Different Ways to Get Funds into Roth or Other Tax-Free Accounts

“Hey Mike, what’s the best way to get funds into a Roth IRA?”   

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Episode Transcript

Mike (00:05):
Welcome to How to Retire On Time, a show that answers
your retirement questions. Myname is Mike Decker. I'm a
licensed financial advisor andfiduciary. And with me in the
studio today is my colleague,David Franson, who will be
reading your retirementquestions. As always, you can
submit those questions to [phone].
Again, that's [phone].David, what do we have for

(00:26):
today?

David (00:28):
Hey, Mike. What's the best way to get funds into a
Roth IRA? And do you just clicka button and they move over?

Mike (00:35):
Yeah. So I wanna open up the conversation more than just
Roth. Okay. But let's just talkabout tax free in general. So
there's kind of a couple ofcategories that I would consider
the tax free category to be in,and they're slightly nuanced.
So you've got a Roth IRA. RothIRAs or the after tax part of
your four zero one k or fourzero three b or whatever.

(00:57):
Basically, it grows tax free, asin it grows without being
subject to capital gains tax. K.And then when you take it out,
it's tax free.
It doesn't hurt your provisionalincome or your Social Security
calculations. It doesn't hurtyour income taxes and so on. So
that's one way that you canoperate tax free, and people
love it because it's the easiestto do. It is difficult though to

(01:21):
get funds into a Roth becauseyou have to be working, and you
have to make within a certainthreshold, and you may not
qualify for Roth, and thenyou've got these other things to
get money into Roth, and let'sjust briefly go through those.
You've got your Rothcontribution.
You've got your IRA, yourbackdoor IRA to Roth, so you can
put funds into an IRA, and thendo an IRA to Roth conversion.

(01:43):
And then you've got yourbackdoor or your mega backdoor,
which is through your four zeroone K, which is kind of another
way you could do this. Okay?

David (01:50):
Okay. I've never heard mega backdoor before.

Mike (01:52):
Yeah. It's not really common. I don't wanna spend too
much time on it. If you wantedme to talk about it more, just
text us that question. Hey,Mike.
Explain the mega backdoor Roth.That's that's a pretty black and
white definition that you couldprobably ask chat GPT to or
whoever you use. Yeah. But let'sjust generally speaking, when
you're working, you should beable to get funds into a Roth in
one way or the other. Nowretirement accounts or qualified

(02:15):
accounts, these are accountsthat are not subject to capital
gains, whether you're gettingmoney into a Roth or an IRA,
it's it's very beneficial.
There's a huge benefit to theseaccounts, but you have to ask
yourself at what cost? So we getmany very successful people that
are earning 250 to $400,000household income that are

(02:39):
saying, everyone says I shouldget money into the Roth, or I
should do the backdoor Roth orthe IRA Roth. The Roth is where
funds need to go. And I say,okay. What's your adjusted gross
income or your modified adjustedgross income, depending on the
situation?
Yeah. And then what is yourwhat's your tax bracket? And
they'll tell me. I'll say, okay.Would you like to pay that or
potentially more, depending onwhere they are, just to get

(03:01):
funds into a Roth right now?
Or let's look at your adjustedgross income when you retire.
Would you rather pay thatpercentage on the conversions?
And almost every time they soberup and say, what? It's like they
they let go of this FOMO, thefear of missing out, because
everyone else is putting fundsin the Roth, and they're just
they're deferring their incometax, put it into their IRA, and
then they're gonna put funds inthe Roth later. So there's an

(03:24):
important understanding of theenvironment in your tax
situation and the sequence ofhow to get funds into the Roth.

David (03:31):
Yeah. Because anytime you put what do I wanna say? It it's
income. Right? When you'removing from a traditional IRA to
a Roth, that's income.
You're paying income taxes.

Mike (03:39):
Yes. So at what tax bracket or, in my opinion, a
more appropriate measurement,what's the effective tax rate of
you moving those funds over?

David (03:48):
Okay.

Mike (03:49):
How does that change your dynamic environment? Does that
affect your health care? Ifyou're on Medicare, is that
gonna put you into IRMAA? Areyou okay with that? Are you
gonna do it for a limited periodof time?
Are you not gonna do it for alimited period of time? Are you
on affordable care act becauseyou retired before 65 years old?
All these questions matter. Soyou don't wanna be like I don't

(04:10):
know what is are those lemmingsthat just run off a cliff
because other lemmings fell offa cliff or whatever? Is that the
right expression?

David (04:16):
Yeah. That's

Mike (04:17):
right. You wanna go online, this would be a fun
webinar to do. I don't know ifwe'll do it or not. But just
going on Reddit, and justfinding threads, and then
explaining why they're idiots.Now I wanna defend Reddit.
Yeah. Half them are selfproclaimed philosophers that

(04:38):
believe they're financialwizards, and the other half are
brilliant financial advisors.Like, they actually know their
stuff. But to the uninitiated,they both probably look the
same, And that's the problem.How do you differentiate?
I mean, that's like me going onthe medical forums and trying to
figure out what is right. Let'sstep on a landmine right now.

(05:02):
Let's talk about vaccines for asecond. Can we talk about that?

David (05:06):
Can't wait. Yep. Let's talk it.

Mike (05:07):
Not a medical professional. Do you think I
could properly sort through themedical research on if that's
good or not?

David (05:14):
Yeah. That'd be tough.

Mike (05:15):
I'm not qualified to do that. Weird. That's that's kind
of how I like to envisionsomeone who doesn't have a
financial background trying tofigure out how to proceed with
all of this. You have no ideahow to differentiate the the
differences, and you could putit in the chat GPT, but chat GPT
is gonna give you the mostpredictable answer it believes
it's supposed to give you. Yeah.
It's not actually doingresearch, and for all those who

(05:36):
don't know, large languagemodels take the information
that's in there, and whoever hasthe loudest voice or the most
popular form, it's going toinfluence the answer that it
gives you. So it's a tricky one.So when you have this idea, how
do you get funds into a Roth?You have to first ask yourself,
is Roth the next step, or shouldyou be putting funds to do with

(05:58):
IRA, and then put the funds inthe Roth later? Can you even put
funds to a Roth?
And by the way, this is animportant distinction on Roth
contributions versusconversions.

David (06:07):
Okay.

Mike (06:07):
So a contribution is when you take after tax funds, like
your checking and savingsaccount, and you add it to a
Roth account. If you're able todo that and you add to a Roth
account, there's around a fiveyear holding period. You can't
take the funds out.

David (06:18):
Okay.

Mike (06:19):
If you do a conversion, dollar for dollar, you can take
those funds out. Oh. The fiveyear holding period is only
based on the gains of thoseassets. You have to do a proper
accounting of how the funds aremoving, but people misunderstand
that as well. So there'sdifferent ways to move the funds
over to the Roth.
Now there's other tax free waysthat you could also consider.

(06:42):
One of them being municipalbonds. You're not gonna make as
much money probably withmunicipal bonds for the growth
potential, but you probablywon't lose as much money, but
that's a tax free source thatthere's no limit. The sky's the
limit, so the ultra wealthymight use municipal bonds just
to try and lower all theiroverall cash or taxable
situations for a period of time.Should someone with twenty to

(07:05):
thirty million dollars just goall in on municipal bonds to
avoid taxes?
I don't think that's prudent. Isee a lot of people do it, but I
just don't think it's prudent.Because what's the end goal? To
send in municipal bonds and justcall it good and to suspend
critical thought, or is it to beindustrious with your money, and
prudent with your money, andgrow your money in different
ways? Got some heartburn withthat.

(07:26):
Now the insurance industry is isgoing to propose what's called
an index universal lifeinsurance policy. All life
insurance, technically, it growstax deferred or tax free because
you're not creating a taxablesituation as the money grows.

David (07:41):
Okay.

Mike (07:42):
You can borrow against the policy tax free because you're
not taking income out. You'renot taking cash out, you're
borrowing against the policy taxfree. That is a true statement,
and then whenever you pass, thedeath benefit will then pay back
the loans on the policy, andthen beneficiaries allegedly tax
free. Now that depends on yourestate, and does the benefit go

(08:02):
to your estate, and does thatcross over an estate tax
exemption? I mean, there there'sdifferent ways that that could
create a taxable situation ornot, so be very careful with how
you structure your estate planand any life insurance benefits.
It's not as cut and dry aspeople assume. But going back to
the life insurance side,insurance is not an investment.

David (08:22):
Think I've heard your say that before on the show.

Mike (08:24):
Insurance is not an investment, but there is a cash
vehicle associated with thesepolicies. It's not like term
life insurance. And so when youget people online or on TikTok
or on the radio saying, this ishow you cheat the IRS is through
index universal life insurance,and that's how the Rockefellers
did it, and that's how youshould do it too, and this is

(08:45):
how the wealthy do it. It's not.I'll tell you right now.
When I work with someone thathas 20,000,000 plus, and we're
talking about their planning, Iwill jokingly say, alright. We
can talk about life insurance.Do you feel that you need to get
a death benefit? Then theylaugh. And I say, I thought so.
And then we move on. K? Maybethey do it because there there's

(09:06):
some sort of risks they wannapay for to hedge against. I see
that. But the rich aren'tcheating the IRS by growing
their cash through lifeinsurance.
If they buy life insurance, it'sfor a certain specific time
frame that if they died soonerthan they expected, that's going
to help cover some potentialilliquidity or other issues on

(09:29):
passing their estate. You don'tcheat the market. You don't get
more money by just buying lifeinsurance and then dying soon.
If you're on your deathbed,they're not gonna insure you. So
the odds have to be against youfor the death benefit to work
out.
K? And this is I cannot say thisemphatically enough. I get

(09:49):
probably the most pushback frominsurance agents, whom I am an
insurance agent technicallyspeaking, and from the ultra
wealthy who were sold this ideathat life insurance is how they
solve their estate planningissues and their estate planning
tax issues, and there's thisvisceral resistance. I mean,
almost like they're foaming atthe mouth. It's like, no.

(10:11):
I wasn't lied to. Well, let'sjust run the numbers. Here's the
different times where it wouldmake sense, and here's when it
wouldn't have made sense basedon these average projections.
The insurance company isn'tprinting money to give you a
larger death benefit. They'renot cheating the stock market,
and you aren't either.
Life insurance is paying for adeath benefit so that if you die

(10:32):
sooner than expected, knowingthat the odds are in the
insurance company's favor, yeah,you might get a nice ROI. Yeah.
That can bridge the gap when itcomes to businesses being
illiquid or maybe things aren'tsettled in the right way for the
estate tax purposes, whatever itis, and you're willing to pay to
hedge against that risk. Butyou're not getting rich off of
life insurance. Life insuranceis a great way to hedge against

(10:54):
that, to hedge against spousalrisk if a spouse were to pass
sooner than expected, hopingthat your spouse doesn't pass,
or maybe I'm going out on a limbhere.
Maybe you're taking the bondfund component or the lower risk
part of your overall plan in theportfolio, because most people
aren't all in stocks. They'vegot some lesser risk assets that

(11:16):
aren't growing as much as the Sand P, but they're not losing
when the S and P goes down.Maybe you take some of those
assets and you structure anappropriate index universal life
insurance policy so that thecash value hopefully advances at
an equal or near rate as thecash value would have done with
bond funds, depending on how theportfolio was done, and you get

(11:38):
the death benefit. That is areasonable possibility. That is
a reasonable, in my opinion,thing to look for.
As long as you're okay payingfor the death benefit, as long
as the insurance policy isstructured, as long as it makes
sense from a funding standpoint,because you're probably not
gonna make much money for tenyears in doing this. This is a
long term play. There's a lot ofas long as you're okay with fill

(11:59):
in the blank situations.Sometimes it makes sense.
Sometimes it doesn't.
But let's not tell everyone thateveryone should do the same
thing. Let's get into thedetails and understand what's
going on. But that is anothervehicle that you could funnel
money into that would grow taxfree and help shelter potential
tax issues. It just depends onyour situation. That's all the

(12:26):
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