Power Up Wealth podcast – The Final Countdown – Episode 71 transcript:
James Derrick 0:00
The clock is ticking down, and some tax rates are likely to move up. I’m James Derrick, Chief Investment Strategist at Smedley Financial. Today, I’ll be joined by Sharla Jessop. We’ll be talking about some of the tax cuts of recent years that are likely to expire.
Sharla Jessop 0:26
Welcome to the SFS Power Up Wealth podcast where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics, preparing you to make smarter decisions with your money.
James Derrick 0:49
Thank you for joining me today, Sharla.
Sharla Jessop 0:51
Thanks for having me.
James Derrick 0:52
Yeah, I’m happy to host this time. Sharla Jessop is President at Smedley Financial Services, and she has a CFP designation and plenty of experience with taxes going up and down. So today we’re going to talk about this. Sharla you mentioned, as we were discussing this before the podcast, you want to help people choose the tax rate they pay. Is that really possible?
Sharla Jessop 1:16
It is, but not in the way you’re thinking, James. There are some limits. But when you think about it, people have money that they’ve put into retirement accounts, whether it’s a 401(k), IRA, SEP IRA, whatever, whatever the retirement plan is, and for the most part, they’ve done it tax-deferred. And so over the years, these accounts for people who are retiring now, on average, are around a million plus, and the money’s continuing to defer. We’ve talked about this in the past, but this is almost like a tax time by time bomb, because the money continues to grow and you’re going to be required to take money out at some point in time and pay tax based on whatever the tax rates are at the time you take it out. So all I’m suggesting is you can choose to do that and see what the tax rates are going to be in the future, or you can take advantage of the lower tax rates that we are experiencing right now.
James Derrick 2:02
Okay, I like the sound of that. What are some of the options people have while tax rates are low?
Sharla Jessop 2:08
What we’re talking about is the tax law that was put into effect back in 2017 which reduced taxes significantly in many different areas. We’re just going to focus really on marginal tax brackets. But right now, people who have money that’s growing, they’re putting everything in retirement and it’s going into tax deferred. If you’re still working and your tax bracket allows, in other words, if you’re not in the highest tax bracket, this might not be a strategy you want to do, but if you’re right in the middle, this would be a great strategy. Take some or all of the money you’re contributing and put it in the Roth. The benefit of doing the Roth option in your 401(k), SEP IRA, or Roth IRA, is that you’re going to pay tax now, while the tax rates are lower and that money is going to grow tax-free, and in the future, you’re never going to be required to take a distribution for that money. You can pass it to your heirs tax free.
James Derrick 2:54
Yeah, that sounds amazing. How common is the Roth 401(k) option?
Sharla Jessop 2:58
Very common. They just passed some tax laws in the last two years where it’s even available in SEPs, where it hasn’t been available in Sep and SIMPLE IRAs, they’re offering that now. So going forward, beginning in 2025 those options will be available.
James Derrick 3:14
So many people might not even be aware, but their employer may be offering the opportunity to contribute to a Roth 401(k). It’s really the same program. You fill out some additional paperwork to swap it out so that you’re paying taxes now, instead of delaying them for the future.
Sharla Jessop 3:30
That’s right, you make a contribution. Still comes out of your paycheck. The difference is, taxes are paid first, then it’s contributed. You still get the company match. It doesn’t impact that at all.
James Derrick 3:39
And one of the benefits is, is that it doesn’t matter what tax rates are in the future, if my tax bracket is higher in the future, then I’ve saved money.
Sharla Jessop 3:47
That’s right.
James Derrick 3:48
Okay. That’s contribution. What about conversion opportunities?
Sharla Jessop 3:52
Well, there are many people who are retiring, some retiring maybe at 62 and they’re not probably going to start taking Social Security, hopefully not going to take Social Security until they are full retirement age, which for those people is 67. Or they might defer so they can maximize Social Security benefits to age 70. If they do either of those, then they have a window of opportunity where their income is going to be a little bit lower, and they can convert a portion, they don’t have to convert all, they can convert, over time, a portion of their money from traditional meaning tax-deferred to Roth. So they’re triggering the tax. You might say, well, why would you why would anybody want to start paying tax? Well, because you’re going to pay tax on that money at some point in time. It’s not optional, the money’s never taxed. It’s going to be taxed either to you by required distribution or to your heirs through inheritance. So why wouldn’t you want to pay taxes now, when we have historically low tax brackets compared to what they could be in the future, when you think about the deficit and the financial situation of our country, it doesn’t seem likely taxes are going to get much lower than they are right now.
I want to throw you a curveball here. How low are taxes compared to historical rates?
Well, they’ve been as high as 80% at one point in time, and I’m going back hundreds of years, but they’ve been as high as 80% and even in the past 50 years, as high as 50%. Right now, a married couple filing jointly with an income between 201,000 and 383,000, is in the 24% marginal tax bracket.
James Derrick 5:23
24% is a lot better than 50% for sure. And I saw recently that tax rates in Europe and Canada are much higher than here. So it’s quite possible that we do move back in that direction. And speaking of that, we have some sun-setting tax cuts, right? So these tax cuts from 2017, 2018 are sun-setting, which means that they had an expiration date at the time that Congress passed them. Do you think that they actually will expire?
Sharla Jessop 5:48
Other times I’d say no, certainly they’re going to do something about that. But I am not extremely confident in the ability of our lawmakers to make decisions, combined decisions. Hopefully they will change the law and keep things the same, but it’s likely they will probably increase them, but not all the way back up to where they were. I don’t think they’ll let it sunset. In other words, I think they won’t take some action. If they let it sunset let me give you just an example. I talked about someone with 201,000 to 383,000 and they were in the 24 tax bracket. Back in 2017 if your income was at the same level, actually a little bit lower. At 153,100 you went into the 28% tax bracket. So you can there see, and then up to 233,000 you’re in the 28%, 233,000, and over 233,000 you went into the 33% tax bracket. So you can think about, when you’re taking money out, what the impact of that is going to be, and you know, you’re going to have to take money out in required distributions. If you’re retiring now, you’re going to have to start taking distributions at age 73. If you were born after 1960 then you’re going to start taking distributions at age 75.
James Derrick 6:53
I think it’s worth mentioning too that tax rates could go up or they could stay the same. Likelihood of them going down even more, is pretty low. As you mentioned, the government has a lot of debt, I think, like $35 trillion in debt. And every second of the day, I mean, it’s it’s going up by an unbelievable amount, so the chances of rates going down even lower, very unlikely. And so that makes a conversion opportunity off of an IRA even more attractive.
Sharla Jessop 7:19
I agree, completely.
James Derrick 7:20
It can get a little bit complicated, so let’s try to keep it as simple as possible here. But could you explain how doing a large conversion could throw you into a higher tax bracket and then mess things up with Medicare?
Sharla Jessop 7:31
That’s something everybody needs to be aware of, which is the reason why I would not recommend people try to calculate this and determine it on their own. We have software packages and the ability to help people figure that out before they make conversions, so we can keep them out of trouble. And the trouble I speak of is when you are on Medicare Part B. So think of Medicare Part A covers hospitals. Medicare Part B covers everything else. Once you go on to Medicare Part B, you start paying a premium for your Medicare insurance. And that insurance premium that you pay is based on your income level, and if you go over a certain income level, then you jump into what we it’s a cliff bracket, meaning if you go $1 over, you pay more for your Medicare Part B premiums, and that continues to increase incrementally based on your income. So it doesn’t make sense to do a Roth conversion over a certain amount to save money on taxes and end up paying more in premiums for Medicare Part B. That’s what you have to negotiate and manage, is how much can you afford to convert based on all of your income sources, not just what you’re going to take out and convert, but everything you’re going to get.
James Derrick 8:32
And so then this brings us full circle back to choosing your tax bracket, because you’re eyeing your income and your conversion possibilities, but keeping an eye the whole time on that upper limit of your current tax bracket.
Sharla Jessop 8:43
Anytime you’re in a low tax bracket, you want to do everything you can to maximize that marginal amount, take it right up to the limit where you can before it jumps into the next bracket.
James Derrick 8:53
Anything else you want to share with us about the final countdown?
Sharla Jessop 8:57
I do.
James Derrick 8:57
These tax laws.
Sharla Jessop 8:58
Something that’s not changing. We’ve been talking about getting money out and the taxes you’re going to pay. And one way you’re saying that you wanted to determine if you could pay zero tax. I’m going to tell you how to do that too. When you’re 70 and a half, which is a few years out for you. But when you’re 70 and a half, you can make what’s called a qualified charitable distribution. And that means you’re going to gift money to a charity. It can be any charity, any qualified charity, which could be a church, a school, a hospital, it could be anything that is considered to be a 501(c)(3), charity. So you take the money out of your IRA or tax-deferred account, we’ll talk about an IRA, and you gift it directly to your charity of choice. That money you don’t have to pay tax on, and you don’t have to count it as income when you do it. It’s a tax free exchange for a charitable contribution.
James Derrick 8:58
Let me clarify here. You’re not actually taking the money out and then gifting it. It’s going directly from your IRA to the 501(c)(3) organization?
Sharla Jessop 9:54
Correct.
James Derrick 9:55
And what other little loopholes do people need to know about or you know what are the little nuances they need to know about so that they do this properly?
Sharla Jessop 10:04
Well when you’re making a qualified charitable distribution, you want to talk to your advisor, because it can qualify as part of your required minimum distribution. When you reach those ages we talked about where you’re required to take money out, you can actually donate a portion of that. It doesn’t count as income, and the benefit to you is if your income is lower, then that may not impact your Medicare Part B premiums, like we were talking about with IRMAA, and it may also not impact you paying more taxes on your Social Security benefits.
James Derrick 10:33
And this is like a win win situation, and there aren’t a lot of those when it comes to taxes, and it seems like it makes the most sense for people who are going to be giving to charity anyways, and they’re over 70 and they have tax-deferred money, and for them, it should be a no brainer. Is that right?
Sharla Jessop 10:51
I agree, 70 and a half is the age, and it’s not, not a month before. I mean, you have to be 70 and a half before you can make this contribution. But it is a no brainer. People are always looking for ways to reduce taxes, and this is a wonderful way.
James Derrick 11:04
Fantastic. Well, Sharla, thank you for joining me today.
Sharla Jessop 11:07
Thanks, James.
Shane Thomas 11:13
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn. The views expressed are Smedley Financials and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Osaic Wealth, Inc., member FINRA/SIPC. Investment advisory services offered through Smedley Financial Services, Inc.® Osaic Wealth is separately owned, and other entities and/or marketing names, products, or services referenced here are independent of Osaic Wealth.
The Final Countdown
