RMD - Retirement Planning

[S T]

I have a client that is age 65 and has been talking with a "Rep" at an Insurance Annuity Investment location.
The "rep" is suggesting some sort of fund distribution or conversion of Traditional IRA and 457 Plans to Roth to avoid RMD when the client turns 70.5.

Current Balance amounts are approx $ 90,000 (68K Traditional and 22K 457 Plan)

Have not investigated enough with the client to understand this reasoning as the RMD at 70.5 should not be that much

Client with current Retirement is in approx 25% tax bracket Fed - taxable income Single year 2015 was approx 47,000

Adding conversions from Traditional IRA and 457 Plan to Roth and paying tax now on conversions each year over the next 5 years, should not the question be - can the tax paid and the earnings benefit taxpayer in 5 years from a Roth - Will the Roth earnings be enough to offset the taxes paid and growth earnings?

I am more concerned about making these conversions now over the next few years and paying taxes on the conversions, rather than having NO RMD at 70.5.

Any thoughts on this?

Sandy

[Rapid Robert]

I am more concerned about making these conversions now over the next few years and paying taxes on the conversions, rather than having NO RMD at 70.5.

I share your concern. What's the big deal with RMDs? They can always be invested in after-tax accounts, where there will either be cap gains, or step-up basis on death.

[JohnH]

Financial advisors have learned to jump on the "RMD Problem" as just another sales gimmick.
They set up a phony problem then proceed to offer a solution.
Predictably, the solution always involves a hefty commission, usually because it just happens to be based on buying an annuity.

[S T]

Thanks,

My thoughts exactly - waiting for some information regarding balances so we can determine RMD and the what if's, if taxpayer is going to listen to Rep

Sandy

[Roland Slugg]

IMO converting a traditional IRA to a Roth IRA by anyone in the 25% tax bracket or higher (and perhaps even the 15% or 10% TBs as well) is just about the most irrational tax decision a person can make.

Most financial planners, especially commissioned ones including those who sell annuities and life insurance products, recommend things that are good for THEM, not things that are good for the taxpayer.

Trust your instinct and judgment, Sandy. You shouldn't have to seek opinions from people on this board to know your client is not being well-served by that insurance rep's recommendations.

[JohnH]

I may have posted this before, but here goes anyhow:

Client : Tell me again why you want me to buy this (MLP, High-Load Fund, Annuity, etc)?
Financial Planner: It's for the kids' college education.
Client : But I don't have any kids.
Financial Planner: Silly client - I'm talking about MY kids !

[TaxGuyBill]

I may have posted this before, but here goes anyhow:

Client : Tell me again why you want me to buy this (MLP, High-Load Fund, Annuity, etc)?
Financial Planner: It's for the kids' college education.
Client : But I don't have any kids.
Financial Planner: Silly client - I'm talking about MY kids !

LOL. Thanks for the laugh. :-)

[kathyc2]

It's hard to tell if it applies here, but there are times when it may make sense. I've ran projections when adding additional income from retirement accounts can result in a tax increase of around 29%. This comes from not only the IRA money being taxable but also making more SS benefits taxable. IMO the best way to determine is to run projections of what income expectations will be in future years to see how the numbers shake out.

[Snaggletooth]

Whopping RMD

It's hard to tell if it applies here, but there are times when it may make sense. I've ran projections when adding additional income from retirement accounts can result in a tax increase of around 29%. This comes from not only the IRA money being taxable but also making more SS benefits taxable. IMO the best way to determine is to run projections of what income expectations will be in future years to see how the numbers shake out.

Yes, sometimes it does work, particularly if the taxpayer is in a lower bracket now and may not be at age 70.5.

However, just looking at the original post, with a retirement account of $90K, just how bad will the RMD be? Maybe $2500 in the first year? And we are going to save the taxes on this paltry amount and pay the whopping taxes on the conversion? Sounds like this financial planner is like many around here that I've had disagreements with.

I would print out these responses from forum members and give to the client, telling him these responses are from people who are totally independent. I think most of us are pretty much in unison about what's going on.

[kathyc2]

Yes, sometimes it does work, particularly if the taxpayer is in a lower bracket now and may not be at age 70.5.

However, just looking at the original post, with a retirement account of $90K, just how bad will the RMD be? Maybe $2500 in the first year? And we are going to save the taxes on this paltry amount and pay the whopping taxes on the conversion? Sounds like this financial planner is like many around here that I've had disagreements with.

I would print out these responses from forum members and give to the client, telling him these responses are from people who are totally independent. I think most of us are pretty much in unison about what's going on.

I agree that people selling investments don't generally look at structuring transactions for tax savings.

Although the RMD would be small, at some point the money is going to be taxed either to the client or heirs. It's not totally accurate, but I generally use the rough presumption that good investments will double every 10 years. If 10K is converted this year, it will have 2,500 in federal tax. If in 10 years the 10K in IRA is now worth 20K and client is still in 25% bracket, disbursement of the 20K will incur 5,000 in tax. Then the question becomes where will the money come from to pay the 2,500 tax this year? If the client does not have the cash and would need to take a cash distribution of 2,500 to pay tax, then only the net of 7,500 would be converted to a Roth. If however, the client has the 2,500 available in non-qualified investments converting the full 10K and lower future tax on the earnings of the 2,500 in non-qualified may lower overall tax over a period of time. Like I said, you really need to run the numbers for your individual client before reaching a conclusion that it's a bad idea.

[Burke]

I agree with all of the above. The only time I have seen a great advantage to this scenario is when an ageing senior's medical expenses are wiping out his taxable income due to home health care or a nursing home. If it can be done in a year (or planned over a period of years) where there is no income tax liability even when including the IRA conversion to a ROTH, then go for it. Then no one pays any taxes on it as long as you can make the 5-yr waiting period.

[JohnH]

I agree with all of the above. The only time I have seen a great advantage to this scenario is when an ageing senior's medical expenses are wiping out his taxable income due to home health care or a nursing home. If it can be done in a year (or planned over a period of years) where there is no income tax liability even when including the IRA conversion to a ROTH, then go for it. Then no one pays any taxes on it as long as you can make the 5-yr waiting period.

I agree. The actual situations where any significant money is saved are few and far between. Not saying they are non-existent, but they're rare. Generally you'd spot it with a cursory look. Most of the time the result is only a minor tweak in the actual tax liability in the long run. I've even seen people do this to avoid RMD's while knowing that they will need to take more than their RMD each year in order to meet living expenses. I think the financial sales people play on the emotion that people just don't like the idea of the government telling them what to do with their money at 70.5, and then wrap it up in a "tax saving" scheme. At the end of the day, the Roth money winds up in a high-commission product - very convenient for the FA, not so good for the client.

[Rapid Robert]

Then no one pays any taxes on it as long as you can make the 5-yr waiting period.

The 5-yr waiting period only applies to pre-age-59.5 conversions, correct?

[Rapid Robert]

people just don't like the idea of the government telling them what to do with their money at 70.5, and then wrap it up in a "tax saving" scheme.

Wait, what? Since when is anyone forced to defer income tax on earnings throughout their entire working career?

[JohnH]

Wait, what? Since when is anyone forced to defer income tax on earnings throughout their entire working career?

I wasn't referring to the act of contributing to a qualified plan. My comment was in reference to the RMD. I often have clients react very negatively to the concept. Those who have sufficient resources and don't need to withdraw will balk at the requirement that they MUST withdraw and pay tax at any age. It does little good to tell them that was a condition of the original bargain they made with the government when they contributed to the plan. They will often respond in the same way they respond to hearing of the "fine print" in any type of agreement - they view it as a trick.

I'm not saying their assessment is correct, but that emotional response is very common. So a sharp financial advisor will seize upon that emotion to sell his/her product. They convince people who are going to be withdrawing in the normal course of events that somehow the government plans to force them to do something in order to extract more tax from them. The advisor then offers a "solution" to the imaginary problem. It's just more sleazy behavior from an industry that thrives on smoke and mirrors.