Ep 27: Understanding Annuities – The Basics

On This Episode

There are a lot of strong opinions on annuities. Some people heavily advocate for them, while others claim they are a bad investment. Today John and Nick will break down the basics for us by discussing what an annuity is and some important terms to know.

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Disclaimer:

PFG Private Wealth Management, LLC is an SEC Registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. The topics and information discussed during this podcast are not intended to provide tax or legal advice. Investments involve risk, and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed on this podcast. Past performance is not indicative of future performance. Insurance products and services are offered and sold through individually licensed and appointed insurance agents.

Here is a transcript of today’s episode:

 

Speaker 1: Hey everybody. Welcome into the podcast. Thanks for tuning into Retirement Planning Redefined with John and Nick from PFG Private Wealth. We appreciate your time as we’re going to get into understanding annuities, we’re going to do a series on annuities, several podcasts coming up but we’re going to start out with the basics, annuity basics. So, stick around for that, we’re going to get into that in just a second. But first, let me say hi to the guys. What’s going on, Nick? How are you?

 

Nick: Staying pretty good, just waiting for the weather to cool down a little bit here in Florida. We are ready for, I guess what we would consider our winter or fall one.

 

Speaker 1: Do you get fall? Isn’t it just summer, winter?

 

Nick: I feel like when I first moved here, there was some fall back in ’03, ’04, ’05. But the last few years, it feels like it’s just kind of jumped from one to the other. But whatever it is, where it’s not 90 plus and sticky out, I’m ready for it.

 

Speaker 1: Right. Yeah. John, how you doing my friend?

 

John: I’m good, I’m good. I’m with you. I was thinking we’re just chatting about the weather and it’s still 87 here and it feels like 92 and I’m ready for a low 80s and no more humidity.

 

Speaker 1: There you go. Yeah, the humidity can be the bear, that’s for sure. Well, good. I’m glad you guys are doing well since our last time chatting here on the podcast. So, we’ve got a lot to cover, we’re going to try to keep this into our timeframe. We’re trying to keep this into a digestible amount of time for folks here. So, let’s jump in and start talking about annuities, understanding them and again, as I mentioned, we’ll start with the basics.

 

Speaker 1: It’s just really important to understand them because they can offer some things to people, it can be a vehicle that some may find useful. There’s risk reduction, retirement income, tax deferral, death benefits, so let’s just get into some of this stuff. What is an annuity to kind of start off with guys?

 

John: When you break it down, it’s a contract with an insurance company. So, that’s kind of the premise of it all and what that contract, typically, you’re getting some type of guarantee and we’ll dive into that a little later but it could be some type of a principal protection guarantee, income guarantee, death benefit guarantee. So, that’s what you’re looking for. And it’s really important again, kind of going back to understanding it because it is a contract with an insurance company, so you need to understand all the details of it, just because it could come back to bite you. And we’ve seen that happen quite a few times as we’re doing some reviews with clients. They just don’t truly understand how it works because these are pretty complex vehicles and there’s a lot of moving parts.

 

John: So, it’s just important to understand how, going back to the overall plan, how does the tool work with everything else? And then one thing that we, again, being a contract, the guarantees are based on the paying ability of the company that you’re with. So, one of the things that we always kind of look at is what’s the rating of the company you’re going with because if you want to set the contract for some type of guarantee, you want to make sure that they’re going to be around to actually give you that guarantee.

 

Speaker 1: Right, yeah. Yeah. So, Bob’s insurance is not necessarily the best idea, right?

 

Nick: Yeah. And I will say one other thing that we like to preface this sort of conversation with and part of the reason that it is so confusing for people is that there are many different subsets or different types of annuities. And so, oftentimes people have heard the term annuity but they don’t realize all of the different types and that their experience may pertain to one of 10 different types. So, as we get into the differences and kind of the nuances, we’ll kind of joke sometimes in our classes that we almost wish that they were called different things. It’s like saying, “Hey, should I buy a vehicle? Well, do you want a car? Do you want a truck? What are you trying to do? Is gas mileage important to you? Is off-roading important? What is it?” And that same sort of mentality is important when you are talking about it.

 

Speaker 1: Well, you could think about that analogy Nick with and just leave it at cars because many people would just say, “I need to get a new car.” Even when they’re looking at like an SUV or something like that, they don’t really refer to it that way. So yeah, that’s a great way of thinking about that. And we will cover, we we’ll get into, like I said, we’re starting with the basics today but we’ll get into some of the different types, their names, what they are, so on and so forth. So, John gave us kind of what the gist of it is. There’s a couple of phases to think about, what are the phases?

 

Nick: As we get into it and when we’re talking about deferred annuities, there’s essentially what’s called an accumulation phase and a withdrawal phase. So for the accumulation phase, what that is referring to is, between the time that you initiate or deposit money into the annuity and between that starting point and then the period in time in which you start withdrawing money, it’s called the accumulation phase. And that’s important to know because there’s different rules, which we’ll sort of get into but that accumulation phase is important to understand because by itself, an annuity does provide tax-deferred accumulation or tax-deferred growth during that phase.

 

Nick: So, if somebody says an example of that is the easiest way to compare it is, client has $100,000 in a money market account at the bank and they get to collect, when they get interest on that account, they get a 1099 at the end of the year, they pay taxes on the interest in the year that the interest is incurred. In the annuity, in its own chassis, it’s going to provide tax-deferred growth, which means that that growth just compounds without having to pay any taxes on it until the point that you start taking it out. That’s a pretty big deal and could be a really useful tool for higher income earners that are looking to put money in places that are more tax beneficial especially if we do enter into a higher tax bracket, phase, which we may in the next four to eight years.

 

Nick: And then for the withdrawal phase, it is that money starts to come out. So, the first thing that people need to understand is that when you take that money out, if it’s non-qualified or non-IRA money, there is going to be some form of taxation. It’s going to be ordinary income, which means whatever tax bracket they’re in, those withdrawals, as long as they’re part of the gains that have happened in the contract, those earnings are going to come out first and they’re going to be taxed at ordinary income.

 

Nick: So, understanding how that works is kind of an initial importance. There is a term and a methodology of taking out money inside of an annuity via what’s called annuitization. Again, this is one of those things where you wish that they would just come up with words that aren’t confusing, annuity, annuitization, et cetera. So, annuity is basically like a noun, it’s a type of account. Annuitization is an action essentially. Annuitization is when the company liquidates your lump sum of money and starts paying you in it whether it’s a monthly or an annual payment. And one of the benefits of annuitization is that they can actually spread out your gains over a longer period of time and it can be a more tax-efficient way and can guarantee you payments over a certain period of time.

 

Nick: And so, in one of the other future series, we’re going to get into that process a little bit more. But the easiest way for people to think about it is kind of like a pension payment, a fixed amount of money that’s going to be paid out over a certain period of time. And then, there are guaranteed withdrawals and we’ll talk about that a little bit where you can kind of structure how you want to take out withdrawals. So, it is confusing, there’s a lot of moving parts and it’s a good example of why we’re going to have in-depth series on this.

 

Speaker 1: Yeah. That’s a good example of why to work with an advisor as well to help you go through some of these things. And John, there’s definitely caveats that go with it. There’s things you’ll want to know, some big bullet points if you will. Give us a few of those in the basics of an annuity.

 

John: Yeah. Important again, any contract you go into important to understand what the rules are and these are things you want to consider. So, similar to an IRA where there’s that 10% penalty if you withdraw before 15 and a half, annuity has the same scenario. So actually, this just came up with some advisors I was working with and we were doing some planning and the client needed money in a four-year period and really needed to, they wanted to make sure there was some guarantees to it. So, it was discussed of kind of an annuity to provide some type of principal guarantee. But by the time they would need the money, they would have only been 58. So, it was decided, “Hey, this isn’t a good vehicle for you because you can’t touch it ’til 59 and a half due to do that 10% penalty.”

 

John: So again, important when you’re going into anything, just understand the rules because had they put that money into it and then in four years when they needed it, they wouldn’t be able to access it penalty-free. So, just important to understand that one. Another one that we see a lot of people mistake or not understand how it works is the surrender period. Some of these contracts basically, when you give the money to the insurance company, there’s a period of time where you actually can’t get access to all your money full and clear. And this is separate from the 59 and a half but the surrender periods can be as short as three years. So, let’s say you give your money to XYZ insurance company, they give you these guarantees and they tell you, “Okay, for a three-year period though, you can’t get full access to your money. We’re basically keeping it.”

 

John: So, it can be three years and we’ve seen as high as 16. And that’s one of the things you really want to understand what you’re getting into because unfortunately, we’ve seen some people where they’ve gotten to the 16-year period, is that they had no idea they we’re getting into it and they have limited access to their funds. And we’ll go through … There is a piece of money you can get at but you just want to make sure how long has this contract going to be before you can get out of it. And with that is what we call the surrender charge. So, let’s say your surrender period is seven years and in year five, you want to pull out money. Well, there’s actually a descending surrender charge. So in year five, if you decide, “Hey, I can’t do this anymore. I need to get access to my money,” the insurance company might charge 4% of your principal for you to actually get out of the contract.

 

John: So, an example of that would be seven-year contract. First year surrender charge could be 8%, second year would be 7% and so on. So, that’s where you really want to understand exactly, “What’s my surrender period? And if for whatever reason, I need to pull out of this contract early before the surrender period’s up, how much am I going to get charged to do so?” Again, it’s all about reading the fine details in the contract.

 

Nick: And within that, many contracts have a 10% free withdrawal amount that will avoid you having to pay a penalty even that surrender charged during that surrender period but that can be confusing as well. And sometimes, that’s used to oversell or kind of force people into not necessarily force, but convince people to put more money than they feel comfortable with into something like that. But many of them do allow for a 10% withdrawal each year.

 

John: Yeah. So an example of that, so I’m glad you brought that up, Nick is, let’s say you had $100,000 in an annuity and you’re in year three. And you don’t necessarily need to cancel the whole contract but you do need access to some funds, you could pull out. Typically we see a max, they allow up to 10%. We’ve seen some as low as 5%. But in a 10% scenario, you could pull out 10 grand in that year free and clear of any charges. So, that’s important to understand exactly what’s your free withdrawal amount. And then, one thing to understand is once the surrender period is up, so if you’re in a seven-year contract, once that seven years is over, you can move your money wherever you want or you can keep it in the current contract. So, once a surrender period’s up, it’s 100% liquid at that point in time.

 

Nick: And just one other thing on that surrender period, if somebody out there is evaluating them, a good question to ask is whether or not the surrender period is what’s called rolling or not on rolling. So, what that means is that if it is a non-rolling surrender period and it’s a seven-year contract like John explained or kind of detailed, the seven-year period starts when you first deposit the money and it never extends. So, you can make an additional deposit down the road, say in year five and that new deposit does not have its own seven-year surrender period, it only has two years left just like the rest of the money.

 

Nick: So, that can be a really useful tool for somebody that’s trying to sock away some money, make ongoing contributions to it but still maintain access to their money. Whereas a rolling surrender charge period, each deposit has its own seven-year surrender period which can get really squirly and hard to keep track of. So, that’s an important thing to look out for.

 

Speaker 1: And so, you mentioned some of those bullet points there, John, to think about, you mentioned guarantees and the insurance company and so on and so forth. Are there protections in there? A lot of times people wonder what kind of creditor protections are there?

 

Nick: So, creditor protection tends to vary from state to state, which is actually a good kind of segue. So, one thing that people may notice, especially we’re in Florida and we have a lot of people that live in different states, et cetera, or at least part of the time. Insurance companies are regulated state by state. So, even though XYZ insurance company may have contracts in 50 different states, the rules and benefits that they provide in each state can be different. So in Florida, and this is always something where you want to, before you make any major decisions, you want to check in with an attorney, especially in estate planning or asset protection attorney, somebody that really works in that space.

 

Nick: But in the state of Florida, annuities fall into one of the categories that have a level of asset protection via loss, kind of joke that it’s the OJ Simpson rule, why he became a resident here many years back after he was found liable in court for the murders back in the ’90s were because the State of Florida provides asset protection on annuities for their residents. So, that is an area where we’ll have people that are high income earners, maybe physicians, specialists in medicine, things like that, where they’re very worried about asset protection, they may use annuities as a place to put money for growth but also provide them with a level of protection.

 

Speaker 1: Okay. And does that apply to a probate things of that nature in some protections, wills, so on and so forth? Is that caveat also?

 

Nick: So, probate typically is the process of essentially the court system, implementing the direction of a will or your estate and there’s a fee for probate. So, because an annuity is considered an insurance contract, you can actually list the beneficiary in the insurance contract, which will allow that process after a death of the funds to transfer directly to your beneficiaries and avoid them having to go through probate to get those assets, which can be a savings of somewhere from three to 5% of the assets in there. And not only that, it keeps it private instead of a public process, which probate is, but it just is a much cleaner way to be able to leave assets by listing the beneficiaries in the insurance contract, which is the annuity in this case.

 

Speaker 1: Okay. So, let’s talk about some more basics here. We often hear the term riders, make sure you get something with a rider and this has that so on and so forth, different options. John, what’s a rider?

 

John: So, a rider’s basically an additional piece to the contract that you can add, some type of guarantee or some type of benefit. And let me preface it by saying, most riders will have some type of cost associated to it. So, an example of a rider would be like a death benefit. You could put a death benefit rider on the contract where your initial principal payment, that’s your guaranteed death benefit. So, if you were in a, we’re talking about variable annuities, but if you’re in a variable annuity and the market dropped, you put in 100,000 and the market dropped to 80 due to market fluctuation, your death benefit stays at 100 or there could be a rider where the death benefit could potentially increase each year by a guaranteed rate.

 

John: Some other riders could be like a principal guarantee where you can’t lose any of your initial purchase payment amount. And then, the most popular one that we see is a guaranteed income rider, where it will guarantee income throughout the life of the contract similar to, when Nick was talking about what the pension and we’ll dive into this a little bit deeper on how this works in some of our future sessions, but when people are asking questions like, “Hey, what is this rider?” It’s typically some type of benefit or guarantee within the contract. And there is more often than not some type of fee associated with it and it’s important to understand how that fee works and then how the rider works on your contract if you like that type of benefit.

 

Speaker 1: It kind of goes into the factor of, is it worth it or not for that purchase that you’re making for what it is you’re trying to accomplish, right? What you want that vehicle to do for you.

 

John: Yeah and with the annuities, it really all comes down to the guarantees and if that’s what you’re looking for. Are you going to be guaranteed against some type of loss, guaranteed some type of income and is the cost of that guarantee worth it in the annuity contract? And for some people it’s great, it really gives them peace of mind and for other people, they don’t want to pay that extra fee or any type of cost on their money. Anything I missed there, Nick?

 

Nick: No, I would just say the way that you want to view any sort of, really any sort of investment vehicle itself, but especially annuities are through the realm of yourself, your specific situation, your plan. Because there are so many different variations of annuities and there are lots of bad ones and there are a bunch of good ones. Oftentimes, where we see the biggest mistakes made are when people implement a strategy that was good for their friend, their neighbor, their brother, their sister, but not good for them. And so because of that, and because of that decision it’s like, okay, these are bad,” where instead it should have been, well hey, you used the wrong strategy, you used the wrong type, this wasn’t something that made sense for you because X, Y and Z.

 

Nick: So, when you kind of evaluate these sort of things and as you kind of listen through the upcoming sessions and we talk about the positives, the negatives, some of the features and the benefits, et cetera, you really want to look at it through the realm of yourself and your specific situation because your brother, your sister, your neighbor, your friend, they may have different tolerances for risks, for expenses, their income levels may be different, they may have a pension where you don’t. So, every situation is different and I think that gets amplified by a significant amount when it comes to annuities and it’s part of the reason why they’re so often misunderstood.

 

Speaker 1: Well, and like any financial vehicle you already said that you want to make sure what’s the right fit for you. There’s so many vehicles out there, so many different financial products, there’s pros and cons to everything. And so, it’s finding the right balance, the right fit for you. Well, we’re going to wrap this up here in just a second. So, you mentioned, actually John mentioned variables, there’s basically three types. So, what are the three types we will be covering on the future conversations?

 

John: Yeah. So, we’re going to jump into fixed annuities and breaking down those and the pros and cons of variable annuities and then also fixed index annuities. We’re really going to try to do a good job of giving people details so they have the education and the knowledge to have good conversations, whether with their advisor or for themselves to really figure out if it’s the best decision for them.

 

Speaker 1: Makes sense. And so, we’ll finish it off by saying, make sure you subscribe to the podcast if you haven’t done so yet, they’ll also send this out for those folks if you’re getting that already. You can do a couple of things. You can either just go to the website, pfgprivatewealth.com, that is pfgprivatewealth.com or you can type in retirement planning redefined on whatever app you’re using like Apple or Google or Spotify. You can find it on all the most popular apps as well, just type in retirement planning redefined in the search box and you should have that pop up and you can subscribe to it that way.

 

Speaker 1: If you’ve got questions or before you take action, you should always call a qualified professional like John or Nick at PFG Private Wealth. They are financial advisors here in the Tampa Bay area. So, give them a call at (813) 286-7776, it’s (813) 286-7776. And we’ll also address guys that we’ll find a little bit here, it’s just a bias. You kind of alluded to it. People, they hear things and it’s like, “Oh, I don’t even want to talk about them because I know they’re all bad.” So, we’ll also discuss a bit of the biases for them and against them.

 

John: Yeah. So, with the biases, we find a lot of people based on stuff they read and articles and things they’ve listened to, they really come in with a bias, whether for them or against them. And one of the things that we like to just say is say, “You have an open mind and just learn about it and figure out if it works for your plan because if you’re reading an article and it’s telling you that annuities are bad, all the stuff,” and I’ll say like, “Fisher Investments, they’re really dog annuities,” but when you look at it, what they do is asset management. So, their primary focus is getting money, going into stocks, bonds, mutual funds, things like that. So, they’re not really offering annuity so they’re basically, they’re going to be against them.

 

John: And vice versa, we’ve seen some advisors that aren’t actually licensed but they have an insurance license and all they can offer is an annuity. And guess what’s the greatest thing out there? It’s an annuity for you because they can’t do anything else. So, whatever you’re reading, you got to kind of look at it from a perspective of, “Is this person open-minded to it?” And that’s where Nick said it’s really important to look at the tool, the annuity, the pros and cons to it and does that fit with your plan and what your goals are?

 

Speaker 1: Well, that’s a great way to end the podcast this week. Thanks so much for your time here with John and Nick as we were talking about understanding annuities on the podcast. This has been Retirement Planning Redefined. We appreciate your time. Make sure you hit that subscribe button on whatever app you use or reach out to John and Nick at pfgprivatewealth.com and we’ll see you next time.

Ep 15: Roth IRA 101

On This Episode

Last week we covered the basics of the traditional IRA and today we will shift our focus to the Roth IRA. John and Nick will once again explain the basics to this investment vehicle. We will also compare and contrast the Roth IRA to the traditional IRA.

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More Episodes

Check out all the episodes by clicking here.

 

Disclaimer:

PFG Private Wealth Management, LLC is an SEC Registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. The topics and information discussed during this podcast are not intended to provide tax or legal advice. Investments involve risk, and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed on this podcast. Past performance is not indicative of future performance. Insurance products and services are offered and sold through individually licensed and appointed insurance agents.

Here is a transcript of today’s episode:

Speaker 1: Hey everybody. Welcome back in to Retirement Planning Redefined. Thanks for tuning into the podcast. We appreciate it. Maybe you’ve received this podcast through the team’s newsletters or email blast. Or maybe you found us online on various different podcast outlets like Apple or Google or Spotify. Either way we appreciate your time. And we’re going to spend a few minutes with John and Nick talking some more about IRAs. And this go round we’re going to spend some time on the Roths. But first guys, what’s going on? How are you?


John: I’m good. So my one year old is sleeping through the night very well, so I feel like a new man.


Speaker 1: That goes a long way that’s for sure. Well kudos on that. And Nick, how you doing, buddy?


Nick: I’m pretty good. My 15 year old dog is not sleeping through the night.I’m okay.


Speaker 1: Yeah, getting up there. I’ve got a 13 year old dog and she’s a pistol. I got a 22 year old daughter and I can’t tell which one’s a bigger pain in the butt, the dog or the daughter. But they’re both doing pretty well. The kid’s actually graduating from nuclear engineering school. Actually I get to go see her Friday, and she’s now a petty officer. She ranked up in the Navy. So we’re all proud of her.


Nick: Congrats.


Speaker 1: Yeah, I appreciate that. I’ll tell you what, let’s not talk about babies, dogs or the Navy for just a minute. Let’s talk about the Roth IRAs as I mentioned. So if you happened to catch the last podcast, we wanted to go through and talk about IRAs, about the vehicle. And we spent some time on the traditional side. So guys, do me a favor first, let’s just do a recap, a little bit, of the traditional IRA before we switch over to the Roth so people have some context on that.


Nick: So one of the biggest benefits for any sort of IRA account are some of the tax benefits. But one of the things that we wanted to remind everybody of, and this helps with IRA accounts, but also just really any investment account. Sometimes the feedback we’ve gotten is it’s helpful for people to think about the different types of accounts in three phases of taxation. There’s as the money goes in, is it taxed, is it not taxed. As the money grows, is it taxed, is it not taxed. And then when it comes out so that you can use it, is it taxed or not taxed. So for traditional IRA, you know the first one, as it goes in, in the last session we talked a little bit about it. Most of the time for most people it’s not going to be taxed. But there will be some rules on when that’s after tax money, it’s going to grow tax deferred. So you’re not going to get 1099 on it each year as it grows. And then when it comes out, it’s going to be ordinary income tax.


Nick: And then for the Roth IRA, which is what we’re going to get into today, it is money that’s already been taxed is going to go in. It’s going to grow tax deferred. So [inaudible 00:02:43] 1099s, and then on the backside it’s tax free. That’s the comparison as you go through.


Speaker 1: Okay. Since you brought it up, let’s go ahead and just jump right into it. So John, give us a few things to think about on the Roth side. He already mentioned the tax deferred part. What are some other limitations and things of that nature we talked about like with the traditional, some numbers or some things we need to know?


John: Yeah, so like the traditional IRA, the contributions are based off of earned income. So again, that does not count real estate state income, any interest, income like that, but earned income. And as far as the limits go, if you’re below 50, [inaudible 00:03:20] 6,000. Anyone above 50 can do 1,000 catch-up, which gives you a 7,000 total. And just to again reiterate some mistakes we’ve seen where you can only contribute 7,000 between the two of you. You can’t contribute 7,000 each. Okay, so 7,000 total.


John: And something that some people aren’t aware of is that even if, let’s say one spouse is not working and is staying home for whatever reason. They are eligible to make a spousal contribution to an IRA, whether that’s Roth or traditional, which is a nice feature because that does come up quite a bit. So to talk about the contributions of a Roth, we gave the example of traditional IRA as far as making a pre tax contribution. As Nick mentioned, the Roth is after tax dollars. So example of that, 100,000 of income for somebody, they make a $5,000 contribution to a Roth, their taxable income stays at 100,000 in that given year. So there’s no tax benefit up front with the Roth IRA versus a traditional IRA, you could have a tax savings up front when you make the contribution if it’s deductible.


Nick: So from an eligibility standpoint, for a single person, somebody that makes under 122,000 can make a full contribution. If their income is between 122,000 and 137,000, there is a partial that can be made. If their income is over 137,000, they are not able to make a contribution to a Roth IRA. For married filing jointly, if their income is below 193,000, they can make contributions for both of them and their spouse. If the income is between 193 and 203,000, it’s a partial. And if the household or the married filing jointly income is above or greater than 203,000, then they are not eligible to make the contribution.


Speaker 1: Gotcha. Okay. All right, so we’ve covered some of the contributions, some of the eligibility you mentioned already in the tax deferred growth part. What about access? Did we cover some things there?


John: So one thing the eligibility and it’s becoming more popular now with Roth 401k. So if you’re not eligible to make a Roth IRA contribution, one thing to do is check with your employer and see if they offer a Roth 401k, which actually has no income limits for you to be able to participate in it, which is a nice [inaudible 00:05:37]


Speaker 1: Okay, that’s good to know. Yeah, absolutely. All right, that’s a Roth 401k. Maybe we’ll do another show about that another time. What about the access side, anything there? Is it the same 59 and a half, all that kind of stuff?


John: So rules are fairly similar, where you as far as access getting to the account, there is the 59 and a half rule. And if you do draw early there’s a 10% penalty on your earnings. And I stress earnings on that, because with a Roth IRA and I say this, consult with your tax preparer, tax advisor, we don’t give tax advice. But with a Roth IRA, you can actually access what we call cost basis prior to 59 and a half without any penalty. I’ve seen a couple of people do it where basically let’s say if you’ve put in 30,000 into your Roth in your account at 50. So 20,000 earnings, 30,000 is what you’ve put in, which is considered your cost basis. You can pull that 30,000 out without paying a penalty. It’s just you have to keep very good records of your contribution amounts. And if you do pull it out, you have to work with your tax preparer to go ahead and let the IRS know that you pulled out a portion of your tax basis. And that’s would avoid any type of a penalty on that.


Speaker 1: All right, so we’ve covered several things on the Roth side, so the access, the eligibility, contributions, all that good kind of stuff. So let’s just get into the fact that it’s been hugely popular. It’s been a very hot button issue for the last really couple of years. Obviously one of the reasons, we mentioned earlier that it’s tax deferred. Really, the taxes are low, right? We’re in a historically low tax rate. So one of the reasons that a Roth might be a good place to go, or a Roth conversion I guess I should say, is because of the tax thing. So what are some other reasons why the Roth is just really popular?


Nick: You pointed to one of the biggest reasons from the standpoint of we are in historical low tax brackets. And one of the things that we talk about with clients and it really became evident towards the end of 2019 is, the thing that might be the quote unquote best strategy today, it may not be the best strategy five years down the road, 10 years down the road. So for most of the clients that we meet with, they’re substantially overweight on pre-tax money and maybe only recently have started to build up Roth money. And we think it’s really important to have balance and to have options in retirement. Your ability to be able to pivot and adjust to law changes, rule changes, market conditions, etc. are really important. And then part of that is not having to be forced to take out a required minimum distribution on a Roth helps you maintain that balance and maintain the nest egg, those tax free [inaudible 00:08:18] roles help give you flexibility and balance, the ability to be able to pass on funds to beneficiaries, Roth dollars.


Nick: Especially if you have… Maybe your kids are high-income, you’ve done a good job planning. We go through the numbers, we built the plan and there’s a pretty high probability that you’re going to be passing on money to the kids. The rub, money is usually much better to plan or to pass down, because of the fact that it will be tax-free to them as well. So the ability to really create flexibility in your planning and strategies is one of the reasons that we think the Roths are a really important piece of the pie.


John: Just to jump in. One thing, just backtracking to accessing it tax-free. Just a couple of rules with it is you have to be above 59 and a half. And you actually have to have had a Roth IRA account for at least five years. So an example would be, let’s say I open one up at age 60. I’m above 59 and a half. The person cannot actually withdraw tax free until basically 65. So I have to wait five years and that’s from the first Roth I ever started up. So one thing that we typically will work with clients is if they’re eligible, we might just go ahead and start a Roth IRA just to start that five year window.


Speaker 1: Okay. All right. That’s good. Yeah. Good information to know on that. Now with the beneficiary thing and passing things along, is the change in the SECURE act, does that make a difference in the Roth as well? Is there anything there that would pertain to people if they’re thinking about it that they should definitely be checking with you guys on before doing a conversion or something like that?


John: Yeah, so I believe we’re doing a four part session to this. We’re going to talk about conversions, but yeah, that makes conversions a little more appealing where you have to pull the money out over a 10 year period now. Where basically at least if you have to pull it over 10 years, there’s actually no tax hit. So as your IRA gets bigger, if you’re pulling out of a $1 million IRA over a 10 year period, that’s going to really affect your tax rate. If it was all Roth money, it would have no bearing on your taxes.


Speaker 1: Gotcha. Okay. All right. Yeah, and we are going to continue on with this conversation on a future podcast about which one might be right for you and all those good kinds of things. Nick, anything else that we may have overlooked in there we need to throw in?


Nick: No, I just can’t really say it enough from the standpoint of building in flexibility is key. Most of the people that listen to the podcasts are going to have pretax money, but if they don’t have any Roth money then just getting started can be really important to build that up. Because even if they’re within a few years of retirement, just remember that we’re still planning for 30, 40 years down the road. Having money that compounds over a long period of time and then has tax free withdrawals on the backside is a pretty significant leverage point and benefit.


Speaker 1: Okay, one final question I’m going to ask you guys is you sometimes hear people say, if I’m still working, can I contribute or should I contribute to both kinds, the traditional or the Roth? What do you say when someone asks that type of question? Should someone do both the traditional for the tax reasons and then the Roth for the non-tax? What’s your answer?


John: We’ll answer that in the next session.


Speaker 1: Nicely done. Look at him teeing that up. There you go, folks. All right, I’ll tell you what. We will take care of that on the next session and that way you have a reason to come back. A cliffhanger if you will. So if you’ve got questions about the Roth IRA, make sure you talk with your advisor about that. If you’re not working with an advisor, you certainly should be. Reach out to John and Nick and give them a call at PFG Private Wealth. And you can reach them at 813-286-7776. That’s the number to dial. 813-286-7776 here in the Tampa Bay area or go to their website, check them out online at pfgprivatewealth.com. That is pfgprivatewealth.com. Don’t forget to subscribe to the podcast so you can get those next episodes as they come out. Nick, John, thanks for your time this week.


Speaker 1: I hope everybody has a great week and you guys enjoy yourself and continue to get some good sleep while that baby’s resting, all right?


John: Hopefully it continues. I think it will.


Speaker 1: Yeah, there you go. Nick, appreciate your time, buddy. Take care.


Nick: Thanks. Have a good one.


Speaker 1: We’ll see you next time here on Retirement Planning Redefined with the guys from PFG Private Wealth, John and Nick.

 

 

 

 

 

Ep 14: Traditional IRA 101

On This Episode

We cover the basics on the traditional IRA. John and Nick will break down what this investment vehicle is for and how it may be able to benefit you.

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Disclaimer:

PFG Private Wealth Management, LLC is an SEC Registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. The topics and information discussed during this podcast are not intended to provide tax or legal advice. Investments involve risk, and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed on this podcast. Past performance is not indicative of future performance. Insurance products and services are offered and sold through individually licensed and appointed insurance agents.

Here is a transcript of today’s episode:

Speaker 1: Hey everybody, welcome into this edition of Retirement Planning Redefined with John and Nick here with me, talking about investing finance and retirement. From their office, their PFG Private Wealth in Tampa Bay guys, what’s going on? How are you this week, John?


John: I’m good. How are you doing?


Speaker 1: I’m hanging in there. Amidst the goofiness of the world, I’m doing all right. How about you, Nick? You doing okay?


Nick: Yep, yep. Pretty good. We finished up the retirement classes that we teach recently, so just meeting with a lot of people after that class.


Speaker 1: Okay. Those went pretty well?


Nick: Yeah. Yeah, always good. Always fun.


Speaker 1: Okay, well, very good. Listen, I got a little bit of a kind of a class idea for us to run through here. I wanted to talk this week about IRAs, really just an IRA 101, if you will, and then we’ll follow it up with our next podcast coming up after this one. We’ll follow up with the Roth side of the coin. Let’s jump into here just a little bit and talk about this and get rocking and rolling. Just do us a favor. Just assume that we don’t all have the same knowledge base. What is an IRA? Give us just a quick 101 on that.


John: So yeah, good question. Especially with a tax season coming up, because I know a lot of people when they’re doing their taxes, and whether it’s TurboTax or working with an accountant, at the end of it it says you might want contribute to an IRA and maybe save some taxes this year. Or maybe get [inaudible 00:01:22] taxable income down the road. But you brought this topic up. So when I raise an individual retirement account on the personal side, a lot of people have their employer sponsored plans, but the IRA is for the individual. Really, there’s a lot of tax benefits to it to provide for saving for retirement. One of the biggest questions that Nick and I get, or I guess assumptions, is that most people think an IRA is an actual investment, and it’s really not. I explain it as imagine a tax shell, a tax shell you can invest in a lot of different things, and you have some tax benefits within the shell.


Speaker 1: Okay. So it’s like a turtle shell, if you want to look out that way. It’s a wrapper really, right? So it’s what your Snicker bar comes in. It’s the wrapper. Then inside there you can put all sorts of different stuff. So who can contribute to IRAs?


John: Well, there’s two main types, and Nick will jump into that. But there’s your traditional IRA and then a Roth IRA.


Speaker 1: Okay.


Nick: From the standpoint of how those break down, how those work, we’re going to focus on traditional IRAs today. The number one determination on whether or not you can contribute to an IRA is if there is earned income in the household. So if it’s a single person household, they have to have earned income. That does not include pension income, social security income, rental income. It’s earned income. You receive some sort of wage for doing a job. So that’s the first rule. You can contribute for 2019 and for 2020 essentially, if you’re under 50, you can contribute $6,000. If you’re over 50, you can take part in what’s called a catch-up, which is an additional $1,000 for a total of $7,000.


Nick: So as an example, let say that it’s a two-person household. One person is working, one person is not, and the person that’s working has a least $14,000 of income. Then as long as they satisfy a couple other rules that we’ll talk about, they can make a contribution for themself for the $7,000 and for the spouse for the $7,000. So earned income doesn’t have to be for both people. It has to be for one, and then the amount ties in the amount of earned income.


Speaker 1: Oh, okay.


John: One thing to jump into that, and I’ve seen some people, not our clients, but others, make some mistakes where they think that, we talked about the two different kinds, traditional and Roth, where they think they can make, let’s say, $7,000 into one and $7,000 in the other. It’s actually $7,000 total between the two of them.


Speaker 1: Oh, that’s a good point. Yeah. So, okay, so those are good to know. Whenever you’re talking about just the contribution, the base set up of them. So let’s stick with the traditional IRA and talk about it. What are some key things to think about like as an investment vehicle, as a machine here? These are pre-taxed, right?


Nick: Yeah. When we talk about, and this is where the confusion really sets in for many people, when we talk about traditional IRAs, we really like to have conversations with people to make sure that they understand that there can be both a tax deductible or pretax traditional IRA, and there can be non-deductible traditional IRAs. So the logistics are dependent upon, really, a couple of different things whether or not they’re active in an employer’s plan. Then there are income limits that will determine whether or not somebody can participate in the tax deductible side of a traditional IRA. So that can be a little confusing. We usually have people consult with their tax prepare or and/or their software so that they can fully understand.


Nick: But part of the reason that we bring that up is a real-world scenario is, what [inaudible 00:05:17] this client, worked at a company for 10 years, and she contributed to the 401k on a pretax basis. She left the company, rolled her 401k into a rollover IRA, and she’s no longer working, but her spouse is working and wants to make IRA contributions for them. But he has a plan at work and makes too much money. They might have to do a non-deductible IRA. So usually what we will tell them to do is to open a second IRA, and when they make the contribution, they’re going to account for it on their taxes as they made it. They’re not going to deduct it. So we try not to commingle those dollars together. So a nondeductible IRA, we would like you to be separate from a rollover IRA. Otherwise, they have to keep track of the cost basis and their tax basis on nondeductible proportion commingled, and we’re really just [inaudible 00:06:16] nightmare.


John: Yeah, that’s never fun to try and keep track of and never easy. One thing with with the pretax, just give an example of what that means is, let’s say someone’s taxable income in a given year is $100,000, and doing their taxes, it says, you might want to make a deductible contribution to an IRA. If they were to put $5,000 into the IRA, their taxable income for that given year would be $95,000. So that’s where people look at the pretax as a benefit versus a nondeductible. That same example, $100,000 of income, you put $5,000 into a nondeductible IRA, your taxable income stays at that $100,000.


Speaker 1: Okay. So what are the factors that determine if it’s deductible or not?


Nick: The answer is that it’s fairly complicated. The first factor is, if we talk about an individual, they’re going to look at do you have a plan at work that you’re able to contribute to? So that’s the first test. The second test is an income test. The tricky part with the income test is that there is a test for your income, and then there’s also tests for household income. So usually we revert to the charts and advisors. We work together with the tax preparers to help make sure that we’re in compliance with all of the rules. It should be much less complicated than it actually is. But it’s really, honestly, a pain. I will say that if you do not have a plan at work that you can contribute to, your ability to contribute in [inaudible 00:07:56] to an IRA, a traditional IRA is much easier.


Speaker 1: Okay. Gotcha. All right. So if that’s some of the determining factors in there, what are some other important things for us to take away from a traditional IRA standpoint?


John: Yeah, one of the biggest benefits to investing in an IRA versus, let’s say, outside of it, is and if the account grows tax-deferred. So let’s say you had money outside of an IRA and you get some growth on it, I say typically, because nothing’s ever absolute. But you can really get it [inaudible 00:08:28] every single year and the gains and the dividends and things like that. Within the IRA shell, going back to that, it just continues to grow tax-deferred. So really help the compounding growth of it.


Speaker 1: Okay. So when we’re talking about some of these important pieces and the different things with the traditional, what are some other, I know a lot of times we know that it’s the 59 and a half, right? All that kind of stuff. Give us some other things to think about just so that we’re aware of the gist of it. Now, there was some changes to the Secure Act, which also makes them some of these numbers a little bit different now. The 59 and a half is still there, but now it’s gone from 70 and a half to 72, right?


John: Yeah. With good things like tax deferral and pre-tax, we do have some nice rules that the IRS/government basically hands down to us. One of them is as far as access to the account, you cannot fully access the account without any penalties until 59 and a half. After you’re 59 and a half, you do get access to your account. If you access it before that, there is a 10% penalty on top of a whatever you draw. So that’s basically deter to pull out early. There are some special circumstances as far as pulling out before 59 and a half, which could be any type of hardships financially, health wise, and also first time home purchases. We get that quite a bit sometimes where people say, I’m looking to buy a house and I want to go ahead and pull out of my IRA. Can I do so and avoid the penalty? The answer is yes, up to $10,000.


John: Some of the changes with the Secure Act where they used to be after 70 and a half, you can no longer contribute to an IRA, even if you have earned income. That’s actually gone, which is a nice feature when we’re doing planning for clients above 70 and a half, where we can now make a deductible contribution to an IRA, where before we couldn’t. Nick’s the expert in RMD, so he can jump in and take that.


Nick: One of the biggest things to keep in mind from the standpoint of traditional IRAs are that they do have required minimum distributions. The good thing is that those required minimum distributions are now required at age 72 versus 70 and a half. So that makes things a little bit easier for people. And again, that’s kind of a big differentiator from the standpoint of a Roth IRA does not have an RMD, a traditional IRA does have an RMD.


Speaker 1: Right, and with the RMDs, it’s money that basically the government says, we’re tired of waiting. Where’s our tax revenue? Is there any basic things there just to think about when we’re thinking about having to pull this out? Is there a figure attached to it?


Nick: I would say we try to give people an idea, because sometimes there’s uncertainty on any sort of concept of how much they have to take out. But on average it’s about 3.6% in the first year. I would say though, that probably one of the biggest, or I should say one of the most misunderstood portions about it are that the RMD amount that has to come out, it’s based on the prior years and balance of all of the pretax accounts. So you may have multiple accounts, you don’t have to take an RMD out of each account. You just need to make sure that you take out the amount that is due, and you have the ability to be able to pick which account you want to take that out of, which really, at first thought that can seem more complicated. But if you’re working with somebody it helps increase the ability to strategize and ladder your investments and use a bucket strategy where you can use short-term, mid-term, long-term strategies on your money, and have a little bit more flexibility on which account you’re going to take money out of when.


John: To jump on that, we went through that paycheck series when we talked about having a long-term bucket, and in some strategies that’s where by being able to choose what IRA you draw from, you can just let that long-term bucket just continue to build up and not worrying about pulling out of it.


Speaker 1: Gotcha. Okay. All right. So that gives us a good rundown, I think, through the traditional side of it, and gives us some basic class, if you will, on what these are. Of course, as the guys mentioned, they teach classes all the time. So if there’s things you want to learn more about the IRA, the traditional IRA, and how you might be able to be using it or better using it as part of an investment vehicle, then always reach out to the team and have a conversation about that specifically. Because again, we just covered some basics and general things that apply to just about everybody here. But when you want to see how it works for your situation specifically, you always have to have those conversations one-on-one. So reach out to them, let them know if you want to chat about the traditional IRA, or how you can better use the vehicle, or change, or whatever it is that you’re looking to do.


Speaker 1: (813) 286-7776 is the number you call to have a conversation with them. You simply let them know that you want to come in. They’ll get you scheduled and set up for a time that works well for you. That’s (813) 286-7776. They are financial advisors at PFG Private Wealth in the Tampa Bay area. Make sure you subscribe to the podcast on Apple, Google, Spotify, iHeart, Stitcher, whatever platform of choice you like to use. You can simply download the app onto your smartphone and search Retirement Planning Redefined on the app for the podcast. Or you could just simply go to their website at pfgprivatewealth.com. That’s pfgprivatewealth.com. Guys, thanks for spending a few minutes with me this week talking about IRAs. So let’s, next podcast, talk about the Roth side. We’ll flip over to the cousins, okay?


John: One more thing I want to mention before we go is withdrawing from the accounts of, let’s say someone goes to retire above 59 and a half, and it’s time to really start using this money as income. So it’s just important to understand that whatever amount that you withdraw out of the IRA, assuming everything was pre-tax that went into it, it adds to your taxable income. So for example, if someone’s pulling $50,000 out of their IRA, their taxable income goes up by $50,000 in a given year. So we just want to point that out, because as people are putting money into it, we sometimes do get questions of, when I take it out am I actually taxed on this, the answer is yes, if it was pretax put into it.


Speaker 1: Gotcha. Okay. Yeah, great point. Thanks for bringing that up as well. So I appreciate that. And again, folks, the nice thing about a podcast is you can always pause it, and you can always rewind it, replay it. If you’re learning, trying to learn something useful, or get a new nugget of information here, that’s a great thing about it. That’s also why subscribing is fantastic. You can hear new episodes that come out, as well as go back and check on something that you were thinking about, and that way when you come to have that conversation, you can say, listen, I want to understand more about how withdrawals with my traditional IRA is going to affect me, or whatever your question might be. So again, guys, thanks for your time this week. I’ll let you get back to work and we’ll talk again soon.


John: Thanks.


Nick: Thanks.


Speaker 1: We’ll catch you next time here, folks, on the podcast. Again, go subscribe. We’d appreciate it on Retirement Planning Redefined with John and Nick from PFG Private Wealth.