Today, Bruce Hosler of Hosler Wealth Management talks about converting your IRA into a Roth IRA, and why a market dip is a good time to do so.
First, Bruce and Jon go over requirements for these conversions, such as deadlines and how required minimum distributions, or RMD’s, come into play.
When markets are down, stocks and taxes are “on sale.” They are often below fair value. So a conversion in a down market means paying taxes on the lower value, then watching the value come back tax free if and when the investments rebound.
We also talk about “In Kind” Roth conversions – moving a stock into a Roth without selling it. Or, you can sell something in your current IRA, move the cash into a Roth, then buy something different.
Finally Bruce explains the benefits of leaving a Roth IRA to your heirs, as well as what they need to do with that money and when.
For more information about anything related to your finances, contact Bruce Hosler and the team at Hosler Wealth Management.
Call the Prescott office at (928) 778-7666 or our Scottsdale office at (480) 994-7342.
To listen to more Protecting & Preserving Wealth podcast episodes, click here.
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Bruce Hosler is the founder and principal of Hosler Wealth Management, LLC. He has been in practice since 1997, with offices in Prescott and Scottsdale, Arizona. With his robust team of tax accountants, Enrolled Agents, and Certified Financial Planner® professionals, Bruce developed a synergistic approach to delivering a Foundational Financial Plan™ for his clients, covering some of the most vital aspects of tax, estate, and wealth planning. In the Protecting & Preserving Wealth podcast, Bruce and his guests discuss current financial topics and provide timely answers for our listeners • Tax Reduction Strategies • Financial & Estate Planning • Investment Management • Retirement Planning • Insurance Strategies • Business Owner Exit-Planning Strategies • Current Events and their Market Effects.
Jon “Jag” Gay: Welcome in to episode number five of Protecting and Preserving Wealth. I am Jon Jag Gay joined as always by Bruce Hosler of Hosler Wealth Management, Bruce. Great to be back with you.
Bruce Hosler: Thank you, Jon. Great to see you today.
Jon: Today’s topic is gonna be relevant to almost everybody listening, I would guess because this is such a hot topic and such an important thing to be aware of, and that is converting your IRA to a Roth IRA, particularly during a market dip.
Bruce: Yes. We want to take advantage of getting all of that low buy-in in that Roth IRA. And this is the time to do that.
Jon: Okay, so before we get into the specifics of why to do it now in a market dip, as a recording this of course on June 23rd, and that’s kind of the condition we’re at right now. Let me ask you first, if someone wants to convert their IRA to a Roth IRA, when during the year should that ideally be done?
Bruce: First, we wanna make sure that Roth conversions are done in a tax year.
So a lot of people think they can contribute to their IRA up to April 15th of the year following. It doesn’t work that way with Roth conversions.
Jon: Mm-hmm .
Bruce: They have to take place in the calendar year. Second, all individual taxpayers are calendar year taxpayers. So you have to do that during the calendar year that you want it to count in.
And then third, some people are subject to required minimum distribution rules. So they have to distribute their required minimum distribution before they can make a Roth conversion. Because the first distribution of the year is considered an RMD by the IRS. So we don’t wanna blow that rule. So if you’re over 72, you have to take your RMD out before your IRA for that year can be converted to a Roth IRA. So, having considered all of that, we like to encourage clients to try and make a Roth conversion when the markets are down.
Jon: Okay, so during the tax year, you wanted to count for, after you take your RMD, so uncle Sam can get his cut when you pull that money out.
Jon: But to our main topic today, as you just said, why now? While the markets are down?
Bruce: Well, imagine when the markets are down, that they’re kind of on sale. Yeah. And so we’re using this discount in the fair market value. So when they recover all that recovery that snapback to the upside allows the clients to intentionally have all that growth in a tax free Roth IRA.
Jon: So you’re getting in now on the ground floor, and as it grows, that growth is not gonna be taxed because you paid the tax on the conversion and the growth is tax free in the Roth.
Bruce: Correct. And so you recognize the income, but the portion that you got into the Roth IRA, Will grow tax free in the markets when they snap back, because all that downside in the market gives you a buying opportunity to get it at a discount.
Jon: Got it. Okay, so let me ask you this, Bruce, I’ve heard of an in-kind Roth conversion. What does other does that mean?
Bruce: This is a great question, Jon. And we get it from different people. So an in-kind Roth conversion means that we don’t have to sell your stock or your mutual fund or your ETF or whatever your investment is in your IRA. And then buy it back again once you’ve converted it over to your Roth IRA. Instead, we just take that investment, say a stock, and we convert it in-kind, that means move it over to the Roth IRA account without having to sell it. So the value of that stock on that day that we move it. That’s the amount of your Roth conversion for that particular stock.
So if the markets are down, the price of your stock is down. The value of your stock is then moved across to the Roth IRA account. When it’s on sale at a discount, if you will. Then we let it grow and snap back in that full market recovery with all of that growth inside of the Roth IRA. So all that growth is income tax free.
Jon: That is a great idea and something I wasn’t familiar with. And I’m sure a lot of our listeners weren’t either Bruce, I’m really glad you brought that up. Another angle of this is what if I wanna change investments? Can I sell my investment in my IRA and then buy something different inside a Roth after I’ve converted the money?
Bruce: Perfect, and great question. In this environment right now, we see a lot of people that have lost a lot of money in the tech sector. So, so let’s say that you have a tech stock, it’s getting killed in the markets. You wanna move to something else. Let’s say you want to go to energy, an energy stock. And because you’re holding and growing that inside of your IRA, you can sell the tech stock, or let’s say maybe you’re losing money in that IRA. You can sell the stock in your IRA. You can move the cash over to your Roth IRA. And then in that conversion, now you have the cash over there, you can buy the energy stock inside of your Roth IRA. So you can reallocate from one account to the other, going into different ways of, of making investments.
Jon: So there’s really a lot of different ways to do this Roth conversion, Bruce. It’s either moving the stock over as is, it’s cashing it out and then buying it in on the Roth side or it’s cashing it out, moving the cash, then buying something completely different, pretty versatile repertoire we’re looking at here.
Bruce: As long as you’re invested in those type of vehicles. Sometimes we have clients that have annuities inside an IRA. You cannot do this with annuities inside of IRAs. So that has to be done with cash. But as long as you’re investing in stock, mutual funds, bonds, regular securities like that – we can do an in kind or you can sell those and then buy a new type of investment inside of your Roth IRA.
Jon: Okay. So lemme come back to the RMDs, those required minimum distributions, because you did mention those earlier. So if I’m of age and I’ve taken my RMD for this calendar year, and then I do the convergence, some of my IRA to a Roth, what happens next year on that new Roth IRA? Do I have to take an RMD from the Roth IRA next?
Bruce: Jon, that is a great question. And we get this a lot from different people. The answer is no, you don’t have to ever take an RMD from your own Roth IRA account. That’s your own.
Bruce: But the benefit is that many parents feel like the Roth IRA is some of their most sacred money because that money is not gonna be taxed. And it’s the last money that they want to touch. So they don’t want to draw it out and they’re not required to do that. So a lot of our clients have IRA accounts. They hate it every year that they have to pull it out. Pay the taxes on it. So one of the ways that they avoid that is if they convert it to a Roth IRA, they can stop the RMDs.
Jon: I wanna make sure I understand this correctly. So the whole point of those required minimum distributions is for uncle Sam to get his cut.
Bruce: Oh yeah.
Jon: Because if it’s in a regular IRA or retirement account, that you’ve not converted to Roth, you haven’t paid the taxes on the way in. So you’re paying the taxes on the way out. So those RMDs are there to make you take that money out so that you’ve got to pay the taxes on it. On the flip side, if you’ve converted this money into a Roth, you’ve paid the taxes on the way in to the Roth. So you’re not required to take anything outta the Roth, cuz uncle Sam’s already gotten his slice of the pie. Do I have that? Right?
Bruce: You have that perfectly, Jon. You have that perfectly and many parents, they wanna leave that account, that Roth IRA account as a legacy to their children. So they’ll be able to leave them a tax- free inheritance. They’ve already paid the taxes on it. Now the kids don’t have to pay the taxes on it. The parents love that as a way to make a Wealth transfer that’s income tax free, federal and state.
Jon: Good to know. Well, let’s dive into that a little bit deeper on the kid’s side of it, leaving money to your children. So, what is the situation and the rules around paying RMDs on inherited IRA and Roth IRA accounts if your parents had left you something?
Bruce: So we’re running into that more, the baby boomer generation is getting older. Some of them are passing on and as they do that, they leave the IRA and they’ve named their children as the beneficiaries. So the Roth IRA will allow the children to keep the funds inside of an inherited Roth IRA account for 10 years after you die. And then after 10 years, they have to take that money out. But at that point, that money has grown income tax deferred and it comes out tax free to those kids. Now, on the other hand, if you have a traditional IRA, they have to start taking annual withdrawals generally, unless they qualify under some specific terms.
So if they qualify as an EDB, Eligible designated beneficiary, and they have to be, you know, have some disabilities or be a spouse or some, some other, uh, situations like that. The kids have to start taking RMD out every year for those 10 years. And then they have to withdraw the whole amount at the end of the 10 years.
And so, as you can imagine, if they wait on a traditional IRA, they could be having a big tax bomb 10 years after you die.
Jon: Oh, right.
Bruce: And that could be really terrible because they have their regular income and then they have the whole IRA that has to be distributed. All taxable at the highest levels. That’s a tax time bomb that the kids may not be planning for. So this Roth IRA, the ability to leave the account, growing income tax free, and then pull it out tax free at the end of 10 years, what a great legacy that they can leave to their children that way. And it’s a great investment, uh, because you can invest in anything that you want to and have it grow income tax free.
Jon: Let me ask you a follow up here, Bruce. So assume that money is left to you in an inherited Roth IRA. You’re not paying the taxes for the 10 years, but at the end of the 10 years, you’ve gotta take that money out. At that point, you have to take that money and invest it in stuff that is going to be taxable?
Bruce: Well, you don’t have to invest it. I mean, of course the kids can take it and spend it, and sometimes they can’t keep their hands off of it for the 10 years. Certainly, as you can well imagine.
Bruce: But then yes, they could use it to contribute to their own Roth IRA. But the contribution limits are so small that may not be, you know, of a much benefit, but at least it begins getting them in the right way, but they can look at other investments that may be tax-free.
For example, a life insurance retirement plan. Or they could contribute to their own Roth IRA account, but otherwise you’re exactly right, Jon, the question is good. They have to take it out and now it’s gonna start being taxable again. So we were only able to shelter it for the Roth IRA owner’s life and 10 years after for their children.
Jon: It sounds like if you’re in that position where you’re at the end of that 10 year window, it would really behoove you to talk to someone like the team at Hosler Wealth Management that deals with this kind of stuff every day, all kinds of aspects related to your financial and your retirement future.
Bruce: Absolutely. You need a tax professional and you need a financial professional. That’s helping you plan around these rules that are so specific and help you not blow it. So, yeah, you need to talk to a professional, like our team to help you plan for which counts you should be taking money out of and which ones you shouldn’t touch.
For example, that Roth IRA, it’s hard for the kids not to touch that, but that is really sacred money with a rule of 72. If they leave that growing for 10 years, that Roth IRA can double.
Bruce: It can be twice as big as when you die that your kids can then pull it out 10 years later.
Jon: Do you know the, uh, little kid marshmallow psychological study?
Bruce: Oh yes, I am familiar with that. Go ahead. Tell ’em how that works, Jon.
Jon: So for our listeners who aren’t familiar with it, um, there’s a psychologist who had a bunch of kids in a room and he said, okay, I’m gonna put a marshmallow down in front of you. If you can wait 15 minutes, I’ll give you two marshmallows. But if you can’t wait, you only get the one. So it’s kind of a study in instant gratification, and this really applies to investing. And like you said, doubling the money potentially. If it’s in there for 10 years. Are you gonna give into your temptation to take that money and spend it now? Or can you show the restraint and wait to get a much better payoff down the road?
Bruce: So that is intentionality of the child to be able to defer and, uh, not take the self gratification of eating the marshmallow or cashing in the Roth IRA right away.
Jon: And my wife always says she was the kid who would wait for the second marshmallow. And I said, that’s why I feel better about our future, cuz I’m married and hitched myself to your wagon.
Bruce: You married up Jon. That’s well done.
Jon: Absolutely. Bruce, if somebody wants to come talk to you and the team at Hosler Wealth Management about these Roth IRA conversions or anything related to their financial future, what are the best ways to reach you?
Bruce: They can of course reach us on the website at Hosler, H O S L E R wm.com.
https://hoslerwm.com/. They can reach us in Prescott at (928) 778-7666 or in our Scottsdale office at (480) 994-7342.
Jon: Good stuff as always bruce. Let’s talk again next time.
Bruce: Thanks Jon.
Jon: Securities and advisory services offered through Commonwealth Financial Network, member of FINRA/SIPC, a registered investment advisor. Forward-looking commentary should not be misconstrued as investment or financial advice. The advisor associated with this podcast is not monitored for comments and any comments should be given directly to the office at the contact information specified.
Any tax advice contained in this communication, including any attachments, is not intended or written to be used and cannot be used for the purpose of, 1) avoiding federal or state tax penalties or, 2) promoting marketing or recommending to another party any transaction or matter addressed herein. The accuracy, completeness, and timeliness of the information contained in this podcast cannot be guaranteed. Accordingly, Hosler Wealth Management LLC does not warranty, guarantee, or make any representations, or assume any liability with regard to financial results based on the use of the information in this podcast.
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