#28 | Stop Contributing to IRAs and 401Ks

Jon “Jag” Gay: Welcome to Protecting and Preserving Wealth, I am Jon Jag Gay, joined as always by Bruce Hosler of Hosler Wealth Management. Bruce, good to be back with you.

Bruce Hosler: Good to be with you, Jon. Thanks for being with me today.

Jon: So, today we’re really talking about an intriguing topic. Ed Slott says it’s time to stop contributing to IRAs and 401ks, which is definitely an eye-opener.

Bruce: Yes, that flies in the face of conventional advice by many tax and financial professionals and institutions. That’s why it’s so important that we get the word out on this important information.

Jon: I’ve heard the name before, but for our audience and my edification as well, who is Ed Slott?

Bruce: Ed Slott is a nationally recognized IRA distribution expert. He’s a professional speaker. He’s a television personality. He’s been on many of the TV channels and news channels. He’s a best-selling author, and he’s been named the best source for IRA advice by The Wall Street Journal. USA Today wrote, “It would be tough to find anyone who knows more about IRAs than Ed Slott.” He has an expert IRA advisors group that he puts together, it’s a study group, and I’ve been a member for about 15 years now.

Jon: All right. So obviously he’s widely regarded as one of the leading experts on IRAs, IRA planning. If that’s the case, why is he saying that people should stop contributing to IRAs and 401ks, Bruce?

Bruce: That question is what I wanted to talk about today, because this is a big change. Now, Ed Slott wrote an article for The Investment News Magazine on July 24th of 2023, this year. In that issue, he starts the article with the title, Stop Contributing to Your IRAs and 401ks. Then the first thing it says is, “That has to be a typographical error. After all, traditional retirement planning has always preached maximizing your contributions to tax-deferred individual accounts and 401ks so you can build your retirement savings.”

Jon: Yes. We’re going to link to that article in our show notes today as well. Of course that’s what the financial industry has been teaching for decades. Save your money, tax-deferred, then in retirement, after your income’s lower, take out the distributions when you’re in a lower tax bracket, right?

Bruce: That, Jon, is the fatal assumption. Ed calls it in his article, The Big Retirement Myth. He states, “For most people, lower taxes in retirement is a myth. For those who build the largest IRAs, taxes down the road will generally be much higher as a result of deferring withdrawals until they’re required. This triggers larger IRA tax bills when minimum distributions are required.”

Jon: Okay, Bruce, do people really live on less when they retire?

Bruce: Boy, that has not been my experience. I want you to think about that. We have all these baby boomers out there. Who wants to take a pay cut? None of us. Think about it. You’ve been scrimping and saving your whole life. Now you’re ready to retire and go have some fun. Who wants to cut back on their spending right when they retire? My experience over the last 26 years is that clients do not have lower incomes in retirement. That assumption is erroneous in my experience.

Jon: True. If you think about it, Bruce, you make a good point about wanting to enjoy the fruits of your labor after working for however many decades, but on top of it, you’re not spending the traditional nine to five in an office. You have more time to do, as the kids say, all the things, so why wouldn’t you be spending more money?

Bruce: Absolutely. Just go to an airport today. Look at it. It’s full of baby boomers. They’re all out there traveling. The airports are all full. The cruise ships are full. I am telling you, you have the go-go years, the slow-go years, and the no-go years, and the baby boomers are tearing it up in the go-go years right now. They’re wanting to spend money.

Jon: Yes. That traditional three phases of retirement. Hey, Bruce, if people are not contributing to the traditional 401k, wouldn’t they have to recognize all the income that they’re funding into a Roth 401k as income?

Bruce: Yes, they will. Ed Slott thinks that this is a good thing, because while tax rates are low right now, like they are, those tax deductions are not as valuable. Smart tax planning requires that we pay taxes when the tax rates are low. So, if you can avoid paying taxes when the tax rates are higher later on, that’s a good thing. So, the tax-free income that you will receive in retirement may also help you avoid taxes on your Social Security benefits, or having to pay the IRMAA penalties on your Medicare benefits because your income is too high, because of the requirement of distributions that you have to take later on.

Jon: Real quick for our listeners, what are IRMAA penalties?

Bruce: That’s income related to your monthly adjustment amount. What that means is, is if you are, let’s say, a married couple and your income in 2023, I think it’s about $194,000, if your income bumps up above that, now all of a sudden they slap a penalty on you, like about $360 a month per person on your Medicare benefits, and it starts to add up fast. If you’re trying to convert big IRA amounts, you could bump into that IRMAA penalty, so people are trying to avoid that and do planning around that.

Jon: Got it. Okay. You’ve talked about putting money into Roth accounts. What about existing IRA accounts that clients own? What should our listeners be doing with those accounts?

Bruce: Ed Slott says people should be reducing those accounts through a planned withdrawal strategy. He says, “Don’t wait until required minimum distributions begin, because it may be too late by then.” Conventional wisdom has held that you should delay IRA distributions until you start taking RMDs. That may no longer be the best plans. It’s time to reverse that trend and start looking for ways to get the funds out of the IRAs well before they’re required to come out.

Jon: Okay. Million dollar question, no pun intended, how should our listeners do that?

Bruce: Well, the foundation of good tax planning is to pay taxes when the tax rates are the lowest, and that may be right now. We have low tax rates right now due to the Tax Cuts and Jobs Act of 2017, and that lower tax rate stays with us until December 31st of 2025. Now the time to convert your IRAs to Roth IRAs is right now. You can also use a QCD, which is a Qualified Charitable Distribution, to give your IRA to charities, and that’s one of the best ways to support your charitable wishes. IRAs are the very best funds to leave to a charity because it avoids the taxation, and QCDs are direct transfers from your IRA to a charity. But they’re only available to IRA owners or IRA beneficiaries who are age 70 and a half or older.

Jon: Got it. A tricky topic here, Bruce. What about this whole idea of using your IRA to fund permanent cash value life insurance?

Bruce: Ed Slott says that another way to reduce your IRA balances is to use them to fund permanent cash value life insurance. Just like with Roth IRA conversions, you pay the tax on the distribution, but the cash value grows tax-free inside of the policy, avoiding future higher tax rates.

Jon: How about the new rules that IRAs must be withdrawn within 10 years after the IRA owner passes away by his or her beneficiaries?

Bruce: Jon, that’s a great question because the new Secure Act 2.0 that was just passed at the end of last year requires that beneficiaries of a deceased IRA owner, that are not the spouse or an other EDB, which is eligible designated beneficiary, must take the required minimum distributions and empty out the entire IRA account by the end of the 10th year if the IRA owner died after the beginning date. Now that was a lot of information, let me clarify it.

The required beginning date now is age 73, so if your parent dies after that date, the age of 73, then you have to start taking RMDs out every year and you have to empty it. This change in the law makes IRAs a terrible wealth transfer tool. Roth IRAs are much better but still must be completely distributed by the end of 10 years. But at least these types of IRAs, Roth IRAs, will allow the beneficiaries to keep the account invested and growing without any RMDs for 10 years past the death of the IRA owner.

Jon: Got it. Bruce, I know you do a lot of tax planning with your clients around tax brackets. What about the current tax brackets is helpful for our listeners to know?

Bruce: Jon, right now, if you’re married filing joint, your taxable income now, that’s after your itemized deductions and everything like that, you can have taxable income up to $364,000 and still stay in the 24% tax bracket. So, we’re recommending to clients that they use the tax bracket strategy and this strategy looks at their current tax bracket and then how much more money they could convert from their traditional IRA to a Roth IRA without moving up too far in the tax brackets, thus keeping their effective tax rate as low as possible. We’re recommending that they look at this every year with a tax plan and keep their effective tax bracket, hopefully, around the 24%. We think that’s the sweet spot.

Jon: To your point earlier about the Tax Cuts and Jobs Act still being in effect, the analogy that I’ve heard is that taxes are on sale. If you have to pay taxes at some point, why not do it when they’re lower, lower because of where tax rates are now and lower because you’re hopefully going to be having more income in your retirement?

Bruce: That’s exactly why Ed Slott is advising everyone to stop adding to the pile of tax-deferred money in your IRAs and 401ks. He’s trying to get you to reverse the trend and move more of your money to these tax-free vehicles and keep less out of the tax-deferred nest egg, if you will, because these tax-deferred nest eggs, IRAs and traditional 401ks, they’re going to be like a yoke around your neck dragging you to the bottom of the ocean later on when these tax rates go much higher.

Jon: To give you another analogy, and I know we’re talking a lot about folks who are looking at retirement, but I’m 42. I had a period a few years ago where I changed careers and there was a year in between my careers where I really didn’t make much income. I’m kicking myself now that I didn’t convert that money in a 401k to a Roth when I was making very little money because I would have paid way less taxes on it because my tax bracket would have been much lower. It sounds like the same thing we’re talking about here.

Bruce: It’s exactly that. Jon, people run into different opportunities like that. For example, perhaps they have a business loss and so they have a big write-off on their business one year and their income is down, like you skipped a year. Or maybe they have other situations where they have a year where their income is lower like that. That is a great opportunity to convert and use up that tax deduction.

Jon: Really good stuff today, as always, Bruce, some food for thought for sure. If one of our listeners wants to come talk to you and your team at Hosler Wealth Management, how do they best find you?

Bruce: They can reach us at the website, https://hoslerwm.com, or they can call us in Prescott at 928-778-7666 or in Scottsdale at 480-994-7342.

Jon: Good stuff as always, Bruce. Let’s talk again in a couple of weeks.

Bruce: Thanks, Jon.

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