What advice can you give to a person who is already a great saver and investor?
Scott: Let's talk with Jim in Sacramento. Jim, you're with Hanson McClain.
Jim: Hey guys. Thanks for having me. How are you?
Jim: Great. Great. Well, my question is…I'm in a good position that I make a pretty good income. I've got about four years left to work, and apparently, I make too much to have a Roth IRA. And I've heard that there are other ways of getting around it, like you make three rights to make a left turn and you can do a Roth. Is that correct?
Pat: So you can own a Roth but your income disallows you from contributing to a Roth.
Scott: What you can contribute to is what's called a nondeductible IRA. I'm assuming you're over the age of 50, is that correct?
Jim: That is correct.
Scott: Otherwise, you'd be retiring awfully young. You can contribute $6,500 to a nondeductible IRA. And you're thinking, "Why would I want to do that?"
Pat: For both you and your spouse.
Scott: Do you have other IRAs or just 401(k)s?
Jim: You know I do, I have other IRAs, a 401(k), and I have excess benefits.
Pat: Okay. Let's step back for a second. How much do you have in other IRAs which are deductible IRAs, ones you took a deduction on? How much money is in that? Either you rolled over a 401(k) to get it there or you made deductible IRA contributions.
Jim: About $500,000.
Scott: And have you ever done nondeductible IRAs?
Scott: This $500,000, this is all going be taxable one day?
Pat: Tell us about your 401(k) that you have now. Are you’re self-employed or do you work for someone?
Jim: No, I work for someone and, at age 59½, I was told I could take some out and not be penalized, then roll it into other areas.
Scott: That's right.
Jim: I've done that. I still have about, I don't know, $700,000 at work.
Scott: We are going to tell you how you can take advantage. And does your wife have IRAs outside of her retirement plan?
Jim: Yes, she does.
Pat: We are going to tell you how you can take advantage of it.
Scott: And whether or not it makes sense, we don't know.
Pat: And then we don't know. But we'll tell you how to do it and then you decide whether you want to go through the hassle or not.
Scott: If you made a nondeductible IRA contribution today, we’d finish the conversation now. You say, "Oh, great, I got the advice." You made a nondeductible IRA contribution and then converted it to a Roth, what would happen for tax reasons is the IRS says, "Wait a minute, we can't just look at one IRA. We have to look at all your IRAs." And because you have half a million bucks in IRAs, the vast majority of this conversion, we're going to pretend like it's coming from those other accounts and only a small amount is going to come from that nondeductible IRA. The vast majority of it is going to be taxable. So that's not going to work.
What you can do, whether it makes sense, I don't know. If you transferred all of your IRAs back into your company's 401(k) and your spouse did the same, now you no longer own IRAs. Yes, you own 401(k)s, you might have some other type of pension plans but you no longer have any IRAs.
If you have no IRAs, and you make a nondeductible contribution into an IRA, for tax reasons, your cost basis, is your contributions, $6,500. When you convert that Roth, that nondeductible IRA into a Roth IRA, your taxable amount is going to be zero. At the end of the day, you've got $6,500 into a Roth IRA just like you would have been able to had you not had your income too high.
Pat: And the reason you have to move your IRA back to the 401(k) is because, if you didn't do that, when you do the conversion from the IRA to Roth IRA they do a pro rata on it.
Jim: I see.
Pat: Now in saying all that, if that isn't significantly confusing, I don't know what is.
Jim: No, that's pretty well confusing. That leads me into my next question.
Jim: If a guy has gone everything that he can, invested wisely. The best thing I did was get married this last summer and so we're in the same boat. We make a lot of money. What is one thing that I can do? The house is paid off, we're in zero debt, what's one thing that I can really do, maybe beside this nondeductible IRA, that would be a smart and wise decision?
Scott: As far as saving more?
Jim: Well, yeah, we're saving like crazy but I mean I'm worried if the stock market takes a hit and we're doomed, I'm told.
Scott: What do you mean you're doomed?
Jim: Well, you know, I say that the day you retire if the market's down, you lose just so much money, there's no way to get out of that. That's why I've called on you guys.
Scott: Okay, what percentage of all your assets are in stocks?
Jim: Probably 60% to 75%, I would imagine.
Pat: Okay. Here's how I would look at doing this. The best thing you could probably do is to buy tax-efficient, inexpensive index or ETF funds outside.
Pat: And lower your equity exposure inside...
Scott: I would say a mutual fund just so you can continue to add to it.
Pat: Yeah, so it's easy, on an easy basis. Let’s say you buy the total market, tax-efficient, low cost outside. You take your after-tax dollars and you put it in there and you say, "Well, I don't want any more equity exposure." Lower your equity exposure inside your 401(k) and your IRAs so that you actually remain at the same place. That is going to get you as a tax-efficient as possible. And I agree with you, I wouldn't go through the hassle of moving the IRA back to the 401(k) to make the $6,500 contribution.
Scott: It's not worth it.
Pat: It's just too much of a hassle for very little benefit.
Pat: And you've only got four years to do it. Because you said you're only going to work for another four years.
Pat: But that's what I would do. I wouldn't increase my equity exposure overall. I would just use tax-efficient index funds outside the 401(k) or IRA to do it and lower the equity exposure inside.
Jim: All right. Well, provided I can read these notes I've scratched down, that's what I'll do.
Scott: Well, you can always listen to the podcast of this program or subscribe to our podcast.
Jim: I'll do that.
Scott: I think we send you a copy of this anyway.
Pat: Do we send them something?
Scott: Do we send our listeners a copy or a link of the program? Yeah, we'll send it to you.
Pat: We're going to send it to you.
Scott: See how nice we are?
Pat: It's okay. Throw those notes out the window.
Scott: Thanks, Jim.
Jim: Okay, great. Thanks very much, guys.