Roth Conversions Over the Years – Part 1, the “Pro Side”

Once in a while I peruse my archives, assembled over nearly 20 years as a Certified Financial Planner™. Through the miracle of modern electronics, I can quickly search my writings and notes about any subject I have covered in that time, whether for clients, radio, or publications.

Lately, the topic of Roth Conversions has come up quite often, due to past changes in the tax structure that more or less encouraged making Roth Conversions. This week’s search of the topic brought up my original magazine article called Roth IRA Conversion Considerations, which was published in 2009. Reading my “old” analysis, I was surprised how negative I was on the process at that time. Until I remembered why.

Eleven years ago, taxpayers were in much higher income tax brackets. A couple filing jointly entered the 25% marginal tax bracket at the modest income level of $67,900, and the 28% bracket at $137,051. Roth Conversions add to taxable income dollar-for-dollar. In 2009, narrow tax brackets and a highly “progressive” individual tax rate structure resulted in Roth Conversions of any significance elevating tax brackets. Fortunately, income limitations probably prevented some potentially bad choices. These limits were repealed starting January 1, 2010.

Also in my archives was a 2012 update on the topic of Roth Conversions. With the re-election of President Obama, we were faced with the real possibility of higher future tax brackets. The oldest argument in favor of Roth Conversions was to guard against higher future tax rates.

Since income limits for Conversions had been lifted, there were good and valid reasons to do Conversions. Future tax-free withdrawals, coupled with the absence of future Required Minimum Distributions (RMDs), indicated a bias toward doing the Conversion for those in position to do so.

Beginning on January 1, 2018, passage of the Tax Cuts and Jobs Act of 2017 (TCJA) further favored Roth Conversions. Individual Tax Rates were lowered, and tax brackets were made much wider. The same couple reaching the 25% bracket in 2009 with income of only $67,900 could now earn up to $321,450 and still be in the 24% bracket. High earners, who likely would have significant assets for retirement, could perform relatively painless Roth Conversions, and be spared the necessity of taking unwanted RMDs in the future.

Next week we will explore recent developments that are now clouding the desirability of performing Roth Conversions.

No planning tool is suitable for everyone, but a qualified CFP® has solutions to your personal situation.

Van Wie Financial is fee-only. For a reason.

According to statisticians, the huge Baby Boomer generation is enrolling in Medicare at the rate of about 10,000 per day. Those who are not yet collecting Social Security benefits receive a monthly premium bill for Medicare Part “B.” Some are also charged for voluntary Medicare Part “D” (Prescription Drugs). These people know exactly what they are being charged for their Medicare participation.

Those who are collecting Social Security monthly benefits get their Medicare premium costs deducted from Social Security before their monthly benefit is deposited. Too often, these people are not aware of their own costs for Medicare “B” and/or Medicare “D.”

Both groups have exposure to being overcharged for their Medicare premiums. This is not a clandestine plot by the government to confiscate their money. Rather, it is a function of the paperwork flow among and between IRS, Social Security, and Medicare. IRS provides Social Security with your income figure, which is always a year behind your most recent tax filing. That amount is then applied by Social Security to next year’s Medicare premium determination. By then, the information is 2 years old.

The problem occurs when new Social Security recipients are receiving a substantially reduced amount of annual income, versus their 2-year-old Tax Returns. Reasons for income reduction can include retirement or reduction of hours, marriage or divorce, and other significant life-changing events. The U.S. Government doesn’t take responsibility for asking if your circumstances have changed. That is 100% up to you. That’s the bad news.

Here’s the good news; you are in control, but you may not know that. If you are like many people, you have a lower income in your first Medicare year than you had 2 years before. Whatever the reason, retirement being the most common, Social Security acknowledges your changes, once you inform them.

Unknown to most people is that Medicare costs more for some people than for others, based on income. Everyone is charged the “Base Rate” ($148.50 in 2021), and higher income people are also assessed a surcharge. The extra amount is called “IRMAA,” which stands for Income-Related Monthly Adjustment Amount.

Around Thanksgiving every year, Social Security mails an Informational Letter to all recipients. This letter itemizes on Page 1 your next-year charges beginning in January, including the Base Rate, and also any IRMAA surcharges you will be assessed. If you aren’t paying anything under IRMAA, you are not being overcharged.

If you are being charged under IRMAA, dig deeper to see if it is correct for your current circumstances. IRMAA brackets are itemized on page 2 of your Information Letter. If your total income has dropped, or will drop, into a lower IRMAA bracket, you may be able to get a reduction in your Medicare premiums. In fact, the process is included in your annual Information Letter, but almost nobody actually reads the entire letter.

Correcting your own Medicare pricing is not a particularly fun process, but we are talking serious money for many taxpayers. Entering your later years, saving money should be a very high priority.

There is no difference in Medicare benefits, only in costs. Medicare Part “B” has been the fastest rising cost for seniors since 2000, having risen 149% faster than inflation. Don’t make it worse. If you are confused, a qualified Certified Financial Planner® may be able to help you.

Van Wie Financial is fee-only. For a reason.

Soon, the year 2020 will be over, but will not be missed by most of us. COVID-19, wild market fluctuations, an unsettled election, a quarantined population, business closures; all will be remembered far longer than we prefer. Yet, there were some positives. Some of 2020’s good news applies to both savers and investors.

From both a business and a personal perspective, two of the highlights were passage of the CARES Act and the SECURE Act. CARES suspended all 2020 Required Minimum Distributions (RMDs) from Qualified Retirement Accounts for the year. SECURE raised the age for RMDs from 70-1/2 to 72. Both made other beneficial changes as well.

As 2020 winds down, Congress is considering revisions to the SECURE Act. The revisions have been dubbed SECURE Act 2.0. A summary of the original SECURE Act (we call it 1.0) and the proposed changes (2.0) include:

• (1.0) Repealed Age Limits for Traditional IRA Contributions. Many Americans today are working beyond the age of 70-1/2, and those workers were formerly not able to make Traditional IRA contributions. (1.0) enabled contributions from working people after age 70-1/2. (2.0) No change.
• (1.0) Raised Required Minimum Distribution (RMD) Age. Owners of Traditional IRAs and other tax-qualified retirement accounts were formerly mandated to begin taking taxable withdrawals at age 70-1/2, but (1.0) postponed beginning mandatory withdrawals until age 72. This affects anyone who was born after June 30, 1949. (2.0) Further elevates the RMD age to 75, affecting the same population.
• (1.0) Repealed and replaced “Stretch IRAs” for beneficiaries. For owners’ deaths after 2019, beneficiaries are no longer be able to take annual RMDs based on their own life expectancy. Instead, (1.0) requires the entire Inherited Account to be emptied in 10 years, with no annual requirement. (2.0) No change.
• (1.0) Proposed smaller RMDs for all. IRS agreed to update Life Expectancy tables to reflect our increasing lifespans. This would keep more money in Retirement Accounts for a longer period. Unfortunately, the tables were released too late in 2020 to take effect in 2021. (2.0) No changes proposed at this time, but the new RMD tables take effect for RMDs in 2022 (except for 2021 RMDs delayed until early 2022, which must use the old tables).

Our Federal Government claims to be in favor of the citizenry providing for themselves later in life. Financial behavior is easily influenced by the U.S. Tax Code. CARES and SECURE (1.0) made a large difference in taxation and self-reliance. We applaud the passage of both, and strongly support passage of SECURE Act (2.0). Follow this Blog, and we will report progress as it happens.

Van Wie Financial is fee-only. For a reason

Four years ago, on the Van Wie Financial Hour radio program, we discussed the economic power of fear and greed, and how mass media headlines are often designed to appeal to those emotions. Far too many headlines espouse wild claims that defy established economics, crossing over to the murky area of economic theory, practice, and real-world experience. My term for these dubious claims is Bizarro Economics.

The year 2020, being a Presidential election year, means that economic policies of both sides were and are on display. One side proposes further tax cuts to stimulate a COVID-19-related soft economy. After all, they claim, tax cuts worked every time they were tried, and as a result employment rose, as did government revenue.

Competing would-be political powers claim that they will achieve fairness by raising taxes on the rich. After all, they claim, our economy was “built from the bottom up.” That qualifies as Bizarro Economics, as there are no known instances where workers went out and hired themselves a boss. This false claim of power fosters greed.

Further “Bizarro” examples abound, such as offshoring factories to reduce the cost per unit of manufactured goods, therefore (supposedly) improving general prosperity. This pipe dream has been in place for many years, and results from the Bizarro concept that “free trade” apparently means not charging tariffs on imports, but allowing foreign companies to impose harsh tariffs on our exports to them. “Free trade” may sound good, but as millions of Americans lost solid Middle-Class employment, the American standard of living took a downturn. Declining domestic purchasing power resulted in fewer and fewer consumers, and fostered widespread economic fear. We now realize that “free trade,” as implemented prior to 2016, was not “fair trade.”

In recent years, new trade policies have resulted in factories closing overseas and reopening here. Employment was rising, wages increasing, and productivity escalating. Unfortunately, COVID-19 caused a sudden, but temporary, setback to our progress.

COVID-19 also exposed another truly frightening feature of Bizarro Economics, when we discovered that our necessary pharmaceuticals are manufactured overseas, in countries that don’t necessarily share our national security concerns. This created real, rather than politically motivated, fear. Solid economic policy must assure that our national sovereignty remains intact. Bizarro Economics apparently does not consider this a priority.

Following an election that still is not decided, the two sides are staking out their positions, and they could not be more different. I would much prefer to return to an early 2020, pre-COVID-19 economy, than to implement Bizarro Economic Theory on the false premise that it will create some hypothetical version of fairness. That simply plays to greed. Good luck, America.

Van Wie Financial is fee-only. For a reason.

It seems that nearly every fiduciary, fee-only financial planner has the same reaction when the subject of annuities arises; “I hate annuities.” While that is not acceptable, many clients will agree with them. As with most generalizations, hating a concept, such as annuities, does not constitute a true analysis of annuities or the client’s individual situation. Understanding the reasons requires a definition of the term annuity.

What annuities are is easily understood; they are transfer of risk products that supply income streams for people who need them. The income can last for life, or for a guaranteed period of time. For that purpose, they are invaluable to those who need them. Nothing else works like an annuity.

What annuities aren’t is more complicated; they are not investments, though they can be financially rewarding. Salespeople who claim that annuities are investments are misleading the public. Similarly, the home you bought to live in is not an investment, per se, but may well turn out to be financially rewarding. Not all financially rewarding purchases are investments.

Today we look at the decision-making process involving consideration of an annuity purchase.

• Step 1 is “WHEN.” By far the most common use for annuities is WHEN retirement or other events permanently curtail your stream of income. The product of choice in this circumstance is called a Single Premium Immediate Annuity, or SPIA. With a SPIA, you pay a predetermined amount of cash to an insurance company, and that company immediately begins to pay you a monthly benefit that has been determined in advance by length of guaranteed payments, prevailing interest rates, and your demographic characteristics.
• Step 2 is “HOW.” No longer do annuities have to be purchased from captive agents who represent only one insurance company. As with all capitalistic endeavors, competition can result in the best purchase being selected by the consumer. Today, annuities can be purchased through websites, independent brokers, and large custodians such as Schwab, TD Ameritrade (now part of Schwab), Vanguard, Fidelity, etc.
• Step 3 is “WHY.” The amount and nature of assets available to a person approaching retirement is as varied as our population. Desired lifestyle in retirement is just as diverse, and the result is a complicated retirement planning process. Some people already have sufficient lifetime income and/or assets to preclude any additional income needs. Others will fall short of the income goals.

In certain situations where existing assets and cash flows are insufficient for retirement, annuities can help satisfy the goal of income for life. This may be the opportune time to advocate for independent financial advice from a fee-only fiduciary. Annuities can be part of a comprehensive personal financial plan. Actually, most Americans already have an excellent annuity; Social Security. WHY someone might need another annuity is simply to solve his or her (or their) problem of providing sufficient lifetime income.

Rather than falling for a sales pitch in a fancy restaurant, it is smarter to seek comprehensive advice from a qualified CF®.

Van Wie Financial is fee-only. For a reason.

Last week we addressed investors’ expectations, reasonable and otherwise, and the potential to affect long-term success and happiness. Today, we move ahead to “adulting” your money. This step begins once the groundwork has been laid and accomplished in your investment portfolio. Typically, this stage comes when the investable assets are north of $100,000 by a comfortable margin.

At that time, most investors would benefit from establishing a relationship with a fee-only, fiduciary, Certified Financial Planner® (CFP® ), organized and operating as a Registered Investment Advisor (RIA). Many RIAs have minimum account sizes, but most will accommodate at no cost an investor who requests a meeting to discuss his or her situation. Some planners will take on smaller accounts held by serious, dedicated savers and investors. There are also planners who work on an hourly basis.

Expect a visit with a CFP® to include a comprehensive overview of your own situation, as well as an education regarding investment risk and return. Today’s financial software is very advanced, measuring your personal risk profile, your long-term goals, and planning portfolio design and construction to best fill your expectations. We suggest meeting with at least three fee-only planners or planning firms before making a decision. A long-term relationship is based on trust and respect, which must exist on both sides.

As a direct result of an initial meeting (Van Wie Financial refers to our initial discussion as the “Suitability Meeting”), further diversification should be justified and implemented. As we explained earlier, there are seven fundamental Asset Classes, and the goal should be to select assets from as many of those classes as needed to satisfy expected risk and return goals. This is integral to a comprehensive personal financial plan.

No longer is a financial plan in the form of a written document with pretty pictures, graphs, and charts, nicely bound in a three-ring binder and placed in a drawer in the den. Instead, modern software is online, accessible, and flexible enough to accommodate a changing life, changing markets, and a changing world.

Many recent studies have shown that a relationship with a fee-only CFP® produces investment results well in excess of the fees paid to that planner or firm. Don’t limit your own future by shying away from paying a professional advisor. Fees are normally deducted from the investment account, and do not require the client to write periodic checks out-of-pocket.

Van Wie Financial is fee-only. For a reason.

Last week we addressed investors who have accumulated sufficient assets to have diversified into positions in Bonds and Foreign Stocks. No longer should these investors be considered novices, but they are far from experienced. As their accounts grow, more diversification can further spread their risk, as well as improving their chances of long-term success.

Today, we are examining expectations among investors. This may be the most controversial subject we have discussed to date. Many an investor is unhappy today because of his or her unreasonable expectations. Having an understanding of long-term investment returns and principles may save a lot of future headaches.

Things you need to understand include:

• You will not “beat the market,” so don’t try (more on this below).
• Individual stocks are very risky. Good things happen to bad companies, and bad things happen to good companies. Spread the individual stock risk through diversification.
• Annuities are not investments, but rather transfer-of-risk products. This does not mean that they are useless by any means. They solve certain problems for certain people, but are historically over-sold.
• Commissioned salespeople are not required by law to place your interests ahead of their own. Fiduciaries (such as Van Wie Financial) are required to place your interests first.
• The market always over-reacts to events, so don’t be a lemming and blindly follow. Greed and fear, when acted upon, cause investors a great deal of pain.
• Losses feel worse than gains feel good, so minimize losses for long-term success.
• Make a plan before you invest. A “starter” plan can be simple, but it must remain flexible to accommodate growth and changing personal situations over time. A Financial Plan is not a document; it is a process.

“Beating the market” implies that your personal returns would be higher that the major market indices, which are comprised only of Domestic Stocks. You may outperform common market indices over a short time period, but don’t count on doing that for too long. A reasonable goal for investors involves understanding and accepting both a targeted return, and corresponding risk, over a long time period.

The Dow-Jones Industrial Average represents only 30 very large companies. The S&P500 Index contains 500 large company stocks, and the NASDAQ Composite contains a motley assortment of over 2500 company stocks. They sample only the first of our seven Asset Classes, Domestic Stocks. True diversification into several asset classes renders irrelevant any direct comparison between stock indices and an investor’s portfolio.

Nest week we will discuss the necessary relationship between risk and return in various portfolios.

Van Wie Financial is fee-only. For a reason.

For the past couple of weeks, we have chronicled the steps that new investors should take to begin investing for the long term. Review those Blogs if you are catching up and interested in one of the most important aspects of “adulting” – preparing for personal long-term financial independence. Today we further explain the reasoning behind our recommendations in the last two Blog entries.

Last week we addressed investors who have accumulated between $50k and $100k in long-term investment assets. While technically no longer ranked novices, these people are unlikely to have a good understanding of the fundamental goals of portfolio diversification. In a previous Blog, we addressed the “why” aspect, so today we will begin explaining the “how.”

As we noted last week, the investing universe is comprised of 7 fundamental classes of assets; Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Cash (and Equivalents), Real Estate, and Hedges. Most are self-explanatory, and we will deal with hedges in a future Blog.

“How” to include more Asset Classes in a portfolio requires an understanding of some basic mathematical principles. In this case, the term in the spotlight is “correlation.” When two variables move together, they are called “correlated.” The closer movements are to each other over time, the higher the correlation. When two variables move in opposite directions, they are called “inversely (or negatively) correlated.” The “correlation coefficient” scale runs from -1.0 to +1.0. A diversified portfolio seeks to achieve a correlation coefficient that is low, or even negative.

As markets move, a low correlation means that as some items go down in value, the portfolio does not go down as much, if at all, because other assets may rise. Over time, multiple Asset Class portfolios will generally experience smaller losses then a 100% stock portfolio. When resultant declines are lower, and the recovery period shortened. Regaining lost ground quickly is the essence of long-term successful investing success.

The novice investor who has accumulated shares in a broad market Exchange-Traded Fund (ETF – see last week’s Blog for explanation) is participating only in the first Asset Class, Domestic Stocks. Somewhere between account values reaching $50,000 and $100,000, it is time to add at least one other Asset Class. As discussed last week, this is generally done by introducing bonds in the portfolio.

We also mentioned that our current interest rate environment is not conducive to holding a large percentage of bonds. Therefore, to enhance diversification, we must choose yet another Asset class. Right now, we are interested in Foreign Stocks. Again, we are not suggesting placing a large percentage of Foreign Stocks in a portfolio; about 10% is enough to influence results.

In the Foreign Stock Asset Class, we often use actively managed mutual funds, as fund managers have more time and expertise to make their stock selections. When contemplating any mutual fund, be sure to do some research. Begin by only looking only for “no-load” funds, meaning there is no sales charge to buy or sell shares. Look at the track record of the managers, the reputation of the affiliated company, and the internal costs of the fund itself. There is much to learn, but learning and adhering to the fundamentals will improve your chances of success.

Van Wie Financial is fee-only. For a reason.

Last week we chronicled the steps that a first-time investor should take in order to “dip a toe in the market.” We explained that Van Wie Financial has 2 goals – protecting novice investors from unscrupulous brokers and insurance salespeople, and maximizing beginners’ probabilities for long-term success. A quick review of that Blog will highlight the fundamentals, including creation of an Emergency Fund, and selecting a custodian for your money.

Today we address novice investors who have accumulated substantial funds in their investment accounts. For these people, it is time to begin the process of diversifying holdings. While there is no absolute threshold for beginning to diversify, having about $50,000 of investments should trigger the planning process, with implementation at or before the $100,000 threshold.

Diversification for diversification’s sake is not convincing, so it seems important to explain when, why, and how it should take place. In a previous Blog, we addressed the “when” aspect, so today we will address the “why.” The investing universe is comprised of 7 fundamental classes of assets; Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Cash and Equivalents, Real Estate, and Hedges. Most are self-explanatory, and we will deal with hedges in a future Blog.

The novice investor who has accumulated shares in a broad market Exchange-Traded Fund (ETF – see last week’s Blog for explanation) is participating only in the first Asset Class, Domestic Stocks. Somewhere between account values reaching $50,000 and $100,000, it is time to add at least one other Asset Class. This is generally done by introducing Domestic Bonds. Again, we look to mutual funds and Exchange-Traded Funds to simplify our diversification goal.

The world of Domestic Bonds is very complex, and includes (among others) Corporate Bonds, Government Bonds, High-Yield (“Junk”) Bonds, Municipal Bonds, and a host of others. Equities are owned until sold, whereas bonds are owned until maturity or until sold, whichever comes first. Most bond types are issued in differing maturities, which means the amount of time until the issuer buys them back varies from issue to issue.

Complexity in both stock and bond markets is the reason we advise novice investors to buy funds that are created and maintained by experts. There are not enough hours available in any given day for a novice to become a successful “do-it-yourself” bond investor.

Returning to portfolio diversification, the easiest way to add bonds to an existing portfolio is to allocate a portion of future purchases to a Bond Fund of the investor’s choice. While Van Wie Financial does not recommend any particular Bond Funds, we would limit Bond Fund purchases to perhaps 10% for the time being.

In coming weeks, we will be getting into the why and how of diversifying into not just Bond Funds, but other Asset Classes as well. For now (given the low interest rate environment), we suggest keeping your Bond Funds short-term, and minimal in percentage of overall assets.

Van Wie Financial is fee-only. For a reason.

Welcome to the complex and exciting world of investing. The purpose of this introduction is to provide a “how-to” for (mostly young) people who have never invested in the stock and bond markets. Van Wie Financial has 2 goals – protecting novice investors from unscrupulous brokers and insurance salespeople, and maximizing beginners’ probabilities for long-term success. After all, the goal of investors is to achieve long-term Financial Independence.

Creating simplicity from the complex is never easy, nor could it ever be complete. However, our “getting started” outline should give the novice a framework for laying the cornerstone of a lifetime plan. Let’s get started, from absolute scratch.

• Start saving and investing young; start today if possible.
• The first step is to accumulate a “Rainy Day Fund” of at least $5,000 for people ages 30 and under, and $10,000 for those over 30, in a credit union or bank.
• Once that has been accomplished, open an investment account.
• Investment account types include Traditional IRA, Roth IRA, 401(k), 403(b), Brokerage Account, and a few others.
• The account type is completely independent of what assets are held in the account.
• The type of account you need depends on your particular situation, but if you are earning under about $75k annually, most likely a Roth IRA will best serve your short-term and long-term needs.
• Your account requires a custodian, which is a large, well-known financial powerhouse, such as Schwab, TD Ameritrade, e*Trade, Fidelity, etc., with a website of their own.
• Obtain a User ID from your custodian, and set up your password for anytime, anywhere access to see your balance and activity (this should all be free).
• Fund the account with whatever cash you have available, then add to it as you can, leaving your “Rainy Day Fund” intact.
• We suggest buying one of many Exchange-Traded Funds (ETFs) that mimic the entire domestic stock market, including SPTM, IWV, SCHB, or others.
• Buy as many ETF shares as you can with the funds you deposit over time.
• Repeat until rich. (OK, it isn’t quite that easy, so next week we’ll get into more complexity for accounts that have been growing.)

Note the term ETF, or Exchange-Traded Fund, above. These investments trade like individual stocks, except that each ETF purchase contains fractional shares of many different stocks or other securities for diversification, much like mutual funds. For comprehensive definitions and explanations of all financial terms, we suggest Investopedia.com.

Van Wie Financial is fee-only. For a reason.