Seeing The Whole Playing Field

18175546_sI call them the “young ones,” newly retired couples typically in their early 60s who are anxious to plan their financial future. John and Barbara, a couple of “young ones” who retired here from Chicago, came to me for a second opinion on their investment and retirement plan. They are Cutter Family Finance readers and had read one of my articles about Roth conversion strategies. They were anxious to discuss those strategies.
Barbara, a retired schoolteacher and mother of three, was trying to figure out how she could move some of the couple’s tax-deferred IRA into a tax-free Roth IRA. The countless stock brokers they consulted had warned them against Roth conversions, reasoning that it would be expensive to convert their Traditional IRAs to Roth IRAs. While the brokers were correct, that the transfer of dollars from an IRA to a Roth could create taxable income to them both; they failed to inform John and Barbara that the couple could create a Roth Conversion Plan to minimize the tax effects of such a Roth conversion. Nor did the brokers look into John and Barbara’s portfolio to determine if there were opportunities to mitigate the cost of Roth conversions. In essence, the brokers had truly failed to “see the whole playing field” from the clients’ perspective.
You see, Susan and I believe that every retiree must have an investment plan, an income plan and an advanced tax plan. Additionally, we recommend that retirees create an estate plan and a legacy plan. Planning is very important as it allows us to take advantage of simple opportunities that we might otherwise fail to consider or which might expire over time. By creating a plan and taking advantage of these opportunities, we can completely change the game for the benefit of our clients. Let’s take a look at what happened with John and Barbara.
They were actually in solid financial shape. John had a generous pension, which was part of the problem, as their marginal tax rate, or the rate at which the Roth conversion would be taxed, was very high, about 33 percent. So, if they converted their $600,000 IRA to a Roth IRA in a single year, the account would “shrink” to approximately $400,000. Now how many stock brokers would advise you to do that? Shrink the assets they have under management from $600,000 to $400,000! Well, not many.
Now here is where it got interesting. When I reviewed John and Barbara’s will I found two very interesting provisions. The first gave the 25-acre family farm to a local charity and the second bequeathed some highly appreciated stock to their church. I asked them why they were waiting until their deaths to make their charitable contributions. Their response . . . “Well, that’s what everybody does, give away their assets when they die.” I asked John and Barbara if they would consider gifting these assets before their deaths so that they could benefit from the tax deductions during their lifetime. John was skeptical. First of all, he wanted to continue to visit his deceased parents’ farm for the rest of his and Barbara’s life and secondly, he was concerned about giving the church such a large single donation so early in his life. Goodness, what if he and Barbara moved or even switched to another church?
Hmm . . . this is why it is so important to see the whole playing field.
Let me explain. If we plan ahead, we can use charitable deductions during our lives to create “free” Roth Conversions. In order to do so, however, we must survey the entire playing field. For example, John and Barbara had the option of splitting the property rights in the family farm. They could give away the development rights to a local land trust generating an immediate tax deduction and at their death they could give away the farm to the charity of their choice. This would generate another tax deduction at their death. In order to accomplish this, we needed to engage an attorney so they could deed a conservation easement on the family farm to a local land trust. This would allow John and Barbara to use the farm for the rest of their lives. It would also give them an immediate $250,000 tax deduction. The farm would still be deeded to the charity at death and, therefore, there was no reason to change their will. This would produce another $150,000 tax deduction, or more, at the date of their death.
Second, we created a private charitable foundation for John and Barbara through a national custodian that administers such organizations. We funded the foundation with the low basis stock, thereby creating $350,000 of tax deductions. The J&B Private Foundation will make yearly contributions to John and Barbara’s church, ensuring that they stay in good stead with their pastor. This way, if John and Barbara move, or even switch to another church, their contributions will move with them. Finally, and most importantly, we worked with their accountant to confirm that all of the tax deductions could be used to offset the additional income created by Roth conversions; and that the maximum amount of IRA was converted to the Roth at low or no cost and as soon as possible.
Mission accomplished. John and Barbara now see the true value of planning one’s retirement. It takes a quarterback who is willing and able to survey the entire field, create a plan, and use the resources available to their clients to see that the client does indeed cross the goal line. In this case, to convert a Traditional IRA to a Roth IRA that will grow for their lives and the lives of their children—completely tax-free.
Folks, it does get tricky out there so remember to be vigilant and to stay alert, because you do deserve more.