Is your portfolio forward-thinking? Caller Al has certainly lined up the full "alphabet soup" of investments, but listen-in to find out if he's missing something important.
Scott: Let's talk to Al. Al, thanks for joining Hanson McClain.
Al: Hey, how are you guys?
Pat: Good, Al.
Scott: Hi, Al.
Al: I have a retirement riddle for you guys, which I think will be of general interest to many of your listeners. Neither my wife nor I have ever had a job that came with a pension, and growing up poor, I was always a saver. So over the years that I've been working, since IRAs got invented, along with 401(k)s and 403(b)s and Keoghs and all that stuff, I didn't understand them, but I always said, "Okay, I'm just going to invest as much as I can." And that's what I did.
So a few years ago, I heard about these things called Roth Individual Retirement Accounts, and I found out it was possible to convert an old IRA into a Roth IRA which would mean paying tax on the amount. But then the Roth IRA could continue to grow and I figured, "Well, I've got 20 years left. So it'll grow and it'll pay for that tax and more.
And so I sort of adopted that strategy. And every year for about the last five years I've converted some IRA money into Roth IRA accounts.
Scott: All right.
Al: So this time, I'm counting my blessings because my wife and I have the full alphabet soup of retirement assets. We each have a regular IRA, a Roth IRA, she has a 403(b), I have a 401(k), I even have money in a Keogh, which is now called a Qualified Retirement Plan.
Al: She's 70 and I'm 62. So my two strategic questions to you guys are, how should we draw those retirement assets down? Is there some sequence or should we exhaust some first before the others? And what happens to those assets when they ultimately get inherited by kids and grandkids? What's the strategy there?
Scott: Okay, so let me ask a couple of questions to begin with. You're self-employed?
Al: Yes, have been for about 10 years.
Scott: Are you still making contributions to your Keogh?
Scott: All right. And do you have much in savings or assets outside of these retirement plans?
Al: Yes, we do. So that's why I'm even bringing up the inheritance issue. I think there's a good chance there will be some for them to inherit.
Scott: So if we exclude your primary residence for a moment and look at your other assets, these retirement assets, what percentage would that comprise of your overall assets? In other words...
Pat: Liquid net worth.
Scott: What's outside real estate?
Pat: Yeah, and rentals or commercial property or anything like that.
Al: I would say half or maybe less than half.
Scott: Okay, so you've got less than half maybe. And then what percentage of your retirement assets, the IRAs, 403(b), Roth, what percentage is in a Roth?
Al: Oh, I would say a quarter. A quarter of the half.
Scott: Yeah, so you've got approximately 12.5 percent in Roth and you've got 50 percent in liquid or quasi-liquid, but outside of a retirement plan.
Pat: And what's your...so your primary question to us is how would you withdraw these assets?
Al: And also, should we consider, assuming we don't outlive our assets, what is best for the kids?
Pat: Got it.
Al: So I empty out the IRA and let them inherit the...
Scott: You will, so I can almost guarantee...
Pat: That's a great question.
Scott: I can almost guarantee you will die with assets because everybody does. How many beneficiaries are there?
Al: There's three adult children who don't need any money. And there's five grandchildren, four teenagers, one of whom is seven.
Scott: Okay, so here's the thing to look at. What determines whether you should spend the Roth now or the taxable IRAs now is kind of dependent upon what the tax bracket of the beneficiaries is compared to your own.
Pat: The tax bracket you're in.
Scott: As compared to yourself. So if they're in a higher tax bracket than you are, then you want them to inherit the Roths. If they're in a lower tax bracket than you are, then you want them to inherit the taxable IRAs.
Al: Which, of course, that's a very difficult question to answer because we're projecting years out into the future.
Pat: Let me throw one more wrench in there. So I've read, there's been some talk about Congress trying to do away with this whole stretch IRA concept. So right now if you were to, let's say you both passed away today, and let's say, just to make it easy, you had it divided amongst your three kids, each retirement account. Each retirement account could be split three ways. And so each child could have a beneficiary IRA and a beneficiary Roth IRA. Then they could choose how they want to spend those dollars. They would all have to take some sort of minimum distribution based upon their own life expectancy. That is under current rules.
But if I were a betting man, I would bet that at some time in the future, probably 10 years or less, we'll see this stretch IRA concept, where you can stretch that life expectancy, going away. And the reason I state that is there's a lot of money that's sitting in there untaxed and it's a political...I mean, the amount of people that would argue against that is small.
Scott: Yeah, and it's not a focal...no one's going to care about it.
Pat: Here's what, if you were sitting in our office, we would say, "Okay Al, what does your retirement look like? What sort of..." I assume you have your house paid for, is that correct?"
Al: No, actually. We refinanced the house in California to buy a retirement home in Texas last year.
Scott: Oh, so you're moving to Texas when you retire?
Pat: Are you moving to Texas?
Al: At the moment, it's kind of half and half.
Scott: And I wouldn't convert any more to a Roth at all. Because you're paying tax in California and Texas will not have any state income tax.
Pat: They'll have higher property taxes but...
Al: So once we move to Texas, though, you'd say go ahead and convert?
Pat: We might, we might.
Scott: Depending on your tax bracket.
Scott: But one of the things I would be looking at now is if you really think there's going to be ample assets left at your death, you might consider starting a 529 plan for the grandchildren to shrink the estate. And to do what you want to do. And that is all dependent on the children as well, your children, right? But I wouldn't do anything in terms of converting any money from the IRA to the Roth IRA.
Pat: Not now, not if you're planning on going to Texas.
Scott: Not now. I mean, you're in a great...
Al: That's because of the state income tax?
Pat: Absolutely. Less cost.
Scott: That's correct. And then once you go to retire, you've really got to look at it on an annual basis and look at it and say, "All right, what distribution amount is going to make the most sense this year?"
Pat: Some years, it might be an IRA, some years, it might be a Roth, and other years it might be a combination of the two.