issues are not a big issue, oh, another big issue that’s a benefit for IRAs is another acronym. Here we go. Qualified Charitable Distributions, QCDs, the ability to transfer from an IRA to a charity of you’re 70 and a half years old or older. You can’t do that from a company plan. So if you want to use your IRA for charitable gifting, then you’re better off in the IRA. So there’s pluses and minuses on both sides.

Jean Chatzky: (29:25)
Just another reason to read your book, The Retirement Savings Time Bomb.

Ed Slott: (29:36)
The New Retirement Savings Time Bomb.

Jean Chatzky: (29:36)
The New Retirement Savings Time Bomb. Ed, I have had so much fun geeking out about all things IRA with you. Thank you so much for being with me.

Ed Slott: (29:42)
Great to be on with you. Thanks Jean.

Jean Chatzky: (29:44)
And thanks to all of you for joining me for this special edition of the HerMoney mailbag. I hope that this show has inspired you to think about your IRA, maybe make some changes with your IRA, and maybe send us a letter about what’s going on in your financial life. We love hearing from you. If you like what you hear, please subscribe to our show at Apple podcasts. Leave us a review because we love hearing what you think. We’d like to thank our sponsor Fidelity. We record this podcast out of CDM Sound Studios. Our music is provided by Video Helper and our show comes to you through Megaphone. Thanks so much for joining us and we’ll talk soon.