Ep 22: Case Study- Implementing Roth Conversions

We spent last podcast talking about what exactly a Roth conversion is. Today we will examine a financial plan and see how implementing Roth conversions can potentially improve this situation.

 

Case Study Before Implementing Strategy:

Dual income Household: Ages 55 & 53 

Existing Accounts:
$500k Pre-Tax 401k Funds
$25k Roth IRA Funds
$50k Cash
Mortgage on the home – paying extra on mortgage ($250/m) (5% rate on 30 year loan, 10 years in)

Income:
Person 1: $110k
Person 2: $60k

Current Savings strategy:
Total Joint Savings 18% of income ($30.6k/yr.) – all into pre-tax
Each person has 3% company match for pre-tax ($5.1k/yr.)
Total being saved: $35,700
EE Contributions: $30,600
ER Contributions: $5,100

 

New Strategy:

Refinance Mortgage to a 15 year loan with significant reduction interest rate lowers total monthly payment, allows for $250/m extra payment recapture & additional $150/m savings
New Total being saved: $40,500
401k EE Contributions: $21,400
Pre-Tax: $15,900
Roth: $5,500

401k ER Contributions: $5,100
Roth IRA Contributions: $14,000

Person 1 strategy: EE Total: $23,600, ER Total $3,300
EE Pre-Tax 401k Contribution: $11,100 (10%)
EE Roth Contribution: $5,500 (5%)
ER Pre-Tax 401k Contribution: $3,300 (3%)
Max Roth IRA: $7,000

Person 2 strategy: EE Total: $11,800, ER Total $1,800
EE Pre-Tax 401k Contribution (No Roth Available): $4,800 (8%)
ER Pre-Tax 401k Contribution: $1,800 (3%)

 

Helpful Information:

PFG Website: https://www.pfgprivatewealth.com/

Contact: 813-286-7776

Email: [email protected]

For a transcript of today's show, visit the blog related to this episode at https://www.pfgprivatewealth.com/podcast/

Transcript of Today's Show:

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Marc: Hey, gang. Welcome into another edition of The Retirement Planning Redefined Podcast with John and Nick from PFG Private Wealth. Mark Kelly in here along for the ride as we talk investing, finance and retirement with the guys. And this week, actually, we got sort of a follow-up to our prior podcast. We're going to talk about implementing ... Really a case study about implementing Roth strategies into your plan, some things to think about there. Again, if Roth conversions are on your mind, this is a great podcast for you. And as always, if you've got questions or concerns, let the guys know. Reach out to them at PFGPrivateWealth.com. John, what's going on this week, man? How are you?

 

John: I'm good. I'm good. Nick still hasn't taken me up on that race offer, but I picked up some yoga in the meantime.

 

Marc: Oh, okay.

 

John: So, I'm doing well.

 

Marc: All right. So rowing and yoga. After a couple of weeks, you should be lean and mean and you should be ready to roll.

 

John: I'm trying. I'm trying to get in shape for when I go back out in public.

 

Marc: Did you get the quarantine 15?

 

John: Yeah. A lot of Oreos eating over here.

 

Marc: Oh, yeah. I hear you. Nick, how are you doing, bud?

 

Nick: Pretty good. Pretty good. Yeah, John's definitely going to have to spend a little bit more time rowing before he can catch up. I've got a month head-start on him.

 

Marc: Oh, okay.

 

Nick: And luckily, the irony for me is because I've been forcing myself to get out I've actually been losing weight, which is kind of nice.

 

Marc: Oh, nice.

 

Nick: And going out to eat a little bit less. It's funny when you see what kind of difference that makes, for sure.

 

Marc: Yeah. It really does. And everybody has their vice. Oreos, as John was mentioning. Everybody's got their vice. Yeah, during the quarantine, in lockdown, I certainly was no stranger to my own vices as well. And I was like, "Yeah, this isn't good. I'm getting fat." Not happy about it so I'm right there with you, John. Wasn't Oreos but just as bad.

 

Marc: Anyways, let's jump into our topic this week and talk about this case study, really, and ways it helps you see implementing how a Roth conversion may or may not work. Nick, take it away. Give us a quick breakdown on what this is and just walk us through it.

 

Nick: Yeah. What we wanted to do with this session is kind of mix it up a bit where ... One of the things that we found just communicating with people, especially in the classes that we typically do is when we walk through almost a little bit of a case study and give a sample example of a household, what they have in assets, what they have in income, how they're currently saving and the things that we can do with pretty minor changes within the structure available to really try to improve their overall situation and planning.

 

Nick: The scenario that we had put together was a dual-income household, ages 55 and 53.

 

Marc: K.

 

Nick: And their existing accounts were pretty heavily dominant to the pre-tax side. Half a million dollars in pre-tax 401K funds. They had about $25,000 in Roth accounts, $50,000 in cash between checking and savings, 30-year mortgage ... About 10 years in to a 30-year mortgage. And they were paying an extra $250 a month towards the mortgage to try to get it paid down.

 

Nick: One of the most common questions that people have when they come in to see us or come into a class is, "Hey, I'm saving. I'm doing a good job with saving. But am I saving in the right area? Should I be paying this extra money towards the mortgage, et cetera?" The breakdown in income was person one, $110,000, person two, $60,000 of income. So, total household income of about $170,000. And the reality is that both of them were getting a company match into their 401K and they were saving ... Between the two of them, they're saving essentially 18% of their income but they're putting it all into pre-tax accounts. The Roth accounts that they have on their balance sheet are essentially accounts that they've had for a long time. They funded it early on and then at a certain point they got phased out because they made too much in income.

 

Nick: Their main question or, I should say, potentially goal when they came to us was, "Hey, again, we have a good income. We're living comfortably. We live within our means. We save a good amount of money. But are we doing it the right way?" One of the first things that we did was evaluate the mortgage and, really, what we've seen in John's work on these quite a bit with a few different clients is that mortgage rates have obviously dropped in the last .... These clients were 10 years in so mortgage rates have dropped. And they went ahead and spoke to their credit union and they were able to refinance. One of the things you always want to look into is try to keep down closing costs, et cetera. And they were able to reduce the payment.

 

Nick: And so, really, with rates where they are, they were able to go from having 20 years left on their mortgage to refinancing to a 15-year mortgage, which is something that they felt much more comfortable with. When we discuss mortgages, we always have the conversation of pure finance decisions versus a comfort level as well. They were able to reduce their monthly principle and interest payment by $150 a month over their 30-year. Essentially, what we're able to do is we're able to recapture the $250 a month that they were paying extra towards the mortgage to try to shorten it, take five years off the mortgage with the refinance and save an additional $150 a month. Really, we've got a $400 a month savings plus we shaved five years off the mortgage automatically. The goal being how do we redeploy that money?

 

Nick: John, any tips for people when they're looking for refinancing on the mortgage and some things to look into?

 

John: Yeah. One thing, you just want to analyze what the rates are, what you're currently at. I know a lot of people use the rule of thumb of basically if you can lower it by one percent it might be a good idea to at least look into it, and that's where we start is look into it depending on what rates are and what your current rate is and then work with an advisor or some type of mortgage specialist to evaluate exactly, does this make sense for me? A decent website just to see where rates are at is BankRate.com. Just be wary putting your name into anything because we have had some people where they ... "I put my name into this. I'm getting bombarded with phone calls from everybody." BankRates is a good place to view but ultimately, you definitely want to work with someone and just figure out what's best for your situation.

 

Nick: For sure. From there ... Again, part of the emphasis for us, and I know that a lot of our listeners and our clients have heard us talk a lot about the importance of balancing ... Trying to create some sort of balance or equity in portfolios from the standpoint of we want to diversify future taxation and current taxation. With this client, they were very heavy on the pre-tax. Half a million in pre-tax, only $25,000 in Roth dollars. Client one, essentially their plan at work allows for Roth 401K contributions where client two, their plan does not allow for Roth contributions. That's one of these things where sometimes households we've seen when there's a dual-income household they try to make everything even and it's not always the best strategy when we look at it from a global standpoint.

 

Nick: The other thing that we've seen people not necessarily consider or quite realize or understand is that when their employer is making a match contribution for them, those match contributions are pre-tax contributions so there's additional money going in. Previously, for the household, they were contributing on their own about $30,000 a year into retirement accounts and they were getting about $5,000 a year of company contributions. And now, after the refinance, what we're actually able to do is increase the amount that they're saving.

 

Nick: One of the first things that we'll look at for clients is the income test on whether or not they have the ability to contribute to an individual Roth IRA account. This household came in underneath the limits, which means ... And they're over the age of 50, which means that all of them are able to contribute $7,000 a year into a Roth IRA account. The benefit, obviously, of having an individual IRA account is that they're going to have some more flexibility on the investment options that they have and if they want to work with us and have us invest the money for them, they have that option. Whereas when they're dealing with accounts that are strictly held at their employer they're required to use the funds that are inside of there.

 

Nick: Previously, again ... And I know it gets a little confusing in this sort of format, but essentially they were saving $30,000 a year pre-tax. Their employers were putting about $5,000 a year pre-tax. So, about $35,000 a year pre-tax into accounts and then another $3,000 a year into their mortgage, extra. Now what we've done is we've said, "Okay, we're able to recapture those dollars from the mortgage and the total amount that's going to be saved has increased up to $40,000 a year, which is a nice jump." That breakdown is going to be $14,000 between the two of them into Roth accounts, $7,000 each. The employer contributions are staying the same, so that's still a little over the $5,000. But client one, because they have access to both pre-tax and Roth options in their 401K, they're going to put a little less than $16,000 a year into the pre-tax and about $5,500 into the Roth per year.

 

Nick: What we've done, in this case, is where previously they weren't putting any money into Roth accounts, they're not approaching $20,000 a year of Roth contributions that they weren't completely aware of how to be able to take advantage of that. And again, we think that that's a super important step to be able to build in diversification to not necessarily ... If a conversion down the road makes sense for them, they can do a conversion. But if we can do it up front, take advantage of the low tax rates that we are currently in in this current environment and not have to worry about future brackets from the standpoint of dealing with conversions, this is something that really allows them to start to build up their Roth funds.

 

Nick: John, do you want to talk a little bit about ... From the standpoint of how we might adjust their actual holdings and risk allocation in a Roth versus the traditional funds?

 

John: Yeah. One thing that you want to look at when you're looking at allocation, overall funds, it's typically ... And I say typically because everyone's situation is different. You want to be more aggressive or take a little more risk in the Roth IRA or Roth 401K accounts because that has more potential for growth so that gives you a little bit more, again, potential to have more money down the road in a Roth bucket, tax free.

 

Nick: Yeah. We like to try to capture that upside, especially because when you look at it from the standpoint of the total amount of funds when you look at the overall nest egg, the money that's in the Roth is a lot less money so we feel a little more comfortable taking a little bit more risk with those dollars because it's a much smaller chunk of the pie. And then we dial back the risk on the pre-tax dollars because that's a bigger piece of the pie and try to create some balance. And for anybody that may have gotten tripped up with some of the details, because we know there are a lot of moving parts in this, we will have the breakdown in the show notes to be able to walk you through to check that sort of situation out; to see if something like that might make sense for you.

 

Marc: Okay. All right. Absolutely. Definitely a little bit different this week on the podcast, but it's certainly and interesting way to take a look and see about how different strategies can be implemented into unique scenarios and help things along. As Nick pointed out, follow along with the show notes. They'll have a break down in there for you, as well, on that. And anything else we need to wrap up with this week on implementing this case study that we were talking about?

 

Nick: I would say that the biggest thing is just for people to make sure that ... Again, where people will often times analyze the decisions that they're making from an investment standpoint is with the sorts of holdings they have and not necessarily with the types of accounts that they have. Just making sure that the methodology that you're using and how to save and put money into accounts is something that you're looking at and looking into, whether it's with your employer, asking, "Hey, do we have a Roth 401K option in our plan?" And if not, getting a few people together to try to push for something like that can really open up options for you. That sort of process is always important.

 

Marc: All right. There you go. All right, folks. Great episode here this week on Retirement Planning Redefined. Hopefully you enjoyed this case study; a bit of a break down and look into implementing Roth strategies. Again, follow along with the show notes on the website. Go to PFGPrivateWealth.com, click on the podcast page. That's PFGPrivateWealth.com and then you'll see the podcast page. Click on that and you can follow along in the episodes. And, of course, subscribe to us if you have not yet done so on Apple, Google, Spotify; whatever platform you like to use for your podcast needs. And if you do have questions, if you do want to talk about a conversion or implementing a strategy, reach out to John and Nick. Let them know you want to chat by calling 813-286-7776. That's 813-286-7776, serving the Tampa Bay area. Get on the calendar, have a chat with them.

 

Marc: Please, before you take any action you should always check with a qualified professional like John and Nick at PFG Private Wealth. And with that, guys, we'll say goodbye this week. Hope you guys have a great week. Stay safe, stay sane and all that good stuff. For John, Nick, I'm Mark. We'll talk to you next time here on the show and we'll see you later on Retirement Planning Redefined.