Roth-ing Past a Retirement Time Bomb

Roth-ing Past a Retirement Time Bomb

By Sean Roth

Real Estate Editor

Ed Slott worries that what most financial advisers don't know could have a lot of us eating cat food in our old age. Slott, a nationally recognized IRA distribution expert, author and professional speaker, is on a mission to focus attention on the disbursement side of the retirement equation.

The Wall Street journal described him as the "best source" for IRA advice. Slott suggests in his books and seminars that IRA investment returns matter far less than the tax bite when funds are withdrawn, yet too few financial professionals are knowledgeable about proper distributions.

On Tuesday, Slott, who most recently wrote, "Parlay Your IRA Into A Family Fortune," brought this point of view to Sarasota with two free seminars hosted by the financial management firm Udell Associates. Prior to the seminars, Slott spoke with the Review's Sean Roth about his retirement message. The following is an edited version of that conversation.

What drew you to focus exclusively on retirement vehicles and their tax consequences?

I was an accountant, which I guess I still am. Years ago I tried to build my business, and I didn't want to be like every other accountant. I wanted to have an edge.

So back in the early '80s it hit me when the '81 Tax Act came out. It revised all this estate planning and high level planning, and I said 'That's for me.' Maybe I'll go into more of this estate planning to stand out. To have more of a higher level of services, to serve clients better and make more money. So I did that for a while, holding client seminars. When everybody started catching on to that; I didn't feel so special anymore.

I was working on a program in '87 when the IRA rules first came out. I remember working on a program with somebody, I said 'What are these rules that just came out?' I remember the guy's response was something along the lines of 'I don't know, but it's going to effect everyone with a retirement account, and nobody's going to understand it.' Those two things hit me between the eyes. That's were you want to be. If nobody understands it, I'll be the guy that understands it.

I saw the need for educating advisers and the public on how to get that money out without turning half of it or more over to the government. It doesn't matter how much your adviser makes for you. They could make you 30% a year, but if you lose 60% to 70% on the way out, who cares? All you did was build a savings account for the government.

Now it's happening just as I predicted 15 years ago. You see more of the World War II generation dying out, and they have issues that most financial advisers are simply not equipped to handle on the way out.

So I realize still today almost no one is addressing this. It's become so complicated that the average advisor just throws up their hands. So I really believe the public is not being served well.

I'm being generous saying even that 1% of advisers know how to get this money out. This is why people are losing small fortunes now as events occur like death, people changing jobs, rollovers, reaching 70-and-a-half. All of these events where money has to come out of a plan. People are saying 'What happened?'

That's when I get calls. I tend to get calls from people, who are desperate. They're family was wiped out; can anything be done. In almost every case, I say I can't fix it anymore. Only then do they realize how important it would have been to have an advisor that addressed distribution planning.

I remember one client came in; I use his quote now in my seminars. His quote was 'Now, I know what to do the next time my parents die.'

So how do you help?

The way I do it is by training advisers. But only about 1% of advisers take the training. For example, I have a newsletter I publish for advisers to teach them. I cull it out of the tax code, out of rulings, things that are happening. We have maybe 4,000 advisers that get that. Now, there are a million advisers out there. There are no other competing publications, so it's not like the advisor can say 'Oh we get this elsewhere.' They just don't acknowledge it.

In other words, they only get paid when money comes in not when money goes out, so why bother learning about what to do when money goes out.

The tax rules, even though they are complicated, are very friendly to protecting retirement funds; it's just that most people don't know to take advantage of them.

So what I did on my website (irahelp.com) was to create such a list. These are the rare advisers who have actually taken extensive training with me so they can help their clients in their distribution area.

You are starting to see lawsuits all over the place. I get called as an expert witness, and it's always the same thing - the advisor didn't know. Well, he shouldn't have taken the money in then.

If [advisers] do it right; you will have a happy client, who will refer more people. Plus you will have more money to manage from that family, because it was set up right. It will actually grow to more than you ever dreamed of. It almost like getting new accounts, and that's the big long-term message. Basically they bring in an account and they move on to the next family. Rather than working to make sure that account stays with them and their company for 50 years.

Aside from using a professional adviser, what are some of the biggest problems you see in your work directly with the public?

Keeping your own affairs up to date. Checking beneficiary forms - for one - to make sure you can take advantage of these tax rules that allow your beneficiaries to keep this growing through the rest of their lives tax-deferred or even tax-free.

Even with the number of advisers in the market, most consumers are making these choices on their own....

I don't think that should be done. You are always going to have your do-it-your-selfers, that's why Home Depot's in business. But you know with Home Depot if it falls apart you build another one. The retirement account doesn't work that way. You break the eggshell - that's what I consider the retirement nest egg - its over. You really have one chance to do this right. This is not for do-it-yourselfers. The funny thing is the do-it-yourselfers are usually that way because they think they're saving money. And they'll never know that they're not saving money until after they die, when they're family says 'What the heck did he do to us?'

Is there anything you would suggest employers should do differently particularly in regards to their employees?

Probably put better resources in their human resources and employee benefits division. Many employees go to those divisions for advice on their retirement accounts, and often the advice is very poor. The company looks at it 'We don't make money off of that. We are just doing that to help these people.'

Tell them 'Look. We don't know much about this.' Be up front; 'See your own personal financial advisor.' That's what I always advise. Always remember your company may be great, and may have great people. But the people you are asking for advice don't work for you; they work for the company. You need someone who works for you.

Are not enough people using the Roth IRA?

I think so. I think the Roth is the greatest thing since sliced bread, because your money grows tax-free forever. My feeling is the way you build wealth is to keep your money away from the government. And add to that the compounding. You keep all of your earnings. Why wouldn't everyone do a Roth?

The catch is you don't get a tax deduction for the money you put in the Roth. People go with the regular IRA because they get that gratification upfront when they get a tax deduction. Some people say in theory that you're better off with that, because the tax deduction will give you a bigger refund, and if you invest that refund you will have all this money. But in the real world that will never happen. That money is spent before the IRS check is cut to you. So as long as you are going to waste the deduction, don't go for it.

With a Roth you don't get the deduction up front and now you have tax-free income for the rest of your life. If you use the stretch IRA concept you can actually keep that growing another 50, 60, 80 years for your children and grandchildren, all tax-free. It doesn't get any better than that.

When is it too late to make that change?

It's never too late. You can convert existing IRAs to a Roth, but I wouldn't go broke converting. If an older person asked me 'Should I convert;' you are not doing it for you, because you don't have enough years for the benefit to exceed the cost. But some people say 'I don't need the money. I'm doing this for my kids and grandkids.' Then it might pay.

So it is a different answer for each person. Certainly younger people should get that money in the Roth, because they have the greatest asset of all; they have time.

Any particular tips for high-income individuals 51 to 65?

What I would do, if you are currently contributing, is switch over to a Roth. Even if you don't think you are going to need the money, you can leave it to a child or a grandchild, who could get a huge hit out of this.

Here is my New York example: Put Granny to work. If you pay her $4,000 a year, she can open a Roth IRA. Let's say she does that for 10 years; starting at age 75. After 10 years of shoveling she just poops out. Well, if she was smart enough to name her one-year-old grandchild as a beneficiary, that grandchild can stretch distributions, building that inherited Roth tax-free over the rest of his life providing millions and millions of tax-free income. Just let it sit there, just taking the required distributions each year, and you will have millions just off granny's 10 years of work.

A lot of your focus is clearly on leaving a legacy. Why?

That is where you can really milk the tax laws for all they're worth. We find that a lot of people who have been diligent savers in a retirement account, generally have been diligent about everything else in their lives and when the time comes for their retirement it turns out they don't need the money. So they want a plan to say 'What can we do to get this to our family and have this become a legacy to them as long as possible?'

The stretch IRA is perfect. If you have seen some of my examples just starting with modest amounts you end up with hundreds of millions of dollars starting with just small amounts based on compounding and tax-free growth.

Are there any tricks to help encouraging people to save a smart amount for their retirement?

The reason people don't address [retirement] is they are overwhelmed by their choices or intimidated by them. So that's why I make it easy . . . I go down to one choice - a Roth IRA - and I call it 'My $11 a day plan,' because I think most working people could part with $11 a day. That comes to just about $4,000 a year.

Let's say you did nothing else. You started at 35 just doing $11 a day and every other dime you spent. At age 65 you would have $489,383. That's almost half a million dollars tax-free. I compound that out at 8%, which may sound like a lot now, but over 30 to 40 years, that's right in the ballpark of what traditional returns have been. That's at 35. If you started at 25 when you were 65 you would have $1,119,124. That is over a million dollars all tax-free.

You have to start somewhere and take baby steps.

What tax changes do you anticipate?

Things like what the president talked about where they may expand the vehicles for you to put away for yourself. That's just their way of saying 'Because there's not going to be anything else for you, if you don't do it for yourself.'

So I think you will see some liberalization of how much you can put in a plan. They're going to give you incentives, I believe, at some point to urge you to start taking care of yourself.

Why when the IRAs are generating such large amounts do you also recommend life insurance?

I'm not an insurance salesman. But I believe in the product, because my whole vision for my clients is to create financial security. To leverage the assets that you have into more money for your family. You have to pay income tax in order to pay the estate tax. So you get into this tax on tax scenario that eats away at the account until it's gone.

This is not what you want for your kids . . . insurance is one of the biggest benefits of the tax code. You can pass insurance money out state income tax-free.

Money solves a lot of problems after death. If you have a huge sum of money there, it makes a lot of things go away. Especially if you own a business. A business is an illiquid asset. How do you cut it up? What if you have to sell it raise money?

Or maybe you have kids that are in the business. One kid's in it; one kid's not. How do you make it up to the one kid who doesn't want the business? How are you going to pay them out? If you pay them out of the business; it may wipe out the business. So life insurance is very important to provide money when it's needed.