This is a question that we have received a few times in the past, Alan. And this is from
April from Illinois. We used to do a full segment on this, didn't we usually? What is
Ric Edelman saying?
(laughs) Yeah that was a long time ago.
She's like, all right well, "what do you think of Ric Edelman's opinion of Roth IRAs?" So,
first disclosure, I'm a big fan of Ric. Al and I know Ric personally.
Yeah we do.
That's a name drop.
(laughs) If you're not in the industry you probably don't know what we're talking about.
But if you're in the industry, you go, "oh, those guys know Ric Edelman. That's pretty
good." I know him by name. (laughs) How about that? And he knows he knows by me by name
when he looks at my name tag at conferences I go to. (laughs)
(laughs) I think there's a difference of opinions in some of the planning that we do versus
what his firm does.
Yeah I would say there are probably more similarities than differences, but we do have differences.
I think our investment philosophies are almost right on. Pretty close there. I think when
you look at Social Security benefits strategies or claiming strategies, to pension, to life
insurance. All of it. But when it comes to taxes, we differ.
Yeah I agree with that.
And here's the reason why I believe, is that we are a smaller boutique Registered Investment
Advisor with CPAs on staff. We have a very strong financial planning process that monitors
all the financial planning that goes through, and we spend a lot of money, basically, on
very good talent to make sure that we provide a phenomenal product in regards to planning.
Right, which includes a huge emphasis on income taxes, which most firms don't really do.
Including Ric's firm.
And I think there's liability there.
Yes. There is. Right. We're taking a chance. (laughs)
(laughs) We're not taking a chance. It's like we're giving value that most firms don't necessarily
want to, because it's like, well here, they can get tax advice from their CPA. They could
get their tax advice from their enrolled agent, or whatever. They can do it on their own.
We don't want to get in that business. We're in the business of helping them build their
wealth via through asset management. 90% of their focus is more or less investment management.
You can get a financial plan through Edelman or any of these other fine really fine financial
planning firms for maybe a couple hundred bucks. It's not a financial plan, in my opinion,
it's a cash flow analysis just to see if you're on track or not. They might run a couple Monte
Carlos, and it'll take them 15 minutes to put together. And it really helps them to
identify how many other assets that you have, really to see OK, well what can we do and
how much money can we manage. And I think that's a fact with a lot of firms, and there's
nothing wrong with that because they're helping them, A, create a network statement, which
is key. And then looking at well, what do they need to do with the net worth to help
them grow? And if their firm is helping them build wealth, well, God bless them. We take
a little bit different stance to say OK, well yes, building wealth is key, but how can you
also build wealth from things that you can control. And taxes, in our opinion, are a
huge thing that you can control. And so the biggest emphasis that we made since day one
with Pure Financial Advisors is that, all right, we want to have the coordination of
different professionals, CPAs, attorneys, CERTIFIED FINANCIAL PLANNERS™, money managers,
all sitting around the same table looking at things with an objective viewpoint. And
I think that's what made us what, one of the fastest-growing financial planning firms here
in the nation.
April from Illinois, she had sent us a little excerpt from I think Ric Edelman's... and
then did they change his name too, is it now "Edelman Financial Engines?"
Is that the official name?
That I don't know.
OK. April sent that to us about his opinion on Roth IRAs. if you've ever listened to our
show before, you probably have gathered that Al and I are pretty large fans of Roth IRAs.
And so she wanted to get our opinion. And so let me read this real quick of what Edelman
says about Roths, and then we can rebuttal here. From Edelman, he's like, "First ask
yourself what's the goal of investing? Why put money into an IRA in the first place?
Obviously, the goal is to accumulate wealth, as much wealth as you possibly can on an after-tax
basis. The question then becomes what type of IRA produces more wealth, the traditional
or the Roth? The answer might surprise you," says Edelman. "If you run the numbers on a
spreadsheet, which isn't hard to do, you'll quickly discover the answer is neither. It's
a wash. There's no difference. If you convert to a Roth, you trigger a tax immediately.
But converting won't increase your wealth. So why pay a tax right now that you don't
have to pay?" Let's stop there, Al. Let's break this down. What's he talking about?
All right. So he's saying, so you pay the tax now and then you've got less to invest.
Or you don't pay the tax, you've got a higher balance, but then you pay the tax later - a
higher tax. But when you do the math, all things being equal, you end up with
the same net number.
So for instance, if I had $100,00 in an IRA, and let's say I had $25,000 outside of my
IRA. So I had $125,000, total.
OK. So that's your net worth.
That's my net worth - $100, 000 in an IRA, $25,000 in a brokerage account. And if I decided
to convert that $100,000 into a Roth IRA, the hundred grand of the IRA goes into the
Roth. Now I have $100,000 in a Roth. But I have to pay tax to get the $100,000 in and
let's assume I'm the 25% rate. So that cost me $25,000 in tax. Is that fair?
Does that make sense?
It does. So you did the Roth, and so now your net worth is only $100,000 because you lost
$25,000 to tax.
Correct.
So you immediately went backwards.
I went backwards. It's like why in the hell would you do this?? (laughs) So $125,000 is
my net worth. And then if I did the Roth conversion, I had to pay the tax upfront to get that money
to grow tax-free. So now I have $100,000 in the Roth. But let's say you go 10 years out,
and the money doubles - it grows at 7%. So now that $100,000 is worth $200,000, but it's
all tax-free. That's pretty cool.
In the Roth, yeah.
Ric Edelman's point is this, he's like, "let's say you don't do anything. You keep the $100,000
in the IRA. You keep the $25,000 in your brokerage account, and you invest them the same. And
let's assume they get a 7% rate of return over the 10 years. And then with that,
it will double.
Yes. OK. So that's $250,000.
So yeah. That $100,000 is now $200,000 and then the $25,00 is now $50,000.
Yeah. So your total net worth went from $125,000 to $250,000.
So you're thinking, "well the $250,000 is a lot more money than the $200,000 in the
Roth." But what are we forgetting?
Yeah. When you take the money out of the IRA you gotta pay tax.
So if I take the $200,000 out of the IRA, what do I truly net?
Yeah. 25% tax rate, $50,000 tax. So now you end up with $200,000 net, which is the same
as what you had in the Roth.
But how about that $25,000 to $50,000 though? I have to pay tax on that too, right?
Yeah, if there's gain, you bet.
Well it did gain, right? It did 25 to 50, so I've got to pay a capital gains tax on
that. So I think Ric's math is off a little bit too, here.
Well and plus I mean, that's like, I don't know, like a lab textbook case. There are
so many other variables that make this so much better. But that's our starting point.
So he's thinking, all right, well it's a wash. If you pay off your mortgage, do you increase
your net worth?
No.
Because you took one asset and reduced a liability so you've got the same net worth.
When we look at Roth conversions, that's how we look at it, is that we're paying off a
mortgage. We're buying our partnership back from the IRS.
Yeah. Because you've gotta look at your IRA as though it's not all yours, because there's
a tax component when you withdraw the funds.
So there's a mortgage on the overall IRA. So you're trying to figure out what's the
best way to get rid of the mortgage or reduce the mortgage as much as you can. So by having
money in a Roth IRA, and having money in a traditional IRA, there are many more benefits
than just looking at a straight line Excel spreadsheet evaluation.
Sure. Yeah, I agree with that.
One of the biggest, in my opinion, is that you now have control on your distribution.
How much that you pull from an IRA, and then how much that you can pull from the Roth.
Maybe you do a 50/50 split. Hey, I'm gonna pull 50% from my IRA, 50% from my Roth IRA.
That could keep me in a very low tax bracket, even though I have very high cash flow.
Right. So you're managing your distributions to keep out of the higher tax brackets.
That's one. Two: there is no required minimum distribution on Roth IRAs. So that
money can continue to compound for my life, spouse's life, kids life. Pretty good. Number
three: asset location. So if I manage my affairs effectively from an asset location, I will
probably have investments in my Roth IRA that have a higher expected rate of return than
I would in its standard IRA. Because all of the growth now is going to grow tax-free.
Yeah. So then you have your lower expected return assets in your IRA and you end up with
a lot more after-tax money.
So when I'm considering, now, the tax code itself, of the tax reform, has reduced marginal
rates, what, five of the seven marginal rates now are lower? And some of them by
a fairly large margin?
Tax rates are cheaper right now.
So does it make sense for me to pay a cheaper rate today than wait and pay a more expensive
rate in the future? That makes sense to me. So that's another, I think,
a win for doing Roth.
Especially right now because very few taxpayers are subject to Alternative Minimum Tax, which
substantially increases the tax rate. Plus, we have lower rates. Then, Joe, you combine
that with - there are other tax planning strategies that you can do to lower your taxable income
that allows you to do Roth conversions in yet a lower tax bracket. You just have to
know what they are. And if you put all of these things together, and you do the same
mathematics, you come out much better doing the Roth IRA. I will say, if Congress, our
government, decides to tax Roth IRAs?
Well let let let me finish what you wrote here. He goes, "You also asserted that the
Roth avoids the requirement to take distributions starting at 70 and a half." So I'm reading
back to Ric's here. "Can you count on that forever? Be aware that President Obama inserted
language in the 2015 budget that would require distributions from Roths at age 70 and a half
just as with traditional IRAs." So Ric is saying, "hey you know what, you like the fact
that there is no RMDs? No, they're going to change it. Barack Obama tried, but he failed.
But maybe Trump can do it, or whoever is next." "So that's one of my fears about Roths," says
Ric. "The government could change the rules at any time, and do it retroactively. If you
won't reach age 70 for another 20 years, you'll go through 10 Congresses and maybe five presidents.
Are you sure they won't ever change the rules? Consider that Roths will hold trillions of
dollars by then. Money that's currently tax-free. That's a pretty tempting target for a legislator
trying to generate tax revenue." All right. So what do you think? Changing the rules
on RMDs, Al?
(laughs) I would say changing the rules on a Roth to have RMDs, that could happen. But
if it does happen, then that money comes out tax-free. You would have a little bit less
control, but still, for all the reasons that we already mentioned, you come up in a much
better place. I think the bigger concern is, will they change the whole structure and say,
"you know what, Social Security never used to be taxable, and Roths are not taxable.
Now, Social Security is taxable. Let's make Roths taxable." And I would say that's highly
unlikely for that, just because whenever they made changes in the retirement code before,
they've always grandfathered the old stuff in.
You know, last comment on this is that most of the younger generation, the millennials,
are putting most of their dollars into Roth IRAs. And so his argument here of saying,
"hey, you know, in 10, 20, 30 years from now, there will be trillions of dollars in Roth
IRAs, you don't think they're going to change it?" But Ric, guess who's trillions of dollars
that is? It's the people that are going to be in Congress.
And who are they supporting? The people that have all the Roth IRAs that are not gonna
stand for that.
They're not going to hurt themselves.