Far and away, the most frequent questions that pop into the HerMoney Mailbag are on the topic of retirement: Planning for retirement. Managing our money in retirement. How much to save for retirement, and where to save for retirement… and it’s that last one that we’re diving into this week. Specifically, we’re tackling all things IRAs — individual retirement accounts — because there is SO much there. There are traditional IRAs. There are Roth IRAs. There are IRA conversions. There are IRA misconceptions that need to be dispelled.
With all this in mind, we knew EXACTLY who we needed to call. Ed Slott is a CPA, he’s a columnist for AARP, and his company is the nation’s leading provider of technical IRA education for financial advisors, CPAs and attorneys. As if that weren’t enough, Ed has raised more than $65 million for public television with his educational specials, including his most recent, “Retire Safe & Secure! with Ed Slott.” He also has a new book that just debuted a few weeks ago: The New Retirement Savings Time Bomb: How to Take Financial Control, Avoid Unnecessary Taxes and Combat the Latest Threats to Your Retirement Savings. In it, he offers a comprehensive action plan for those of us looking to understand all of the new retirement, tax, and estate law changes that have been enacted in recent years.
Listen in as Ed and Jean chat about the SECURE Act, and how it actually made retirement savings less secure… Ed weighs in on the best planning options available for retirement savers now, with the elimination of the stretch IRA.
We also get really simple and dive into what IRAs are, how to open one, and what kind of paperwork or process is involved if you’re just getting started… We also talk about who an IRA is “right” for… and how you make the choice between IRAs and 401(k)s and other work-based plans.
Of course we dive into Roth conversions and “backdoor” contributions, and when to do them. And we talk “spousal IRAs” that you can use when you step out of the workforce, and SEP IRAs.
Ed tells us what some of the main things are that he wishes more people knew or did when it comes to their IRAs and dispels some common misconceptions around these accounts.
We also discuss how many people are so focused on building up their retirement savings (the “first half of the game”), but not so much on distribution (the “second half of the game”), and how to best use the money in an IRA once you’ve saved it.
For our Mailbag for this week’s episode, please click here. You won’t want to miss this extensive dive into all things IRA, with some very special questions from our HerMoney listeners, and members of our private HerMoney Facebook Group.
Ed Slott: (00:01)
Once you’re 72, whether you’re working or not, you have to start taking the money out. And that’s when the big tax bill hits. That’s why I love Roth IRAs because Roth IRAs, your own Roth IRA, they’d have no required minimum distributions, RMDs, during your lifetime.
Jean Chatzky: (00:20)
HerMoney is brought to you by Fidelity Investments. Moms, is your money working hard enough for you? Join us for a candid women, talk money conversation with moms. And access resources to help you create a roadmap for your family’s financial future. Visit Fidelity.com/HerMoney to learn more.
Jean Chatzky: (00:42)
Hey everyone. I’m Jean Chatzky. We are so happy that you’re here with us today at HerMoney. Over the years, I have heard from so many of you who subscribed to our HerMoney newsletters and spend time at hermoney.com, particularly when you want to take a really deep dive into a subject that you are curious about, like saving for retirement. Because sometimes it’s just nice to have things really spelled out for you. And that is exactly what we’re going to do in today’s episode and in our show notes. Far and away, the most frequently asked questions that pop into our mailbag are about retirement. Planning for retirement, managing money in retirement, how much to save for retirement and where to save for retirement. And it’s that last one that we’re going to dive into today. Specifically, we are going to tackle all things IRAs, individual retirement accounts, because there is so much there and I get how it becomes confusing. There are traditional IRAs. There are Roth IRAs. There are SEP IRAs. There are IRA conversions. There are IRA misconceptions that need to be dispelled. And if you’re listening to this episode the day that it airs, there are officially five more days left to make an IRA contribution for the 2020 tax year. When the IRS extended the deadline to May 17th, 2021. It also extended the contribution deadline for IRAs. And so if you’ve been thinking about opening an IRA and getting in before that deadline, the time to act is right now. With all of that in mind, we knew exactly who to call. Ed Slott is here with us today. Ed was named the best source of IRA advice by the Wall Street Journal. Of course, I agree with that statement. He is a CPA. He is a columnist for AARP. His company is the nation’s leading provider of technical IRA education for financial advisors, CPAs, and attorneys, but he’s not going to get technical with us today. He’s going to talk in plain English, particularly about his new book, The New Retirement Savings Time Bomb: How to Take Financial Control, Avoid Unnecessary Taxes and Combat the Latest Threats to Your Retirement Savings. Ed, I’m so happy to talk to you today. Thank you for being here.
Ed Slott: (03:32)
Well, great to be back with you, Jean.
Jean Chatzky: (03:35)
Let me start with that book, which has some title. I have to tell you. I know that it just hit shelves. I’m so glad that you wrote it. I wish that it were required reading for everyone who has an IRA, or is thinking of opening an IRA. You’ve written books before. What inspired you to write this one?
Ed Slott: (03:55)
Well, there was so many changes, lots of things going on, and this is before the whole COVID thing. You know, I had the original version of this book over 20 years ago, out in early two thousands. So now what’s happened is, first of all, there’s a lot more money at stake in IRAs and Roth IRAs, thanks to continued contributions and the stock market helped a bit too. And what we’re seeing now, more people have more of their savings locked up in IRAs, 401ks, Roth IRAs. For many people, it’s their largest single asset. You know, if you go back years and years, I’d say the late seventies, early eighties, most people that were having this conversation about retirement, it wasn’t a big deal. They got something called a pension check. That’s P E N S I O N. It was a check they gave people for doing nothing. And everybody got these checks. So they didn’t have to worry about IRAs and 401ks. But somebody went back to the corporations at some point, at the early eighties let’s say, and they said, you know, Mr. Corporation, you don’t have to keep giving out these checks. These people are no longer working for you. How would you like something that eliminates the risk and responsibility of saving for your employee’s retirement? And in came the 401k. So now we’re seeing this next generation of retirees that save that way. They don’t get pension checks. Some people do, but most people don’t anymore. The only real pension check, if you want to call it, that, that anybody’s getting these days, is social security. But other than that, people do have their own risk and responsibility of saving for retirement. So now they’re coming into their own into their retirement years and they don’t have a guaranteed check. Some do, but most don’t. They have their IRA. A lot of that was funded by rollovers from working for many years at a company. Maybe through a school or a university of 403B or a 401k at another company. And now they’re on the hook. So they have larger balances, a larger portion of their net worth. And we’re looking at possibly higher taxes just when they’ll need the money the most. So I call this combination, the new retirement savings time bomb. Was there an old retirement savings stock time bomb? Yes, but now there are newer and even more severe threats to your retirement savings locked up in these accounts. It’s the taxes.
Jean Chatzky: (06:35)
Okay. All right. Let me just take a step back here and make sure that we’re really clear on what you just said. So only 17% of people have pensions anymore. I know that number is falling. We do all have social security or at least most of us do, which is a pension, but it’s not going to support you fully in retirement. You have to make up the difference with the money that you save yourself. And typically you do that in a work-based retirement account, a 401k, a 403B, a 457, and then you roll it into an IRA. Or, if you don’t have access to a work-based retirement account, you may just be saving in some sort of IRA all along the way. And the problem, and I heard you say this in an interview recently, is that the Secure Act actually made retirement savings, less secure. Did I get that right?
Ed Slott: (07:34)
Yeah. You know, in my 40 years of studying tax law, and it’s always changing, but the only constant is every time Congress names a tax act, you can almost always bet that whatever they name it, it will do exactly the opposite.
Jean Chatzky: (07:51)
What happened with the Secure Act and why is it problematic?
Ed Slott: (07:58)
Well, for years and still now, everybody, you do it on your show. Congress beats us over the head. You have to save for retirement. Save, save, save. Nobody’s going to do it for you. So now that we’re all in the soup, as we save, Congress says, you know what? We think you’ve saved too much. We believe retirement, this was behind the big provision in the so-called Secure Act, it is called the Secure Act. I call it so-called because Congress decided to downgrade the value of IRAs and 401ks, not for retirement, but to pass on beyond your death as a wealth transfer vehicle. Congress believed IRAs and other retirement accounts should be used only for your own retirement, not as a wealth transfer or estate planning vehicle to leave to your beneficiaries.
Jean Chatzky: (08:52)
Okay. There, you’re talking about the elimination of what’s called the stretch IRA. Let’s just approach this sort of methodically and talk first about the taxation issue. So if I’m saving, saving, saving in a 401k or an IRA, and I actually recently went through this exercise with my financial advisor because we’re accumulating money. I drink my own Kool-Aid and I save, save, save like a, you know, like a good grown-up. And when I looked at our calculations for how much money we would have in retirement, the tax bite was insane, right? The amount of our money that is really not our money, because it belongs to the government, is a big deal. So what do people believe is gonna happen when they save, save, save, and what really happens with taxes?
Ed Slott: (09:53)
Well, you just hit it perfectly. And that’s why I named my book, The New Retirement Savings Time Bomb. The money you think you have is not all your money. I’ve had clients tell me this for years. They’re so proud of themselves. Oh, look, I have $500,000 in my IRA. They show me this statement. See, there it is. And I said, you’re not keeping any of that. That’s just temporarily on your letterhead. A lot of that goes back to the government. Well, how much do I owe the government? It depends what the tax rate will be when you come and reach in for yours in retirement. And I’m worried, that’s why I call it The Retirement Savings Time Bomb, that taxes could go through the roof just when you need the money the most.
Jean Chatzky: (10:36)
Did you think taxes were always going to go through the roof or do you think taxes are going to go through the roof because we’ve had these three success of big stimulus plans?
Ed Slott: (10:46)
They were always going to go there because of, you know, I say the biggest threat to your retirement savings is a four-letter word. And it’s not kids. Everybody knows that’s allows the investment. Where’s the return on that? No, the four-letter word that’s the big risk to your retirement savings was always math. M A T H. The deficits and the debts have been building and building. This is money that’s owed back. At some point, it’s like the whole country is living on a credit card bill. So the tax acts, you’re talking about the tax cuts and jobs act, and then all these stimulus, added trillions to those numbers. And we’re almost at a breaking point where at some point the rates are going to have to go up and it will probably be at the worst time. First of all, when rates go up and you’re in retirement, that’s the absolute worst combination because the paychecks have stopped. You may not have other sources of money other than taxable money. And you’re vulnerable to whatever the tax rates are at that point.
Jean Chatzky: (11:50)
So what is the solution to dealing with that issue? And let me just acknowledge there are these modern monetary theorists out there who say, oh, no, no, no, no. We never have to pay the money back. But I’ve got to say, I’m with you. I’ve been fearful that tax rates are going to go up for a very, very long time, because it looks to me like we’re spending a lot more than we’re taking in, governmentally.
Ed Slott: (12:16)
Yeah, that’s called math.
Jean Chatzky: (12:18)
Math. Okay. I got an A in math in high school. So what is the solution for people like all of my listeners who are saving diligently, who are trying to hit our benchmarks, who are trying to make sure we have enough to live as comfortably as we live now, once we get into retirement? How do we deal with this tax bomb coming our way?
Ed Slott: (12:49)
Yeah. Well, the first thing is that you have to have some kind of certainty. You have to be able to sleep at night in retirement and not worry about these other factors. So take control of them now. And you can do that in two ways. Now this is not for everybody. Some people may say, you know what? My rates in retirement, I don’t see them being that high. And that may be the case. Everybody’s case is different. But in general, I believe rates will be higher. And if you don’t do anything now, your retirement account, let’s hope the stock market keeps going and going. I don’t think you can count on that forever either. But so far, this is what’s happening. But what people don’t realize, every time that market goes up, so does the government’s share of your IRA or your 401k. Think of Uncle Sam as a co-owner, a joint account with your IRA. If you think it that way, then you should be worrying about doing nothing. So what’s the solution? Well, one of the best solutions is going back to Roth IRAs. They’ve been around for years, but I think it’s the best solution right now. I like to call it moving your money from accounts that are forever taxed, tax deferred, to never taxed, tax-free.
Jean Chatzky: (14:07)
So let’s just do a little refresher before we go into it. Roth IRA versus traditional IRA. If you put money into a traditional IRA, you are taking a tax deduction for making that contribution. And when you pull the money out in retirement, you got to pay taxes at your current income tax rate. If you put money into a Roth, you are paying the taxes today, and then you never have to pay them again, correct?
Ed Slott: (14:38)
Yeah, pay once and never again.
Jean Chatzky: (14:40)
Is it the same with a Roth 401k? Cause a lot of us have options in our plans now for Roth 401ks.
Ed Slott: (14:47)
Yeah. It’s the same thing. But here’s the thing. You just said, you get a deduction and that’s the trap now. Think of a deduction as a loan you’re taking from the government. Every time you take a deduction, that money’s coming back. You owe the tax on that money back to Uncle Sam, to the IRS, at some point. But you don’t know when, well, you may know when in retirement, but you don’t know how much you will owe, because it depends on the current tax rate in retirement. That sort of like taking a mortgage. Imagine if you went for a home mortgage and you did all your research and everything, and you know the interest rate and the banker says, don’t worry about any of that. And you say, well, what’s the interest rate. Don’t worry about any of that. When we need the money back, we’ll tell you what the rate is. Well, who would sign up for an open-ended mortgage like that? We all did. It’s called an IRA. It’s a mortgage to be payable at some rate to be named in the future, which we don’t know. So a tax deduction sounds good, but it’s not really worth what it used to be. Not only that, tax rates are at the lowest points most right now that most people will ever see in their lifetime. I think most people can agree that tax rates probably are not going down. So they either stay the same or they’re going to go up. When tax rates are low, the value of a tax deduction isn’t worth as much. So I’m saying, two ways to move from forever tax to never tax, 1) you can convert to a Roth IRA. Move your IRA money to a Roth IRA. And I’ll explain that in a minute. Or change the way you’re making current contributions. Like you just said, if you were just always making contributions to your 401k at work, see if they have a Roth 401k option. Most companies now do. It took many years for companies to come around to that. But many companies have Roth 401k option where you can say, now I want my dollars to go into the Roth 401k. But you’ll pay more tax because you won’t get that deduction. I’m saying, get out of that mindset. That’s short-sighted, short-term thinking. Don’t worry about the tax deduction, if you don’t want to worry about paying it back later.
Jean Chatzky: (17:11)
Right. Okay. All right. When we convert to a Roth, people talk about Roth conversions and this idea of a backdoor Roth, can you take us through both? So how does a Roth conversion work? And then how does a backdoor Roth work?
Ed Slott: (17:30)
A Roth conversion is very simple. You move your money from your IRA to your Roth IRA, a tax-deferred account to a tax-free account, but there’s a price to pay to do that. You have to pay the tax. So if you convert 10,000 of your IRA to a Roth. You will have your income increased by $10,000. And for some people, for a lot of people, that’s the stumbling block. As a matter of fact, a lot of my colleagues, CPAs, they can’t get over the fact that you have to pay a tax upfront. But you get something for your money. You get tax-freedom. Now, that money grows in your Roth IRA for the rest of your life, tax-free. You never have to worry about an increase in tax rates and then you can sleep at night. Plus, there’s no required minimum distributions when you get into retirement.
Jean Chatzky: (18:22)
I want to come back to the whole idea of required minimum distributions. But when you convert assets in a traditional IRA to a Roth IRA, you’re converting them at the current value of those assets. Right now, the stock market, and we are taping this in early May, is soaring. It is soaring. And there are a number of people who will tell you when asked, and I talked to my own financial advisor about this just last week. It’s a tricky time to think about a Roth conversion. Last March, when everything cratered, would have been a great time to think about a Roth conversion because you’d have to pay less taxes on the same number of shares. So can you talk about how the value of stocks and the value of other assets play into when to decide to do a Roth conversion? And the other question that I have about the conversion is, I’ve been told forever that you shouldn’t convert unless you have assets outside of that account to use to pay the taxes.
Ed Slott: (19:30)
Generally, that’s true. But let me get to the timing thing. First of all, there’s a way to smooth out the income, and probably the best idea for most people, and when I talk about Roth conversion, I should always stop and say, you don’t have to convert everything. Cause when people hear us talk about it, they say, well, I have 300,000. What’s the tax bill on that? The best approach probably in everything in life is moderation. Maybe do a series of annual smaller conversions over time to use up, to take advantage of, the lower tax brackets. But on the timing, you really can’t time a Roth conversion, people have tried, because it’s a long-term investment. Remember the power of the Roth is the snowballing for you in the later years tax-free. I’ll give you an example. I had a client of mine, a doctor, and this was I think in 2018. You know, we were going back and forth the whole year. She had a lot of money and all that, but this was part of her IRA. She wanted to convert a million dollars. We were going back and forth the whole year. And finally in December, she says, all right, I’m doing it. I’m going to convert the million dollars. Then she converts and I see this email the next morning. She’s horrified. Distraught. It happened to be the day she converted, the market went up a thousand points. It was the largest one day hit. And she was beside herself. She says, I converted at the absolute worst time. Look at the market. It was so high. I said, calm down. Tell me again why you’re doing this Roth conversion. She says, well, I’m not doing it for me. I’m doing it for my grandchildren. That’s why I’m doing it. And remember, back then we had the stretch IRA and all of that. I said, so what are you worried about what the market is now? What it costs now? Now, going back, I don’t remember the exact value of the market, but it was about 10,000 points less, even at the high then, than it is today. I think it was around 23,000. Now, depending on the day, I hate to date stamp this, like you said, it’s 34,000. But in two hours it could be, you know, 31,000 or 48,000, the way it’s going now. But she was so worried about converting. She was looking at only one day. So she called me again this year. That’s what she’s been doing. She has a healthy IRA. She’s a doctor. Has done very well, but she doesn’t need any of the money herself. She’s doing it all for her grandkids. Not even for her kids. She wants to bypass them. And she did another million dollar conversion and she asked me the same thing in December last year. She said, what do you think? Is now the time? I said, remember we had that conversation a few years ago. I’m telling you, this is a long term. You’re doing this for your grandchildren. Don’t worry about the cost now. This is what you want to accomplish. And the minute you do that, any growth, and I reminded her, you remember when you did it in 2018? 10,000 points of growth is now tax-free to you. And you will worried about that one day uptick. So what I’m saying is, it’s very hard to time Roth because it’s meant for long-term purposes. She didn’t even need it for herself. So she’s not even going to take required minimum distributions for the rest of our life. So you can imagine what that is going to grow to for her grandchildren all because she took the hit at what she thought was a high stock market day.
Jean Chatzky: (22:50)
Alright? So again, we’re going to table required minimum distributions for just a second. Back door Roths. There are income limits when it comes to people making contributions into Roth IRAs. If you earn too much money, you can’t make a contribution. But you can do this thing called a backdoor Roth. What is that?
Ed Slott: (23:13)
Right. First, just for everybody, Roth IRAs I like to say, come in two flavors, contributions and conversions. What we’re talking about, the big money, is in conversions. It’s really funny the way they do the tax law. You know, you wonder where these laws come from. So the contribution most people can make, the maximum to a Roth in 2021, or even 2020, is $6,000 a year. Plus if you’re 50 or over, you get to take advantage of a catch-up provision entitling you put another 1000 in. So you can put 7,000 in. All right? Now, if you want to do that, there are income restrictions. If you make too much money, you can’t put in the six or 7,000. But yet if you want to convert a billion dollars, there are no income limits. Go ahead. Go do it. But if you’re going to put 6,000 in, that’s what we put our foot down. It doesn’t make sense. So, anyway, like you said, there are income limits. They’re very high for most people. But if you’re a high income person and you don’t qualify to do a Roth contribution, the six or 7,000, and you still want to have the money end up in the Roth, you can contribute to a non-deductible, traditional IRA, a traditional IRA where you don’t take a deduction, and there’s no income limits on that. And then at some point after that, you are allowed to convert that to a Roth IRA. And some people have called that, everybody has called that since, the backdoor Roth. So it turns out that IRS finally said, yeah, we’re okay with that. Congress said four times in the committee reports that they’re fine with it. And then it leaked. Normally you don’t see IRS officials talking about this kind of insight information, but on a tax service interview, the IRS officials said, it took us this long to say it was okay because we were examining it. We just didn’t like the name, backdoor Roth. It sounds like a loophole or a workaround or an end-around. If they just called it something else, we would have been fine with it. But now we are fine with it. So it goes in as a conversion. So you end up in the same place. Your six or 7,000 goes into the Roth IRA as a conversion.
Jean Chatzky: (25:36)
Gotcha. Okay. I understand. I know we have a lot more to talk about and we’re going to get there in just a second. But let me just tell everybody once again, HerMoney and this really important conversation is brought to you by Fidelity Investments. Moms, we know that you work hard all year long. Your money should work just as hard for you. Please join us for a special Women Talk Money event. In this candid conversation, we talk about the challenges of the 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. I am talking all things IRAs with Ed Slott, CPA, and author of The New Retirement Savings Time Bomb: How to Take Financial Control, Avoid Unnecessary Taxes and Combat the Latest Threats to Your Retirement Savings. Okay Ed. I want to go back to a couple of things we teed up earlier in the show. The first one is stretch IRAs and the elimination of stretch IRAs by the Secure Act. What’s a stretch IRA?
Ed Slott: (26:52)
It’s funny you asked that because it’s not anything in the tax code. It’s just a name that came to be for the ability of you to leave an IRA, a 401k, to a child or a young grandchild, and they could stretch or extend distributions over a long deferral period. In fact, I have the table here. A two year old, if you had left it to a two year old grandchild, they could defer it, taking only minor distributions up to over 80 years out. So it could be, depending on the age of the beneficiary, 50, 60, 70, 80 years. In fact, when this first came about many years ago, I was telling my clients about it and I got a call from a client. He said, Ed, I’m at the bank. You said get a stretch IRA. They don’t have them. I said, it’s not a product. He thought he was at Bed Bath and Beyond or something. You know, I said, it’s a process. All you do is name whoever you want as a beneficiary. There has to be a person, like a child, a grandchild, anybody, an individual, a human being let’s say. I used to tell clients, if you have a pulse and a birthday, then they get the stretch IRA. That’s a human being. As opposed to other kinds of beneficiaries, like an estate, a charity, a certain trust. So if you’ve named a person, an individual, a human being, on the beneficiary form after your death, they could stretch or extend distributions over their remaining life expectancy. And the younger they are the longer they can go out. So you take a 50, 60, 70 year deferral, only taking minor distributions, you can imagine how that account would blow up and leave some amazing legacy for generations after you’re gone.
Jean Chatzky: (28:37)
So what did they do in taking it away? And who does it apply to? If you already are the recipient, my husband inherited his mother’s IRA and it was incredibly helpful for all of the reasons that you just said. If you’ve already inherited something, does the elimination of the stretch IRA impact you and how do the rules work now?
Ed Slott: (29:03)
Okay. So Congress came along, as I said before, and they said, we think that’s too much of a benefit for inheritors. And we’re going to kill that stretch IRA and replace it with a 10 year rule, which I’ll tell you what that is in a little while. But it depends on when death occurred. Or to put it a nice away, when you inherited. So you’re talking about your husband inheriting. The cutoff point was the end of 2019. So you have these two systems you have to work on now, because if you inherited, let’s say your husband inherited that before 2020, then he gets to keep his stretch IRA. It’s grandfathered in. So you have two systems going at the same time. If you inherit in 2020 or later, he would be subject to the 10 year rule. But here’s the good news. You only have to know these two separate systems for about 80 more years.
Jean Chatzky: (29:58)
Yes. I’m not going to live that long.
Ed Slott: (30:00)
You know why? Because if you add a grandchild, like I said, that inherited at the end, in December, 2019, that grandchild can still go out 80 years and they get to keep that. Just like your husband gets to keep his schedule. But if that same grandchild inherited a few days later in January, 2020, they would be subject to the replacement vehicle that Congress created called the 10 year rule, which means that all the funds have to come out by the end of the 10th year after death. So you’re bunching all of that income into a 10-year period. And depending on the beneficiary, you know, most beneficiaries, if the average IRA owner dies in his eighties are probably in their fifties, themselves, may be in their highest earning years within those 10 years. Plus like we talked about before, they could be at higher rates, new, higher rates. So the government wants to get all that revenue. They want to end this tax deferral. They wanted to put an end date on it. And they did that for most beneficiaries, most non-spouse beneficiaries. But there are exceptions, in case you’re getting worried. The big exception is the spouse. If you’re a spouse, you know, the tax law, especially in this IRA and retirement area, treats the spouse as like the queen in chess. They can do almost anything they want because they treat the spouse, a husband, a wife, whoever it is, almost like the original IRA owner. Whatever he could do, she could do. So the spouse is exempt from all of those rules. There are four other classes of exemptions from the elimination of the stretch, but most people don’t fall into them. The spouse is the big exception, but one exception has fooled lot of people. The exception is for a minor beneficiary. So now you’re saying, but Ed, you just said that grandchild is stuck with a 10 year. It has to be a minor beneficiary of the deceased IRA owner. Like I said before, not a grandchild. Grandchildren, 10 year rule. What are the odds, if an average IRA owner dies at say age 80 or 85, what are the odds of that IRA owner having a twelve-year-old child. The only one I can think of is maybe Tony Randall and he’s dead. So it’s unlikely. But even if you qualify, you know, who’s going to qualify? Unfortunately on an early death, a 40 year old dies, may have a 12 or 15 year old. But in that case, it’s not going to be as much to talk about. But even so, the minor beneficiary only gets this elite status, which the tax law calls an eligible, designated beneficiary. That’s what a spouse is. Only until they reach the age of majority though, which is 18 in most states or up to age 26 if they’re still in school. Once they hit those markers, they’re no longer a minor. They go back on the 10 year rule.
Jean Chatzky: (32:54)
So they get an additional 10 years at that point.
Ed Slott: (32:57)
Jean Chatzky: (32:57)
I understand that these exemptions are pretty minor. So I want to actually turn the conversation to talk about getting the money out of your IRA. Required minimum distributions. There’s a lot of confusion about RMDs. A lot of confusion about who they apply to. And I think some confusion about whether money that you have in a Roth is subject to them at all. Can you just talk about that a little bit?
Ed Slott: (33:28)
Well, that was the deal. I call it the deal we made with the devil years ago. We got that tax deduction up front. Remember we talked about that and I said, that’s going to come back to bite you. That’s what I call your deal with the devil. And with any deal with the devil, there’s a day of reckoning. And the tax law has a name for that date. It’s called your required beginning date, which used to be 70 and a half and now it’s age 72. In other words, that’s the date, the age, by which Congress said, look, we’re sick and tired of waiting for you to drop dead and we want our money back, at age 72 now. And that’s when you are forced to take money out, whether you want to or not. And that bothers a lot of people. Whether you want to or not, they’re called required minimum distributions, which we always call RMDs. You know, we go through, so I’m very careful to say all these things out because we can end up in a conversation, Jean, we’re always talking about is acronyms.
Jean Chatzky: (34:24)
Ed Slott: (34:24)
RBDs, you know, all of these things. It gets to the point, if you use them enough and you had a drinking game, nobody would ever get to the end of the program. So you’re forced to take these RMDs, these required minimum distributions, based on your age after age 72. There’s even proposals as we speak right now, some people are calling the proposal in Congress, Son of Secure. So watch out for that or Secure 2.0, where they are looking to raise that age to 75 over a number of years. But anyway, the age is 72 now, where you’re forced to take money out and pay tax on them in your traditional IRA and generally in your 401k. But there’s an exception. In the 401k, if you’re still working for the company, say at age 72, some companies, most companies, will allow what’s called the still working exception, and you don’t have to take any RMDs from the 401k of that company you’re still working for until you retire. But there’s no such still working rule in your IRA. Once you’re 72, whether you’re working or not, you have to start taking the money out. And that’s when the big tax bill hits. That’s why I love Roth IRAs. Because Roth IRAs, your own Roth IRA, they’d have no required minimum distributions, RMDs, during your lifetime. So if you don’t need the money, now you have your plan, not the government plan. You’re in control. You take the money as you need it. If you need it though, it will generally be tax-free. If you don’t need it, it can still accumulate and compound, tax-free, a hundred percent for you. And whatever it grows to by the time you die, even if you leave it to a child or grandchild, they still can keep it compounding tax-free for another 10 years. But there are no RMDs in your own Roth IRA.
Jean Chatzky: (36:19)
Ed Slott: (36:19)
Now to make things a little more complicated, we talked about Roth 401ks. Remember we talked about that.
Jean Chatzky: (36:27)
Ed Slott: (36:27)
There are RMDs on Roth 401ks in a plan, but you can avoid them by, before you have 72, roll your Roth 401k funds to your Roth IRA and avoid RMDs.
Jean Chatzky: (36:40)
Ed Slott: (36:41)
You sorry you asked?
Jean Chatzky: (36:42)
It is a lot. I have two more quick questions Ed, because I teed up at the beginning of the show, the notion of two IRAs that I think are woefully underused. The spousal IRA and the SEP IRA. Can you just briefly talk about why they’re both so powerful and who should be opening these accounts?
Ed Slott: (37:03)
Well the spousal IRA, I agree. It’s the forgotten IRA. Here’s the thing, to contribute to an IRA or Roth IRA, remember the spousal IRA can work for a Roth. To be able to contribute, you have to have earnings. What do we mean by earnings? Not dividends, interest and capital gains. W-2, earnings from a job or self-employed income. So you have many situations where you have a married couple. One spouse might be retired and have no earnings, not counting interest, no work earnings. But the other spouse has a full-time job. So you can use, let’s say the husband has a full-time job and the wife is retired. It’s probably the other way around. But whichever way it is, the person that has no earnings can use the working spouse’s earnings to qualify for their own spousal IRA. So you take people in their seventies let’s say, one spouse is working, and the Secure Act allowed more people to contribute to IRAs, traditional IRAs. Although I wouldn’t bother with those, I would go Roth. But if you wanted to, past 70 and a half. Before the Secure Act, once you hit 70 and a half, you weren’t allowed to contribute to a traditional IRA. So the Secure Act actually opened the door for more backdoor Roths, like we talked about before and more spousal IRAs. But after 70 and a half, I don’t think anybody should be contributing to an IRA. The deduction isn’t worth it. You have to pay it back. You should be going with Roth or a backdoor Roth. So the spouse could go, let’s say, and contribute 7,000 to a Roth IRA. And if the husband or the working spouse, whoever the working spouse is, contributes seven. There’s 14,000, where most people would have only contributed 7,000. And if they both did it to a Roth, that’s 14,000 going right into a Roth IRA every year, even if only one spouse is working. So that’s a missed opportunity for lots of people. I’m glad you mentioned that. That is one of the big missed opportunities. People think cause I’m not working.
Jean Chatzky: (39:09)
Right. I’m done.
Ed Slott: (39:11)
Jean Chatzky: (39:12)
And a SEP IRA. I just love the idea of a SEP IRA for, we have a lot of people in this audience who I know work for themselves. It’s just a vehicle where you can plow in a ton of money
Ed Slott: (39:24)
If you have it. Yes. You’re self-employed. The only thing is you gotta be careful. It’s best for self-employed, like you said, work at home, independent contractors, freelance with no employees. That’s the key. You can do it with employees, but then you have to put in for them too, out of your pocket. So you can’t have discrimination. You can’t put in just for yourself and not employees. But if you are, you know, the proverbial cook and bottle washer, whatever that saying is.
Jean Chatzky: (39:52)
Chief cook and bottle washer.
Ed Slott: (39:52)
Yeah. Right. Right. If you do it all and you’re just you, and it’s you incorporated, you can do a SEP for yourself and put in a ton of money if you have it. So the limits a much higher than they are for IRAs and Roth IRAs. So you can put in much, much more there.
Jean Chatzky: (40:13)
Okay. All right. Fantastic. You are a huge font of wisdom. So ordinarily at this point, I would say, we’re going straight into our mailbag. But you and I have had this long conversation about IRA. So what I’m going to do, and I’m just letting our audience know this, is I’m going to actually break this podcast into two parts. We have eight questions, maybe nine or 10 questions, that we have gathered, that you have asked us, all about IRAs. We’re going to roll them into a separate mailbag. And we’re going to launch that show the same day we launch this one. And so if you’d like to listen to the mailbag, just look for the bonus mailbag all about IRAs. Right now, let me just say to Ed Slott, thank you so much for joining me today on HerMoney and for imparting such great wisdom about all things IRAs. If you like what you hear, please subscribe to our show at Apple podcasts. Leave us a review. We love hearing what you think. We want 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. We’ll talk soon.