Individual retirement accounts are excellent options for retirement savings. But "traditional" and "Roth" versions of IRAs differ, each with its advantages and disadvantages.
SMI's Mark Biller discussed that with host Rob West last week on Faith & Finance on American Family Radio. Mark and Rob also answered listener questions about 401(k) rollovers, investing in gold, and managing risk near retirement.
Click the play button below to listen. Scroll down to see the transcript.
Faith & Finance airs weekday mornings on AFR. A different version airs on Moody Radio weekday afternoons.
(More radio appearances by members of the SMI team can be found on our Resources page.)
Transcript
Rob West:
Retirement isn't just about how much you save, it's about how wisely you plan.
Hi! I'm Rob West. When it comes to IRAs, the choices you make today can shape your tax bill and your income for decades to come. Mark Biller joins us to break down how to make sense of your IRA options so you can move forward with clarity and confidence.
And then we'll take your calls at 800-525-7000. That's 800-525-7000. This is Faith & Finance on American Family Radio — biblical wisdom for your financial decisions. (opening music ends)
Well, Mark Biller serves as executive editor and senior portfolio manager at Sound Mind Investing, a long-time and faithful underwriter of this program. Mark, we are incredibly grateful for your partnership. Always a treat to have you back with us.
Mark Biller:
Thanks, Rob. Always great to be back with you.
Rob West:
Mark, you've written a really helpful piece in the SMI newsletter on Making Sense of Your IRA Options. This topic comes up so much here on this program, so I'm excited we're addressing it. But before we get into the specifics, let's zoom out a bit. When we think about retirement income here in America, Mark, what's the big picture framework people should have in mind?
Mark Biller:
Yeah, sure, Rob. Well, historically, most Americans have relied on a "three-legged stool" for their retirement income. Social Security is the first leg. Everybody's familiar with that. And historically, Social Security is provided somewhere around 35% to 45% of most retirees' monthly income.
The second leg of that stool used to be company pension plans, but obviously those are increasingly rare at this point. These days, the employer-sponsored retirement plans like 401(k)s, 403(b)s. Those plans fill this particular role. Now, historically, those plans have provided about 15 to 20% of retiree monthly income. That proportion is likely rising since we've become more and more reliant on 401(k) and 403(b) type plans.
Now, the "third leg," that's what we're going to be talking about today — that retirement income stool — that third leg is personal savings. And a key vehicle for building that personal retirement savings is the individual retirement account, or the IRA. Now, that's doubly true for anybody who doesn't have a good company retirement plan, because in that case, their personal savings really has to pick up the slack of both of those legs.
Rob West:
Yeah.
Mark Biller:
And Rob, it's also important to point out right out of the gate, because this is a frequent misunderstanding, that an IRA itself is not an investment. An IRA is just a tax-sheltered account that holds your investments and provides better tax treatment of the earnings of those investments.
So within an IRA, you can own most of the same things that any other investment account can hold — stocks, bonds, mutual funds, CDs, even gold, although that can get a little complicated. But the key here is that you can likely invest your IRA money using the same investments as the rest of your long-term investing plan.
Rob West:
So when someone hears the word "traditional" versus "Roth," what's the fundamental difference they need to understand?
Mark Biller:
Yeah. Traditional IRAs, they came first. They're almost 50 years old. And the biggest point to understand with traditional IRAs is you normally get to take an immediate tax deduction now for anything you contribute. So you save on your taxes now, then when you take money out in retirement, at that point, all of those withdrawals are subject to income tax. Both the original contributions, which you didn't pay tax on originally, and then all the gains taken along the way.
And the Roth IRA just flips that. They're newer. And with Roth, your contributions aren't deductible, but all of the money in retirement comes out tax-free.
Rob West:
Yeah, that's really helpful and a really succinct explanation. Thank you for that. Mark Billers here today. We're talking IRAs. We'll take your questions beginning in the next segment, 800-525-7000.
Rob West:
We're going to continue to unpack this topic today, but we are taking your calls today while Mark is here and he's going to stick around for the entire broadcast. Any questions on the market, the economy, your portfolio, or specifically today, IRAs — call right now, 800-525-7000. Let's dive in. We'll begin in Texas today. Angel, go ahead.
Caller:
I just had a question about my 401(k). I wanted to convert into a Roth IRA — of gold. I wanted to know if that's a good idea. I've been hearing a lot of good things about it and with the things that are going on, I'm wondering if my 401(k) is safe at all.
Rob West:
Good question. We'll get Mark to weigh in on that. Just let me clarify. The 401(k), is it a traditional 401(k) or a Roth 401?
Caller:
Traditional. It's through paychecks.
Rob West:
Got it. Okay. You're looking at two things. You're looking at potentially rolling it to an IRA and then converting it to a Roth. So that's issue number one. And then the second issue is the investment strategy, and you're talking about converting it not only to a Roth, but a Roth that is what's called a gold Roth IRA where it would simply hold the precious metals.
Mark, give us your thoughts on all that.
Mark Biller:
Yeah, there's a whole lot here, Angel. I'm glad that you let off the program with this, honestly, because there are a lot of good angles here. Let's start at the end and then work our way back to the beginning.
So, you mentioned that you want to convert the account largely into gold, and I can certainly understand that, especially the way gold has shot up the last couple of years and really captured the attention of a lot of investors. We've certainly been invested in it heavily and like it a lot as a portion of a portfolio.
What we've been seeing this month since the Iran war started, though, is really a good caution for investors who are considering going into gold. You may or may not be aware even today as we're talking right now, gold is down about 5% today alone, which brings its draw-down from its January peak down to somewhere between 10 and 15% off of that peak — in just really the span of a couple of months.
Now, a lot of investors think about gold as like this slow, steady, safe investment. And that's fair because we often talk about gold as a substitute for the dollar. That's one of the reasons why gold has been going up is a lot of foreign governments have been going into gold rather than buying U.S. dollars and U.S. Treasury bills and bonds. But as we're seeing right now, gold can still provide a lot of volatility and it can be uncomfortable to hold gold in the short term.
And all of that is simply the reason why we, while being big fans of gold, typically recommend that people invest in gold with a portion of their portfolio, but not the majority or certainly not all of their portfolio.
So typically on programs we've done before, Rob, we've typically recommended 5% to 10% of a portfolio being invested in precious metals and gold. We have strategies at SMI that help somebody move their allocation to gold up and down based on certain things going on in the market. So that's kind of an overview, Angel, of how I would think about the gold piece of that.
Now, as we're talking about the 401(k)-to-an-IRA conversion or transfer, generally the approach that I take with that question is if you don't like the options or the flexibility of the options within your 401(k), that's usually the best reason to consider converting it to an IRA — because an IRA is going to give you a lot more flexibility. So in this case, it may be that you don't have a gold option within your 401(k) and you want to have some of that account in gold. So converting that to an IRA may be a good idea. And then you can buy either a gold ETF in there to have some gold exposure that way. Very easy to do that.
When you do a conversion like that, the most important thing is start with the company where you want to move the account to. So if you're, say you pick Fidelity or Schwab or whoever else that's going to give you a wide range of investment options, you would start by contacting them and having them do the transfer of your 401(k) to that IRA. You don't want to take the money yourself out of the 401(k) and then put it in the IRA. That is just a risky way to do it that can subject you to penalties if you don't get it converted in time. So have the new custodian contact your 401(k) and initiate that process.
Now, the conversion from a traditional to a Roth, that's more of a tax question, 'cause you're going to have to pay tax on the full amount that you convert. Now, you can chop that conversion up over time and do a little bit each year. That's how a lot of people will manage the tax bill side of that instead of having that whole 401(k) balance hit your taxes in one year as additional income, that can create quite a tax bill.
And you generally want to only do that conversion to a Roth if you can pay those taxes with money outside the account. If you're going to have to use the proceeds of the account to pay the taxes, then that's a much more questionable proposition.
So I just covered a ton of ground there. Rob, maybe you can help if I missed anything there.
Rob West:
No, I mean, that was three big issues. You covered them perfectly. I couldn't agree more. Angel, any follow up questions?
Caller:
No, no, no. I mean, it's a lot for me to take in right now.
Rob West:
Yeah. So let's do this. You can feel free to go back — either in the AFR app or at AFR.net — and listen to this broadcast. It'll be posted shortly and you can kind of digest that over time.
But I think Mark really hit it. The key here, the primary factors on that Roth conversion, as he said, is all around taxes. It's current versus future tax rate, which is unknown. You're right now, probably as you're working in a higher tax bracket. In the future, you would likely be in a lower one, although tax rates may be higher. So we have to consider that. We also probably, if you do decide to convert either for your heirs or just because it makes sense, you want to fill up those lower brackets and not spill over into the higher ones as you think about that smaller portion to convert over time.
And I think Mark really nailed it with your ability to pay the taxes out of savings or cash flow is really key. Thanks for your call.
More questions with Mark Biller after this.
Rob West:
Mark Biller's here today. We're talking IRA options. I'm Rob West. This is Faith & Finance on American Family Radio. Prioritizing your questions today on the market, your portfolio, the economy, and specifically IRA and retirement-related questions. Do you convert as you're approaching retirement? When does that make sense? And how do you think about your retirement-income streams?
Mark Biller's here today to answer those questions when you call 800-525-7000. By the way, if you want to do a deeper dive on this topic, just head over to soundmindinvesting.org.
Let's go back to the phones — to Virginia. Ken, go ahead, sir.
Caller:
Thank you so much for what you do. I have a quick question for you. I'm getting ready to retire. I'm 71 years old, and I have about $70,000 in my 401(k) plan at work, but it's high risk. And I was wondering, would I be better off to take it out of that and put it in a IRA or CD?
Rob West:
So you're clearly still working, Ken?
Caller:
Yes, sir.
Rob West:
Okay. And how long do you have kind of a runway on when you might transition away from paid work?
Caller:
Yes, sir. End of this year.
Rob West:
End of this year. Got it. Okay. Mark?
Mark Biller:
Yeah. So Ken, you mentioned that the 401(k) is "high risk." Did I hear that correctly?
Caller:
Yes, sir. It is.
Mark Biller:
Okay. Well, you've got a couple of options, Ken. So one thing that you could do is if you generally like the options available to you within the 401(k), you can probably reduce the risk of your 401(k) account simply by changing which investment options you are invested in within the 401(k). So you likely have some options that are more bond fund options, maybe lower-risk stock equity choices that you can make.
And so simply by, let's say, just for the sake of example, if it's invested 100% in US stocks right now, one easy way to bring that risk down would be to just take, say, 40% of that money and put that into lower risk options, like some of the bond fund options, or if there is like a gold option, you could diversify that way, but keep it in the 401(k).
And so usually that's a good option if someone likes the choices that are available to them there, and you may need to figure out how to be able to log into your plan so that you can see all the different choices that are available to you.
Now, sometimes when people get to retirement age, they look at their 401(k) and they say, "I'm really limited in the choices I have here, and there's some things I'd like to do — like Angel was talking about — where I'd like to diversify outside some of the choices that my 401k provides." And in that case, converting that 401(k) when you retire to an IRA makes sense because that will give you more flexible options.
But I just wanted to point out, Ken, that you may not need to do that if you look at the options in the 401(k) and you'd like the choices that are available there.
Rob West:
Ken, does that make sense?
Caller:
Yes, sir. I have one other follow-up question.
Rob West:
Of course.
Caller:
They just changed companies that they deal with and I had everything in low risk before and this new company just took over the beginning of February and when I looked, it was in high risk. That's what concerned me.
And I have a couple $50,000 CDs, but I don't really have any pension other than what I'm going to get from Social Security. So in the future, I might need that money, and that's why I was considering maybe getting another CD, or if that's not a good idea.
Mark Biller:
Yeah. So is there somebody that's kind of advising you on how to invest that 401(k) within the company?
Caller:
They're not really. When I started the 401(k) a few years ago, I just told them I wanted at low risk and they told me they would put it in low risk. But to be completely honest with you, I'm computer illiterate and I don't really even know how to go check it. I probably allowed them to do more than I should without knowing exactly what they're doing. Older people don't know exactly what to do sometimes!
Mark Biller:
Yeah, right. No, that's fair.
Rob West:
I would say a couple of options from my perspective. One is you could reach out to HR and see if there is somebody who could come alongside you and just help you understand the options that are available. Since you're close to retirement, you could just tell them, "Listen, I want you to move me to a more conservative portfolio."
And then you're very close to being able to roll this out to an IRA, and then you could hire an advisor, whether it's SMI or one of the Certified Kingdom Advisors there in Virginia to basically take over and manage this for you, Ken.
But in the meantime, it shouldn't be difficult to get from something more aggressive to something that better aligns with your age and stage of life and goals — even if that's just what's called a life cycle or a target date portfolio, which they should be able to point you to.
Caller:
No, that sounds wonderful. I appreciate that.
Rob West:
All right.
Caller:
I'm going to get in touch with CKA, go ahead and let them management. I think that'd be a whole lot better off because I don't understand it at all.
Rob West:
Well, that's a good point because they could probably go ahead and just look over those options and advise you on it and then take over management once you separate from service and can roll it to the IRA. So it sounds like that's a great idea. Just head Ken to findaCKA.com and you could do a zip code search to find one there in Virginia. There's some great ones. Thanks for calling today.
Texas is where Bill's located. Go ahead, sir.
Caller:
Good morning, gentlemen. I appreciate your excellent ministry and your wise counsel all the time. I think it's fantastic.
My question has to do with a 403(b) that I have, which functions like a 401(k). I'm 78 years old and have fully retired, so I know that I can take things out of it and so forth. So I've started this year — I had a charitable distribution made directly to my church, understanding that that's really not a taxable event then.
My question is, given that I've done that, and I have this distribution that's been made, how does that relate to my taxes? I know that — my understanding is that it reduces your income. How does that relate then to your standard deduction?
Rob West:
Yeah. Mark?
Mark Biller:
Yeah. I don't think that that's going to have any impact on your standard deduction, Bill. The big thing — I'm assuming that that was a qualified charitable distribution that was made, and if all the boxes are ticked and that's done correctly, then basically you have gotten the money out of your retirement account and into this charity, and the big benefit is that that just bypasses your tax return altogether. So you're not going to be able to claim the additional deduction like you would with a normal donation if you were itemizing on your taxes, but you don't have the additional income showing up on your return from taking money out of the 403(b).
So it's really an elegant way to do it. I love that you did that because it's really the best way for retirees to make both their required minimum distribution and be able to do their charitable giving without it impacting your taxes, and impacting it sometimes even in ways you don't even see because your overall income would be higher if you had taken that money out directly and then turned around and given it without making it that qualified charitable distribution.
But to answer your question directly, Bill, I don't think it's going to have any impact on your standard deduction. You can still take that. The income shouldn't show up on your return at all. So it's as if from your tax standpoint, it's as if it didn't happen — which is good for you because normally with required minimum distributions that boosts your income, boosts your taxes, all of those things.
Rob West:
Hey, we appreciate your call today. Lord, bless you, sir.
Let's go to Oklahoma. Shelly, go ahead.
Caller:
Good morning, gentlemen. Thanks for all you do. I had a question about, I'm a retired government employee and I have $161,000 in my TSP [Thrift Savings Plan]. And of that, I have $93,000 that's in a G fund. And I was wondering — I also have $112,000 in Charles Schwab IRA rollover. And I was wondering, should I move some of that money out of the G fund to that rollover to do better with the market? I'm kind of conservative, so...
Rob West:
Yeah. And just for the sake of the benefit for our listeners here in the TSP, they really simplify it. It's actually a very effective retirement solution, but they simplify the investment options to some letter offerings. You've got three in the stock area — the C, the S and the I, common stock, large cap, small cap international. And then you've got an F, which is fixed income, your bond offering. And then G, which Shelly just mentioned, which is basically a government money market.
So Mark, at [age] 63, with a good chunk of her money in that G fund, what would you say?
Mark Biller:
Yeah, Shelly, I think that, overall, your goal is to figure out what you want your balance to be for your total portfolio. So I would encourage you to look at all of the accounts as if they were one big account, even though obviously they're separated. Figure out what kind of a mix you want to have and feel comfortable with.
You said you're fairly conservative, so maybe that looks something like a 60% stock, 40% bond at this point. Some people would go even lower, maybe 50/50, but I tend to look at someone at 63 and say, "There's probably about a coin flip chance of you living 30 more years into your 90s" — now, of course, personal health and family history and all that come into it as well — but that's why I'm hesitant to get too conservative too fast.
But at any rate, Shelly, once you select what you think is an appropriate blend of stocks and bonds, then it doesn't really matter that much which account is holding which of those assets.
So you could potentially leave the bond portion of your total portfolio in the TSP and then use your Schwab account and the rest of the TSP to get the stock exposure that you want. Or if for some reason you liked a different bond option in your Schwab account, you could just flip that and go into the stock choices within your TSP.
But the main idea here is look at all of your options, all of your accounts as one big pot, figure out what you want the overall allocation mix to look like, and then you can make the choices in each account to get that total to line up where you want it.
Any other thoughts, Rob?
Rob West:
No, I think that's great advice. Is that clear, Shelly?
Caller:
I think so, I think so. I was just planning, thinking about moving it out of the G into the C or into that Charles Schwab mutual fund, because it's doing really, really well.
Rob West:
Yeah. Yeah. I think the key with any of these decisions is just what is the right investment mix or what's called allocation for me. And to Mark's point, I think a 60/40 portfolio, probably right.
I think you could even be more aggressive. One of your biggest risks in this season of life is something called longevity risk. The idea that we're living longer and obviously the Lord knows the day or the hour that each of us will go home, but if you live into your 90s, you need this money to last a long time, which means even at 65, you have potentially three or more decades that this money needs to last.
And so that's why we would keep maybe up to 50% in stocks. Even if we got into a recession and the market was down 20% or 30%, you wouldn't touch it. You'd wait for it to come back. And at least historically speaking, it always has. With every correction, crash, you name it.
But whether it's in the TSP through those options by manipulating the G and the C and the S and the I, or moving to some other type of low-cost mutual fund or ETF, that really is a second question altogether.
Thanks for your call. We'll be right back.
Rob West:
Great to have you with us today on Faith & Finance here on American Family Radio. In just a moment, we'll head back to the phones. Mark Biller's here today. We're talking IRAs, your options as you head toward retirement.
Mark, I want to circle back before we head to these remaining phone calls on this idea of converting from traditional to Roth. Is that something that everybody needs to at least consider as they're nearing retirement? How do you think about that?
Mark Biller:
I don't know that everybody needs to do it, but it certainly is worth thinking through the process, right? I mean, that doesn't cost you anything. And the main advantage of converting is you can really, if you do it at the right time — which typically is between roughly 60 years old and 73 when you have to start taking required minimum distributions — what a lot of people will do is they will figure out how much they can convert each year without it bumping them up into a higher tax bracket. And by doing that, you can really manage your tax bills during the final years that you're working, or better yet, the early years of your retirement when your income tends to be quite low.
And by converting a portion of a traditional account to a Roth during that window, you're going to do a couple things. You're going to reduce the required minimum distributions that will kick in when you turn 73, because you only have to take required minimum distributions from traditional IRAs, not from Roth IRAs. And also, of course, you're going to have total flexibility tax-wise with any of that money that has been converted into a Roth because you're going to get all of that tax free. So that's great for you for your own tax flexibility. It's great for any heirs that you might leave some of that account to.
And that's why that window of time in early retirement is really so key from a planning perspective, because you get this rare, kind of short window for most people where their income goes way down from the end of their working career to the beginning of their retirement, and they can actually do some of that converting — which adds to your tax bill, but it's adding to your tax bill at these really low rates that you probably have not been able to pay tax at for quite a while when you were working, when you were in higher brackets.
So that's kind of an overview of how to think about the conversion process.
Rob West:
Yeah. And then last question, there's always this debate around, if I have the option to contribute to both Roth and traditional — so one after tax going in, coming out tax free, the other pre-tax, getting a deduction when it goes in and then taking out paying a tax on it in retirement — people wonder, should there be a split? Should I be contributing to both?
And at one point, you and I in the past had talked about some research that was done that said, if you add the number 20 to your age, that's the amount that should go in traditional, the balance in Roth, as just kind of one rule of thumb. Is that something you would still kind of adhere to or what are your thoughts there?
Mark Biller:
I don't generally look at that particular rule of thumb, although I'm not saying that it's inappropriate. It really does come down to this projection of if I'm paying tax at a higher rate today than what I expect to be paying in retirement. And so that's why for younger people, we almost always default to Roth because younger folks early in their career, they're typically not paying tax at high rates today, but we're hoping that decades out in the future, they'll be earning more, paying higher taxes then. So the Roth is an easy choice for younger folks.
Where it gets complicated is, say, for the 50 plus employees who are now in the heart of their career, making the most money probably that they've made in their career and paying tax at the highest rates. And so for those folks, it may make sense to take the tax deduction with the traditional today. And then like we were just saying, you might have an opportunity to convert that to a Roth at substantially lower tax rates early in retirement. Or even if you end up taking money out of the account directly as a 70 year old, 80 year old, your tax rate may be lower.
And so we cover that in a lot of detail in the articles that are available on the site this month that you've been referring to. So I'd really encourage someone, if they're thinking about that specific decision, read these articles. They will help guide you through the particulars of that decision.
Rob West:
All right. Let's head back to the phones. We'll try to get to at least a few of these calls here before we finish today. Out to Texas. Tim, thanks for your patience. Go ahead.
Caller:
Thank you very much for taking my call, Rob, and listen to you all the time. Appreciate you too, Mark. You pretty much answered my main question. I am 64 years old, still working probably four or five more years. And I have a company 401(k) that I invest in heavily. Second marriage, late in life, don't have a lot of savings. So I mean, I'm putting in 14 to 18% of my income into my 401(k). And I heard online that if you convert it to a Roth IRA, you can save in your taxes. And you pretty much went over that on your first point. Thank you, Rob and Mark.
But my second question then, while I'm thinking here and listening to you guys, is that my tax advisor, because we don't have a lot between my wife and I, said invest as heavily as you can in your company sponsored 401(k) and invest heavily in stocks.
His advice was "Don't invest in bonds at all," because like you said, Rob, they have a very diverse stock portfolio. And it is growing hand over fist right now, which is good thing. And wondering if I should continue doing that.
I mean, if I retire when I'm 68 or 70, I will start taking it out and putting it into a Roth IRA as I get to the lower bracket. But you're right. I'm paying high tax bracket right now.
Rob West:
Yeah. Mark, what thoughts do you have for Tim?
Mark Biller:
Yeah. Tim, the biggest risk of running a really concentrated stock portfolio without a lot of other diversification is the volatility. And, of course, we have seen big bear markets in the past. We had two of them in the 2000s that took the stock market down by about 50% each time. So that happened twice in a span of 10 years. And if you're running 100% stocks when something like that hits, that can really set you back.
Now, I would tend to say, Tim, there are some other ways that you can diversify at least a little bit without bringing in a huge bond portion if you don't want to have a lot in bonds. And I understand that argument. There are some other things you could do. You could add a little bit of commodity exposure, you could add a little bit of gold exposure. Maybe between those two, that could get you to 5% to 10% of your portfolio. It's at least something that would help buffer any direct stock market hits.
There are some other products — we manage some ETFs that kind of have some other asset classes that are brought into the mix as well. So there's some other things you can do beyond just cutting your portfolio in half and putting it all in bonds.
But I would encourage you to think about the diversification side of that. Yes, stocks are absolutely the fastest runner. And so when stocks are good, they're going to get you where you want to go the fastest. But we do have to remember that the markets are cyclical and periodically the stock market does hit its toe and stumble, and sometimes those stumbles can be pretty steep.
So that would be my thought on that, Tim. Anything you have, Rob?
Rob West:
Oh, I love it. I think you're right on. Tim, I hope that's helpful. Thanks for calling today. We appreciate you being a regular listener.
Mark Biller has been our guest today. Sound Mind Investing has been a long time and faithful underwriter of this program. If you want to read this article we've been talking about today, and I would encourage you to do so, head over to soundmindinvesting.org. It's called Making Sense of Your IRA Options. While you're there. Learn more about the SMI newsletter and their Private Client group. Mark, thanks for being with us. We'll see you next time.
And folks, come back and join us tomorrow. We'll see you then. Bye-bye!
