Tax-Free Retirement Savings

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Share it. But most of all, thank you for listening to the Truth Podcast Network. With certified financial planner Hans Scheil, best-selling author and financial planner, helping families finish well for over 40 years. On Finishing Well, we'll examine both biblical and practical knowledge to assist families in finishing well, including discussions on managing Social Security, Medicare, IRAs, long-term care, life insurance, investments, and taxes. Now, let's get started with Finishing Well. Finishing Well is a general discussion and education of the issues facing retirees. CardinalGuide.com, Cardinal Advisors, and Hans Scheil CFP sell insurance.

This show does not offer investment products or investment advice. So welcome to Finishing Well with certified financial planner Hans Scheil. And we've got a really special episode for you this week, I believe, in my heart it is, in that we're talking about tax-free, that's F-R-E-E. As my friend Hans often says, tax-free, retirement, savings, and what all that has to do. But, you know, it's interesting that when you think about this from, you know, your life with God, that the virgins that were supposed to have oil in their lamps, you know, they needed a tax-free way of keeping oil in their lamps so they could light their way.

And as we come, you know, into, as we're recording this, actually, you'll be listening to it on Christmas and thinking about the year of 2022. Well, God gave me a real present along these lines in 2021 that I'd share, that it would help you get more oil in your lamp absolutely tax-free. So here's what God encouraged me to start memorizing certain Psalms.

And he gave me very specific ones before I really knew what was in them. But it started out with the 16th Psalm, which you may know or you might recall is the one that ends with, you know, you've shown me the path of life, you know, in your presence is fullness of joy and at your right hand are pleasures forevermore. Well, when you just listen to the punchline of that, you're like, what else is in that Psalm to get to there?

So, you know, pretty fun stuff. I memorized that one. I memorized the 13th. And then he asked me or challenged me in July to begin on the 119th Psalm, which you may know is eight verses on all 22 letters of the Hebrew alphabet. What it did not see coming, because, you know, at 66 years old, I didn't think, I'm like, you're going to memorize that at this age?

Oh, what a joy it has been. I can't even begin to tell you the oil that it has put in my lamp and the tax free savings. And I mean savings of God's word in my heart that just bear dividends every day I see things come to life that I've never seen before. And so I thought I would give you this idea for tax free heart retirement savings before Hans shared his strategy for the financial side of it.

Well, I don't have anything as profound as that and life changing, but this stuff. So before we get started about where we're going to end up is on tax free retirement savings. Let's talk about the three different tax characterizations or the three different situations that your money is in, depending on whether it's a taxable account, a tax deferred account, or a tax free account. The first one we're going to start out with is a taxable account.

And this is the one most people are familiar with. You know, it's money markets at the bank or a savings account, a CD, stocks and bonds that you hold in a brokerage account. You may hold those jointly with your spouse or you may hold them alone, mutual funds, money that comes into you and rent if you have some property. Just generally any account, the IRS is going to get their income tax on any growth or interest that's earned on that account throughout the year.

So many people out there think this is the way every account works. So we're going to call number one the taxable account, and that's my least favorite of the three types of accounts, but it's still a favorite of mine because it's money in a savings account. As a financial planner, that's a good thing. Now the second one is tax deferred. And what tax deferred really means, a lot of people think that's tax free, but tax deferred means you've never paid taxes on this money.

You're not currently paying taxes on the growth of the money, but you will or somebody will. And you know, that's mostly your 401k, IRA, 403b, any account where you don't pay taxes as you're rolling along. And if you really have difficulty, and sometimes we do when people call into us and they're wanting financial planning, they have trouble answering the question, is this a pre-tax account or is this a after-tax account or a taxable account? And the real clue on that is if you get 1099 from the financial institution at the end of the year, it's a taxable account. I mean, you get no 1099 on your IRA or 401k, 403b, that type of thing, unless you took some money out of it. So are we clear on the first couple of types of accounts? I'm clear, but I would also point out, you know, you were talking about the taxable account first was what you talked about. You know, that comes in really handy, right, from a liquidity standpoint if you're trying to stay tax free later in retirement, right? So that's actually really a critical account to have if you possibly can have that along with the others that you're talking about, right?

Well, it sure is. The catch on that is, you know, if you invested in something or you just put it where you're getting interest, which hasn't been much lately at the bank, you're paying tax every year on that growth on the account, whether you spend it or not. But it's still very necessary to have, I mean, I've got, you know, over $100,000 in a taxable account. And I, you know, it's painful to look at the little interest that I'm getting from the credit union on that, but I have it there because I need the availability of the money.

I mean, we're doing a lot of things and I'm helping my kids out with things and when we buy things, we try not to finance them. So I've got to keep a certain amount of money liquid, as I'm guessing most of you do. So I'm not referring to account number one, taxable as bad. It's very necessary and it's there for liquidity, just so you can go put your hands on it when you need it.

Right. You know, on a tax deferred account, the second kind, a lot of people treat that as a savings account and it's too liquid. I mean, you can, you know, if you got an IRA and you could have several hundred thousand dollars in there and if you wanted to pull out $20,000 to do something, you could do that very quickly without penalty. The catch is, is you're going to have to pay income tax on that whole distribution. If it's large, it throws your whole tax plan off. So the tax deferred account is not a real good savings account, where you're savings for large purchases.

Right. And so what we're talking about today and we're creating actually a few options within that is the tax free account. And by tax free, we mean, as you point out to me a lot, free is, means exactly what it sounds.

It's F-R-E-E free. That means you're never going to pay tax on this money. So you've already paid tax on the principal or the contribution to the account and then as the account grows, you don't pay any tax on the growth ever.

And then if you die with the money in this account, it goes to your beneficiaries tax free. So it's a very desirable account and what it's referred to as a Roth IRA. And a Roth was a guy's name that was one of the congressmen that sponsored the bill that created the Roth IRA, which is a tax free account. And it's been around since 1997.

It, you know, hasn't gained a lot of traction. Meaning that when you, most people that come see us, they either have no Roth account or they have some Roth account. But their Roth account is usually very small compared to their 401k or IRA account or their pre-tax or their tax deferred account. And so what we do a lot of is helping people convert their tax deferred account, their 401k, their IRA, their money they've not paid taxes on. And we help them convert it to a tax free Roth IRA.

And you know, that's the good news. Now you're in a tax free account. The bad news is you've got to pay the income taxes on the thing, on the whole amount you convert. And that's a big stop sign for a lot of people. Yeah, I love the way you talked about it in your video that, you know, why would you come to me to have to pay taxes? Most people come to me to lower their taxes, not to raise them. But this is, this is a hard sale to make.

So we, you know, we, we put on our pads and chin strap and we dig in there and we're, we're, we're going to, if it's the right thing for people, we're going to convince them to do it. So, I mean, I have a guy that I was just on the phone with that we were talking about and he, this gentleman, his wife's a nurse. And she works, you know, in the COVID wing and all that. In fact, she was working while we were talking this morning, just coming in from work, working all night. And she's going to retire in September, he thinks.

He's retiring right now. And they have pretty significant income. They're a couple of professionals. I would just say $150,000, $180,000 a year between the two of them. But what is remarkable is between the two of them, they have over $4 million in IRA accounts. Okay. Wow. Or 401k accounts, soon to become IRA accounts. And a lot of that is he's invested very aggressively. It's paid off. And this man's from a foreign country and they live very, they don't spend a lot of their money.

Okay. I mean, they live very close in a very simple house and they don't really have any intent on changing that. And then he comes to us and he's acting like this is a big luxury he's asking for. He wants to spend $50,000 fixing up his house. And he wants to spend, I don't know, $20,000 on something else and $10,000 on something else and that's it. And it's almost like he's asking me for permission. And I'm like, I'm just telling him, you know, dude, you got almost $5 million, you can do anything you want. And, you know, I told him that this morning, I've talked to him several times, is that you are not going to increase your lifestyle.

I mean, he's just not. You could, but what's going to happen is this money is going to keep growing and keep growing and keep growing. And then, you know, maybe you tap into some of it, but it's going to keep growing and growing. And then I showed him what minimum distributions and the taxes on that at 72. He's 65 now. And then I started talking to him about when he leaves this to his kids, you know, what kind of a tax burden that they're going to have. And that really woke him up because, you know, in their culture, just leaving to your children is just extremely important. I had gotten that out of him earlier. So now he's all on board, or at least he was on board, to start doing these Roth conversions until, and so today's call was really just about preparing him for what I'm going to propose before we write it into the plan.

Because I just wanted to just give him some numbers and make sure that he was semi, and just let him react to it so we're not doing that right in the middle of his financial plan. And it was a real interesting call today. I'll bet. I'll bet.

Well, I hate we've got to jump in here, but we're going to go to a break. And when we come back, we're going to find out a great deal more about tax-free retirement savings. Stay tuned. Hans and I would love to take our show on the road to your church, Sunday School, Christian, or civic group. Here's a chance for you to advance the kingdom through financial resources by leveraging Hans' expertise in qualified charitable contributions, veterans aid and attendance, IRAs, Social Security, Medicare, and long-term care. Just go to cardinalguide.com and contact Hans to schedule a live recording of Finishing Well. At your church, Sunday School, Christian, or civic group, contact Hans at cardinalguide.com.

That's cardinalguide.com. Welcome back to Finishing Well with certified financial planner Hans Scheil, and today's show is tax-free, F-R-E-E, retirement savings. And when we left our hero, Hans, he was working on a plan with you, essentially, to make a huge conversion, right, to a Roth IRA. This couple we were just talking about, their income this year is about $150,000 between the two of them. She's a nurse. He's working in some type of health care but doing analytics, and he's pretty good at math and numbers, and they're Filipino by descent. And they lived, they moved here right after college or right during college, and they've just been working folks for 40-some years. And putting aside the maximum in their tax-deferred account, invest in it very aggressively, and then, you know, voila, this guy's we have between 4 and 5 million bucks. And he's now retired, just the end of this year. She's going to retire in September, and then he's coming to us because he's aware, he's smart enough to know that he's got a big tax problem on his hands. Because he has almost no taxable savings.

I mean, almost no money. I mean, let's just say $10,000 or something, and the rest of his money is all in the tax-deferred accounts. So, what we came up with is, for next year, for 2022, and probably every year thereafter, is the top tax bracket, or the top of the 24% tax bracket is $340,000. So, you know, here I am with this guy that's going to make about $150,000 in 2022, and talking him into raising his income from $150,000, or their joint income, to $340,000 voluntarily. And so, he's going to take $190,000 out of this tax-deferred account, the 401k, and roll it into a Roth IRA, and he's going to pay the income taxes on $190,000.

He didn't like that too much, okay? And just to make it simple, you know, that's about a 24%, it's about 43 grand, something like that, voluntarily signing up for. And this is a guy that's been avoiding taxes, so he thinks he's been postponing taxes, when he's really thinking he's been avoiding taxes, to accumulate that amount of money. And so, we had to do some talking and some explaining, but I got him to take a look at it, and it's, you know, 24% tax rate, for a person with a high income, is the lowest I've ever seen.

You know, we're going to look back 10, 20 years from now, I think, and we're going to say, boy, that was a bargain, we should have taken advantage of that. And so, what I think this guy's going to do, is he's going to just simply do the extra $190,000, or thereabouts, call it $200,000 of Roth conversions, and he's going to be doing that on into the future, so many years, that by the time he's 80, he's going to have about half of this $4.5 million converted into a Roth, although it will have grown by then as well. So, I don't want to get rambling here, I mean, I think everybody's got the concept, and what I'm really talking about on the video is, a Roth IRA is really the same as a traditional IRA, and in terms of what you can invest in, how much it can grow, all of that kind of stuff. The only difference is, is one is tax-free and the other is tax-deferred, and so by doing this while he's in his 60s, he's first of all taking advantage of what we think are lower rates, and then he's secondly preparing himself for later retirement. If he does need this money, he can pull some of it out, or a lot of it out, tax-free, which is a great thing to have in your 80s and 90s, when you maybe are missing a lot of this stuff. Actually, I have a question about that, because you mentioned this in the video, and again, if you're first time listening, Hans has this wonderful channel on YouTube, Cardinal Advisors, and he has a video along these lines, as well as his website, cardinalguide.com. But the question that I had was, in the video, you described that once you take money out of a Roth IRA, you can't put it back.

I found that. So, in my personal case, since you sold me on the idea of Roth IRAs, and since I'm over 65, right, and I'm still working, I can still contribute to a Roth IRA, and I'm paying tax before, so here I've got this tax-free savings, so I'm excited to hear about this, actually. But what I did not know is, so if I started taking money out of that, I could never put it back? Or could I stop being able to put money into it? Well, you could stop putting money into it, or you could continue putting money into it, but if you make a withdrawal, or anybody makes a withdrawal from their Roth, now you've distributed that money, you can't put it back.

I mean, once it's out, it's out. So does that mean that you can no longer make contributions to your Roth after you've taken it? No, no, you can continue to contribute, but that requires income. I mean, most people in retirement don't have the working income to be eligible to make the Roth contribution. You're talking about the difference between a contribution and paying back a withdrawal. Those are two different things. Okay, that's where I got confused. So, again, since I am working, and I can continue to contribute if I want to, but if I wanted to take some money out, I couldn't put that money back, but I could make other contributions, right?

Sure. So the way it plays out for most people is most people aren't going to take any money out of their Roth while they're still doing Roth conversions for several years, and this guy certainly isn't, but there comes a point where you've been putting this money in there, it's been growing tax-free, you have the availability to make tax-free withdrawals, and so when people get on up in the later years, we may decide to start making some withdrawals because you want to start enjoying some of this tax-free, income, or it works out well in your game. The only point I was making in the video is once you take it out, you can't put it back, and I was talking about an alternative where you can't. But let's just stay on the Roth. You get money into the Roth, it's now tax-free when you take it out, but once you take it out, you can't take it out anymore, and this guy's doing it because he's going to leave the Roth money to his kids, okay, and then his kids are going to inherit this tax-free, and he very much likes that, because if his kids get several million dollars available to them, and the only way they can get any money is to pay the taxes. What a lot of kids do is they just pay a gigantic tax bill right off the top, and then they now have this taxable account, the net amount, and that's not very pretty to a guy that spent his life working through this. So he's on board, and he likes the idea of the Roth, and he doesn't plan to withdraw from it, but it's there if he needs it.

He likes that security, and he really is going to give it to the kids. So what we were talking to him about this morning is what we call the maximum-funded life insurance policy has very similar characteristics to the Roth, and then it has some added features, and then it has a few disadvantages, too. So it's not exactly a thing-for-thing comparison, but we have many people in his situation that they're putting part of their converted money into a Roth, and then they're putting part of it into these maximum-funded life insurance policies.

So you say, what in the world is that? Well, it's a life insurance policy that, for starters, has a premium only for 10 years, so you don't want to still owe money on this thing when you're like 90. So it started at 65, paid until he's 74, so he pays in 10 years, and then no more premiums, and then it is really focused on cash value accumulation.

It's set very conservatively, so it's a policy that's designed to accept the largest amount of money given the face amount of insurance. And what we came up for him and his wife was a million-dollar policy that had, for his wife, $76,000 a year premium, which is huge. I mean, I'm talking such large numbers that I don't want to scare anybody off, because I'm going to bring all this down to earth in a second, but this guy's just a regular guy, and we're showing him, since you're giving the money to your kids anyhow, why not leverage this money? And so they pay $76,000 10 times, or a total of $760,000, and they're going to probably have to withdraw over a million dollars out of the IRA over 10 years to pay the 760, but then once it's in the life insurance policy, it's going to pay well over a million dollars, no matter when they die, to their children.

And it's going to go fast, quick, efficiently, and so the part of the IRA that's there for the kids, this overfunded life insurance is wonderful. Right, but to walk back through that, because it took me a second to go, wait a minute, he's paying a million dollars out of the IRA to get a million dollars, it doesn't sound leveraged. However, if he were to take that million dollars out of the IRA and pay tax on it, right, then he's going to have to pay a substantial, what kind of percent, so if he took that, in other words, if the heirs got the money, they wouldn't get anywhere close to a million dollars, right? Right, I mean, so what he's doing is $100,000 a year, he's withdrawing out of his IRA, paying $24,000 in taxes, putting $76,000 into the life insurance, he's doing that 10 times, so his net amount into the life insurance is 760,000, but the reduction in the IRA is a million, but this is buying well over a million dollars worth of life insurance, doesn't matter when he dies.

And he even brought up, what if I died five years from now? Well, your kids are going to get a little over a million dollars, and they're still going to have a whole lot of money in the IRA. And they're not going to pay any tax on the life insurance.

No, they're not going to pay any tax. That's the whole idea, is to give tax-free money to the kids and to leverage it. Now, this is what I was talking about, is that the money that he's putting in here is a cash value in the policy, just like the Roth has cash value, and it accumulates tax-free, and then if he wants to take some of it out, he can, just like the Roth. But the difference in the Roth, if he wants to take it out, he can pay it back. And I actually did this with my maximum funded life insurance plan when I opened my business.

Can you bring it back for, this works just as well for people that have got $200,000, right? I mean, I have lots of people that have $200,000 or less in an IRA, they live off their Social Security, and they just let the money sit in the IRA. And my point is, they could take out $10,000 a year out of the IRA and just convert it to a Roth. And then, now they would have a tax-free account, which is really kind of tax-free for them now if they're only taking out $10,000, because they're not going to pay much tax on that withdrawal or that conversion amount. And so, people that have lowish incomes and a smaller amount of money in a 401k or an IRA can benefit from this even more than he can.

Wow, they really can. I get a lot of joy out of doing this for people, because the key to that is spreading it out. I mean, I do a lot of work. People come into me and they don't feel like they have a lot of money, and they just say, I don't have enough money. See, look, I get the most joy out of helping people that have very limited money, but they still need help with it. So, don't hesitate to call me if you don't think you're Mr. Rich Guy. That ain't the deal.

I mean, this whole concept applies to everybody that's listening. There you go. And to do that, you just go to Cardinal Guide. Don't forget the guide after cardinal.com. Or again, if you want to watch the video that he did, absolutely wonderful. It's at Cardinal Advisors on YouTube. Of course, Hans' book, The Complete Cardinal Guide to Planning for and Living Retirements, all there at cardinalguide.com as well. Tremendous episode. Thank you today, Hans.

Yeah, thank you. Finishing well is a general discussion and education of the issues facing retirees. Cardinalguide.com, Cardinal Advisors, and Hans Shile, CFP, sell insurance.

This show does not offer investment products or investment advice. We hope you enjoyed Finishing Well, brought to you by cardinalguide.com. Visit cardinalguide.com for free downloads of this show or previous shows on topics such as Social Security, Medicare, IRAs, long-term care, life insurance, investments and taxes, as well as Hans' bestselling book, The Complete Cardinal Guide to Planning for and Living in Retirement, and the workbook. Once again, for dozens of free resources, past shows, or to get Hans' book, go to cardinalguide.com. If you have a question, comment, or suggestion for future shows, click on the Finishing Well radio show on the website and send us a word. Once again, that's cardinalguide.com, cardinalguide.com. This is the Truth Network.