If the world of retirement planning were a game of golf, far too many people excel on the front nine but forget to finish the round. That’s no way to improve your handicap or retire sooner, and the man I stole that analogy from recently sat down to tell me why.
Ed Slott is a nationally recognized IRA distribution specialist, professional speaker, television personality, and best-selling author. The Wall Street Journal called him the best source for IRA advice. His latest book, The New Retirement Savings Time Bomb, is all about helping people play that back nine so they can hit the clubhouse with a complete scorecard and enjoy the overpriced martinis. Bottom line – he knows how to make taxes interesting.
In talking to Ed, my hope was to really dig in and find some actionable steps for Americans looking to retire sooner and become a smarter taxpayer and retiree. He did not disappoint.
Roth IRAs vs. Traditional IRAs and 401(k)s
Ed says “We put money in 401(k)s and IRAs and we made that deal with the devil, with the government, saying ‘Alright, we’ll get a little tax break upfront each year.’ But then, as with any deal with the devil, there’s a day of reckoning.”
Under the Secure Act, which became law in 2019, you are forced to make retirement withdrawals at age 72. Why does the government care? Because they get to tax it! Or, as Ed put it, “That’s the date that the government has determined they are sick and tired of waiting for you to drop dead!”
Every time you take a deduction for retirement, you’re in essence taking a tax loan that will be paid back at some future date, most likely at a higher rate. Ed compared it to the Peanuts character, Pig Pen, who always had a cloud of dirt following him around. So, then, how do you avoid Pig Pen’s dirty fate? One of the best ways, according to Ed, is to focus on Roth IRAs. “Every young person should only, only be doing Roth IRAs or Roth 401(k)s at work. They have the ability to start from dollar one, building a retirement account that’s absolutely tax-free. So all the growth, all the compounding, will be 100% theirs.”
As a quick review, a Roth IRA means you pay taxes on the money as it goes into the retirement account but your future withdrawals are tax-free.
I get skeptical radio listeners who worry that they’ll keep their hard-earned end of the Roth bargain, but will the government? “The answer is absolutely not!” says Ed. “You can’t trust these guys as far as you can throw them. Tax laws are written in pencil.” But that doesn’t matter, he went on to say, “It’s here now! Take advantage of it now!”
Does that mean Ed would go so far as to convert traditional IRAs to Roth? It sure does.
Now, let’s say you’re already in a high tax bracket, paying 35% per year. Do you still want to convert your traditional IRA or old 401(k) into a Roth, knowing that every penny you convert is taxable and contributes to your overall income? A tax projection should be run with a CPA to determine how much the Roth conversion would raise your overall effective income rate. In general, my opinion is a tax increase higher than about 24% might warrant not doing the Roth conversion.
Look, Ed’s not a sadist. He doesn’t want you going broke. In some cases, a moderate approach of making smaller, annual conversions is more appropriate. But just in case you think he’d never eat his own cooking, back in 2010 when a new tax law made it possible, he “converted everything: lock, stock, and barrel!”
Some folks in their 60s worry that the conversion would cause a spike in income and make social security taxable. Ed says that’s a non-issue because social security thresholds are so low that it’s already taxable for most people.
But what about medicare premium surcharges? People tell Ed that if they see those premiums rise it will make them angry. “If that’s going to make you angry, do the conversion anyway because I’d rather have you be angry one year than be angry for the rest of your life because if you don’t do it and you do nothing, that account is going to grow, grow, grow and at 72, you’ll be forced to take it out and the very thing that makes you angry is going to happen every year.”
For those who already have enough money to retire comfortably, converting to a Roth IRA can be viewed as a pre-paid tax gift for children and grandchildren. For example, Ed has a client who is a 67-year-old doctor. She’s still earning a nice income but has millions in her traditional IRA from all the 401(k)s that were rolled over in her career. Each year she converts about a million dollars to her Roth IRA. She told him “I’ll never need any of that money. I’m doing it because it’s going to my grandchildren.”
The Sweet Spot
A lot of people who listen to my podcast, Retire Sooner, are really aiming to retire and stop working and maybe need to use at least some of their IRA money early. So, I wanted Ed to walk us through some of the crucial ages of planning. He calls the time between age 59 and ½ and 72—the retirement sweet spot.
Touching a retirement account before age 59 and ½ would mean a 10% penalty for early withdrawal and that’s a dealbreaker to Ed. But on the other end of the spectrum, mandatory distributions kick in at age 72. Therefore, the time between is an oasis of planning where you get more of the carrot and less of the stick. Take advantage of it.
The tax exemption for life insurance is one of the biggest single benefits in the tax code. And most people don’t look at it. Ed says, “You might look at a permanent life insurance policy as a super-duper Roth that has a giant death benefit all tax free without all the government tax rules.” Because of that, it’s another prudent option for people who want to leave bigger legacies to their children and grandchildren.”
“The biggest mistake is not addressing the planning,” Ed told me. “They’ve done all the working, building, saving, and investing. They look at their IRA or 401(k) and say, ‘Well I’ve saved all I’ll ever need for retirement.’” This is a huge mistake. Even if you skip the back nine holes you can be sure the IRS never does.
Ed’s flair for avoiding the pitfalls of a short-sighted retirement plan really brings to life just how crucial it is to keep your eye on the ball. You’ve been to the range. You’ve practiced your chip shots. You’ve saved up for a new putter. Now step up, take a breath, and swing with confidence for all 18 holes.
Listen to my discussion with Ed Slott here.