In this episode of Motley Fool Answers, Alison Southwick, Motley Fool personal finance expert Robert Brokamp, and Fool.com contributor Dan Caplinger answer listeners' questions about backdoor Roth taxes, coronavirus-related distributions, asset management fees, and much more.
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This video was recorded on May 26, 2020.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick, and I'm joined, as always, by Robert Brokamp, Personal Finance Expert here at The Motley Fool. Hey, Bro.
Robert Brokamp: Hello!
Southwick: It's the May mailbag, and we're joined by Motley Fool contributor, Dan Caplinger. We're going to answer your questions about backdoor Roth taxes, coronavirus distributions, and what's a reasonable asset management fee with the family discount, all that and more on this week's episode of Motley Fool Answers.
Hey, Dan, is this the first time you've been on Answers?
Dan Caplinger: I think it is, yeah.
Southwick: Wow! Well, welcome. So, longtime Fools might know you from writing on Fool.com, and I know you're also very busy every Wednesday doing the Financial Planning Power Hour on Fool Live. But for everyone else who doesn't know you, why don't you tell us a little bit about yourself. How did you become a Fool?
Caplinger: You bet. I've been with The Motley Fool since 2006. I jumped over, I had been a financial planner for a boutique wealth management firm in Los Angeles that turned out to be too good to be true; that's a story we can take a whole hour on actually, but I won't do that now. And that got me to apply, I'd been on The Motley Fool Discussion Boards for, like, four or five years, and there was an opening in Personal Finance. Long story short, I did the interview, they hired me and now they have successfully managed to hang on to me, haven't managed to get rid of me yet and here I am.
Southwick: And where are you coming to us from?
Caplinger: I am broadcasting from Williamstown, Massachusetts, which is about as far from Boston as you can be and still be in the great Commonwealth.
Southwick: Alright. Wonderful! Well, Dan, thank you so much for joining us and answering our questions today. We're actually going to get started with a question for Bro first, so we'll give you a chance to sit back and watch how Bro does it.
Our first question comes from Kevin. "I manage the finances in our house and keep my wife informed of what I'm doing. Though, most of the time, she really isn't that interested in the details. Recently I dropped two large chunks of cash into the market. Once at the end of February and again mid-March. All of my picks, except one, are currently beating the S&P 500 quite handily. My wife is now worried that COVID may flare up again in the Fall and the market may crash again. She thinks we should take this money out of the market to be safe and have extra cash on hand. In her defense, she has not been able to work for the past seven weeks and is worried about what would happen if I lose my job. She works part-time and we save/invest all her income, so it's not needed for our monthly expenses. I feel comfortable with our cash position and am confident that if something did happen, we could weather the storm for several months before we would need to sell anything. I also don't see any signs that my job is in jeopardy, but she's right, in that, you just never know. Any thoughts or advice on how to best handle the situation? I'm not looking to "win the argument," but more, what is best for us as a couple to manage our finances in a way that we are both comfortable with our decisions."
Brokamp: Well, that's a very interesting question. I guess I would start by thinking about whether her concern is due to just a general lack of knowledge, since you indicated that she's not really interested in money matters or whether this is more of an emotional anxiety. It's probably a mix of both, but I'd start by clearly laying out the facts. You know, pointing out that over the long-term the stock market goes up. Since 1928, the S&P 500 has made money in 87% of five-year holding periods, 94% of 10-year holding periods. And even when the market goes down, you don't lose all your money, you still have some money that you can access if you really do need it.
You might also demonstrate that you do have enough cash that if you do lose your job, you have enough cash to live out for several months. If you lose your job, chances are, you'll get severance and/or unemployment benefits, she might be even getting some now, just to give her a little bit more peace of mind that, yeah, you're probably pretty safe.
As I have suggested on previous episodes, I do think it's a good idea that if you can't agree, it might be a good idea to hire a Family Financial Planner as sort of an expert second opinion as sort of kind of like a knowledgeable referee, so that's not really you versus her, but you can get sort of an opinion on this. Just get some overall suggestions on asset allocation, maybe also do a retirement analysis, which I think everyone should do once a decade, get a professional look at that.
I will say that a lot of financial planners are not stock pickers, so this financial planner probably won't be inclined to say this stock is good, this stock is bad, but just find someone who is willing to address the questions that you have.
As for the anxiety part, it's important to acknowledge those concerns and that she could be right. I mean, the market could go down and if it doesn't go down this Fall, it will go down again at some point, so she does have to get to a point where she's comfortable. So, I would just ask her, how much cash do we need for you to feel comfortable or how many months of expenses do you feel like we need to set aside to be safe for you to feel comfortable, because that bear market will come again, there will be a big drop. And you know, her number might be different than your number, but you might have to just compromise on that at least a little bit.
Southwick: Alright. Next question comes from Levi. "My Schwab account says I can contribute to my Roth IRA for 2019 and 2020. Are there any drawbacks to putting money into 2020, when I max out 2019?"
Caplinger: You know, Levi, I think it's a great idea to be thinking about getting as much retirement money into your IRA account as you can. And you have an opportunity this year that you don't usually have to get money in, both, for the 2019 tax year and for the 2020 tax year longer into 2020 than usual. In most years, it would be too late by now to get money in for the 2019 tax year, because usually you're looking at the April 15th tax deadline. This year, with all the coronavirus madness, they've extended the deadline to July 15th.
So, for those of you who haven't done IRA contributions for 2019, you do still have some time. But there's no downside that I can think of to putting money in for 2020 early. I always advocate people try to do their retirement contributions as soon as they can, mostly so they don't forget about it. The only thing just to be careful about is when you're talking about a Roth IRA, there are income limitations. And so, if you have income, if you know what your income is going to be in general in 2020 and you know that you're under the income contribution limits then there's no reason to wait. But if your income is uncertain, you might be over those income limits, then it might make sense to wait longer, make sure that you'll be actually eligible to contribute to a Roth IRA and then make the contribution. That's the only thing I could think of as to why you would wait, otherwise doubling up and getting current, both, for 2019 and 2020 makes a lot of sense to me.
Southwick: Alright. Next question comes from Jason. I recently heard about the backdoor Roth IRA and I thought it sounded easy, however, I earn a six-figure salary, participate in a 403(b) and have a rollover IRA. After depositing $6,000 into a nondeductible traditional IRA, I was told by Fidelity that the pro rata rule would take effect due to the rollover IRA and I would pay taxes again on the $6,000 when I convert it to a Roth IRA. Part of me is still skeptical, but afraid the Fidelity rep is right, is he?
Brokamp: Well, as Dan pointed out, there are income limitations on whether you can contribute to a Roth IRA. So, for 2020, your ability to contribute to a Roth IRA starts to phase out with a modified adjusted gross income of $124,000 if you're single and $196,000 if you're married. If you earn more than that, you can do something called the backdoor Roth IRA.
Now, it's kind of a nickname, like, you won't go to IRS.gov and find backdoor Roth IRA. Basically, it's just a conversion. You can contribute to a nondeductible traditional IRA, very quickly do the conversion and you won't pay any taxes on that if you don't have any other traditional IRA assets. If you do, and that sounds to be the case here, then it gets more complicated.
So, I'm going to explain this pro rata rule using an example. So, Jason says he has a rollover IRA and he contributed $6,000. Let's say, his rollover IRA was worth $25,000. You add the $25,000 to the $6,000, you get $31,000, and then he converts the $6,000. Well, $6,000 is 19.4% of the total. So, 19.4% of the conversion is going to be tax free, the rest of it is going to be taxable. So, the Fidelity rep is partially right.
Now, there is a way around this, by rolling over that IRA into his employer plan, which is a 403(b), if he's allowed to do that. Then he doesn't have any traditional IRA assets and he doesn't have to worry about this. The problem with that is, first of all, the 403(b) has to allow it, and secondly, a lot of 403(b) stink, so it may not be worth throwing that money in there just to avoid those taxes.
So, the bottom-line is, if you do the $6,000 conversion or you can do $3,000 or you can do $20,000, most of it will be taxable, some of it won't be. But we're at historically low tax rates, once you do the conversion that money will grow tax free and your future retired self will be very happy to have that money.
Southwick: So, maybe still worth it?
Brokamp: Still might be worth it.
Southwick: Alright. Next question comes from Paul. I'm over 70.5 and took my RMD [Required Minimum Distribution] early in the year when the market was up, now the CARES Act says, I don't have to take an RMD this year. Could I take that RMD money and put it into a Roth IRA? If so, is there a limit? If so, can I transfer it in as stock? And sorry, RMD, Required Minimum Distribution; for those who don't know.
Caplinger: So, it's funny because, you know, once again procrastinators win. There are so many times, I can't tell you how many times I was in school and, like, they told me that there was an assignment due next week and then something happened and they ended up cancelling the assignment. All these people who did it early, they ended up, you know, having to do the assignment for nothing, I'm meanwhile didn't do it, I'm living large. And this is another situation, Paul, you know, "I didn't do an RMD, I've got an inherited IRA. I didn't do my RMD yet, I'm getting rewarded. You took your RMD early, you're getting punished." And so, the quick answer, the technical answer is, you cannot put back a Required Minimum Distribution.
But that's not the answer that you want and the way that we are thinking about it this year is, can you get that money back in? Even if you thought it was a Required Minimum Distribution, is there some other way that we can justify it to get the money back in? And all of the IRA experts around, I looked at Ed Slott, I looked at Michael Kitces. All the folks are looking at ways to try to get you in.
And there's basically several things that you might be able to do. One is, if you have been, if you take the money less than 60 days ago, then you can use the 60-day rollover rule to get that money back into an IRA. So, the thing about the 60-day rollover rule is that you're only allowed to do one of those rollovers in any 12-month period. So, if you've done one in the past 12 months then you're not going to be able to use that provision in order to get that RMD money back into your retirement account.
The second thing you can do is rely on one piece of legislation that said that if you took your Required Minimum Distribution on February 1st or later then you have an extended rollover deadline until July 15th. Ordinarily, you'd have to get that money back into an IRA in 60 days, but with this new rule, you have until July 15th to do it. Again, subject to the one rollover per year rule, but it's still available to you.
The third thing that people are talking about is what's called the CARES Act. That's basically the Coronavirus Stimulus Bill that provided all of these new ways for people to get financial support. It allowed people to make distributions to take withdrawals from retirement accounts, IRAs, like 401(k)s, up to $100,000 without penalty as long as their plans allowed it, or from their IRAs.
In order to qualify for that, you either have to be able to demonstrate that you suffer from COVID-19 or that you suffered financial hardship because of the pandemic. Now, if that's the case, then you're allowed to take that money out and you have up to three years to redeposit it. And so, if you qualify for that assistance, then you might be able to do it even if you took that Required Minimum Distribution, like, the first week of 2020, where all these other rules aren't going to help.
Now, in terms of whether you put back in stock or cash, the general rule for rollovers is that you need to put in whatever you took out. So, if you took cash out as your RMD, you should put the cash back in. If you took out stock, then you can put the stock back in. But the idea is, it should be the same money or property that you received in the distribution. If you meet those rules then you'll be able, basically, to get yourself back to the position you would have been in if you've just been a good procrastinator like me and not taken that RMD in the first place.
Southwick: You're instilling a lot of confidence here, Dan. Your answer was thorough, but the procrastination may have put people off in the beginning, huh!
Caplinger: Oh, really?
Southwick: [laughs] The next question comes from Devoted Listener, Aw! "I just got off the phone with my cousin, who works as a financial advisor. He made a soft pitch for his company to manage my retirement portfolio. They said there was a family discount where the fees structure is only 0.4% annually. That sparked some questions. One, ... " first question, " ... is 0.4% a good deal?"
Brokamp: So, the answer to the first question is, generally, probably, yes. The average assets under management fee is 1% a year. So, if he's really charging only 0.4%, that's good. I would ask what other services are involved with that, because most people who are charging 1% also provide some financial planning services, retirement planning, college planning, do you have enough insurance, things like that. So, if you're not getting any of that then 0.4% is less of a good deal.
Southwick: Question No. 2. "Am I also paying for each individual trade the portfolio manager makes?"
Brokamp: Generally speaking, no, but you definitely want to ask to make sure.
Southwick: And question three. "Are there other fees I'm not aware of?"
Brokamp: Again, a good question to ask, but one example might be that your cousin's firm puts you in mutual funds or ETFs, you will pay the expense ratios, the expenses on those funds on top of the 0.4%. And if there are any, sort of, upfront commissions on any funds or anything like that, you'll probably also pay those fees, but ask to make sure.
Southwick: And last question. "Does this also apply to index funds? An S&P 500 index may have an expense ratio less than 0.5%, but does an owner of said fund also pay the trades necessary to add/remove companies from that basket of stocks?"
Brokamp: So, most of the fees that are charged by fund are captured by the expense ratio and you can just look that up on Morningstar or any sheet that, you know, like, with your 401(k), every fund in your 401(k) has a sheet that has an expense ratio. However, one expense that is not captured by expense ratio is commissions to buy and sell the investments. Fortunately, those expenses these days are either very, very low or nonexistent. However, if you are investing in a fund that is trading bonds or options or maybe really small illiquid stocks, those might have commissions and you won't know how much you're paying for those just from the expense ratio, you actually have to dig into all the boring financial paperwork of the fund to find that out. But for most situations it's going to be pretty low.
And I'll just say one final thought here for our devoted listener is, before you do this, you have to question whether it's smart to mix money with family. If you trust this person then you might feel like this is the person I trust, they're going to take extra special care of me, I should do this. However, if it doesn't go well, that could be very problematic for the relationship. So, just one other thing to think about before you make a decision.
Southwick: Yeah, think about Thanksgiving.
Brokamp: [laughs] Yeah, exactly.
Southwick: Alright. Next question comes from Andy. "I have two one-ounce gold coins, what is the best way to sell them?"
Caplinger: So, there's a couple of ways that I recommend using when you've got a gold coin that you're looking to sell. The first is just your neighborhood coin dealer. Even small towns, my small town has got one, any big cities going to have many different dealers. They'll be able -- generally, as long as the gold coin is one that is generally recognized as a common one, say, an American Eagle, a Canadian Maple Leaf, a couple of other common one, you know, Krugerrands from South Africa, a coin dealer is going to be able to give you a price that's very close to whatever the spot price of gold is on that particular day.
Now, you are generally going to have to accept slightly less than the spot price, that is what the coin dealer takes, basically it's their commission for doing business. If you went into that same coin dealer and wanted to buy a gold coin, that dealer would charge you more for it and that difference is basically giving that coin dealer the money that they need to operate their business.
The other way that I've seen people do sell their gold coins is on eBay and that used to be a really good way of doing things back when eBay's commission rates were really low. I mean, sometimes you could do a sale and pay auction fees of just, like, 1% to 2%, but those eBay fees have gone way up. And so, often what that means is that you can get a better price from the coin dealer than you would get on eBay after paying whatever the fees are. So, you can take a look at eBay and see what the current rates are right now, but if you do have a coin dealer nearby, it's worth giving them a call just to get a sense, compare that with what the spot price of gold is, if it's pretty close then you're probably get a good deal, it's an easy way to sell it without any hassle of having to ship things or anything like that.
Southwick: Alright. Next question comes from Marlene. "I work for the Federal government and max out my contributions, including the catch up to the Thrift Savings Plan. What are your thoughts on it and how would you recommend investing in it? I was speaking to a friend last night and she said she was worried that the government could run out of money and we would lose our investments. Should I be concerned?"
Brokamp: So, there's really two questions here. One question just about the TSP and then the other question is about, should people be concerned about somehow the financial solvency of your employer affecting your 401(k). So, let's go with the TSP. They are savings plans, great, great plans, extraordinarily low cost, I wish the government would make it available to everybody. It's a boring plan. It's all index funds, very simple, but I think for the vast majority of people it would be a great option. There's so many people in this country who don't have an employer-based plan. And that's, like, one of the No. 1 predictors of whether you'll save for retirement; whether you have an employer-based plan. So, if they open this up to everyone, I think that would be a great idea.
One quirky thing about the TSP is that it is overall looked over by political appointees, so it's been in the news recently because for their international fund they're thinking of changing the index from the EAFE [Europe, Australasia and Far East] or the EFA which is basically developed international companies, not emerging markets, to another index which was allocated 11% to China, then the Trump administration said, no, we don't want any money going into China. So, they appointed new people to the five-person advisory board who are then trying to block changing, because they don't want any of this money going into China.
So, that's one sort of unique aspect to the TSP is that it could be subject to some political whims. But the TSP, and like every other employer-sponsored plan, the money goes from your paycheck to your employer, you know, the employer takes the money from you and then sends it to some trustee. Your money is put in trust, it's a whole other account that the employer can't touch. It is protected from them. And if the Federal government goes under or if you don't work for the Federal government, your employer goes under, your assets are safe.
That said, if the Federal government has that much trouble, first of all, we're all in a lot of trouble. But secondly, you probably have some investments in the Federal government, just looking at the TSP, there are two bond funds that invest in treasuries, so those would probably go down. So, I don't think you have to worry too much about your employer, whether you work for the government or not, going under and taking your money. The one thing that is an issue is that when some employers experience financial difficulties, they take the money from your paycheck and they wait until the very last moment to send it to the 401(k) and there have been instances where employers have held onto the money too long, then they go under and that money didn't make it to the 401(k). So, that is something to look at if your employer is really, really cash strapped.
Caplinger: And let me just add to that. I just have to double down on the TSP being one of the best plans that's available. The expense ratios on the fund options that they have, it's really hard to match. And so, yeah, the political suggestions that I've heard about letting people get access to the TSP who don't otherwise have access to a retirement plan, would do a lot to help people who traditionally have gotten left behind in their retirement savings, would give them just an exceptional vehicle to get back on track and get themselves financially secured for their retirement.
Brokamp: Yeah, the final fact is the TSP is the world's largest defined contribution plan, the biggest retirement plan in the world.
Southwick: Next question comes from, we lost the name, so sorry about that. "I'm selling a home which was in a life estate. The life tenant has died. There are five remainder men with various percentages. I understand there's a stepped-up basis and the property will be sold at fair market value. How do I account for no capital gains when I have to file with the IRS? What forms do I need for filing? I will soon get a check for my percentage and a 1099. I have absolutely no idea what anything meant in that email; I am out of my element."
Caplinger: So, life estates are really cool. And this goes back, I just want to thank Professor Johanson in my estate planning class in law school, because this is a throwback to the 18th century. It used to be that you would have real estate that a person would have the right to live in the house just for their lifetime, and after they died it would revert to somebody else. And so when they talked about this, the life estate was what that first person had a property interest to, it let them live in the house through the rest of their lives but it didn't let them sell the entire house because they didn't really own it, they only had the right to use it during their lifetime.
And so, who gets the house after that person dies? It's called the remainder interest. And so, in this case, our listener has five folks who are named to get the house after this person passes away. And so, the question becomes, OK, when that person does pass away, how do you deal with the house? When you've got five people, the usual way that you deal with the house is you sell the thing because otherwise you got five people trying to figure out how to live in the house and how are you going to do that?
The fortunate thing for that is that there is generally not a big tax hit when that property gets sold. And that's because the property gets a stepped-up basis at the death of the life tenant. It's the same way as someone who owns a house outright. If you inherit a house from somebody and that person passes away, they own the house when they die, they get a stepped-up basis. The rule is the same for life estates. And so, the remaining interest folks shouldn't have a big tax bill.
Now, how are they going to establish that, usually what you would do is you would get an appraisal of the home, technically as of the exact date of death of the person who passed away holding that life interest, and then you would compare it to whatever the sale price was when you actually sold the house.
Now, in this case, it sounds like they've already sold the house. I don't know how long there was between the date of death and the date of the sale. If they were pretty close, then the odds are good that the value didn't really change all that much. And so, in general, you can probably just report the tax basis compared to the 1099 that's going to show you what the sale proceeds were, and establish yourself with the zero gain or a minimal gain. But if you want to cross your t's and dot your i's, technically it would be a formal appraisal of the home as of the date of death to establish that basis that you would put on your tax return. And you wouldn't need any other forms than that, you would just report it as a capital gain or loss on Schedule D of your 1040, the same way you would on a sale of stocks or other investments.
Southwick: Thank you, Dan. Now, I know 100% more than I did when this question started. Alright, next one.
Brokamp: I think, Dan, you left out of your bio that you actually were a lawyer at one point, weren't you?
Caplinger: You're right. Yeah, I practiced as a lawyer for a few years. The big firm life did not agree with me, but I still remember that stuff. And I have to say, Stanley Johanson's estate planning class was one of my favorite ones in law school. So, Stan, I hope you're out there listening to this.
Southwick: Alright. Next question comes from Lucas. "I've been a Motley Fool member for a few years now and I've really enjoyed taking control of my family's finances, which The Fool has empowered me to do." Oh, yay! "Previously, most of my investments were with a financial advisor. When I started investing, I did so in my non-qualified brokerage account, which now has a number of The Fool's recommended holdings and a substantial amount of gains. My Roth IRA is a mix of mutual funds recommended by the previous advisor. Naturally, my non-qualified account, guided by what I've learned from The Fool, is outperforming the funds selected by the advisor." Well, that's nice to hear.
"Now that I am self-managing my Roth IRA, what should I do? Should I move out of those funds slowly and try to fill the IRA with new companies I want to invest in? Should I trim down the holdings in the non-qualified account and rebuy in the IRA, which would probably hammer me on taxes? Or should I spread my holdings in a particular company across both accounts?"
Brokamp: Well, Lucas, good for you for taking control of your finances. That's excellent. You used the term "non-qualified account" a few times. I assume you mean just a regular taxable brokerage account, but just so people know, a qualified account technically is an account that's offered by an employer. Many people think that also includes IRAs but that actually is not the case. An IRA is not a qualified account unless it is offered by an employer like a simple IRA or SEP.
So, you said non-qualified account, again, I'm assuming you mean taxable brokerage and not an IRA, but so I just want to put that out there. To answer your question, I certainly wouldn't sell the stocks you've already purchased in your taxable account just to move them to the Roth as long as you still think they're good investments, because you're right, if you have some big gains in them, you'll realize some taxable gains, I would just leave them alone. Instead, I would move money out of the funds, assuming they're not particularly good funds, and use that money to purchase more promising investments, that could be new stocks or new funds that you like better or just more shares of the stocks you already own, but then you'd have some in your Roth and then some in your taxable brokerage account.
Now, when it comes to you deciding, like, alright, I have this investment, I want to buy, should I put it in the taxable brokerage account or should I put it in the Roth? The two things to think about are, the Roth is the account you want to grow the most, that's the account that's going to be tax free. So, you use that account for the investments that you think have the most potential. And then the other consideration, especially if you're farther from retirement, is whether the investment pays a significant dividend or not? If it does, you probably want to keep that in the IRA because otherwise you'll be paying taxes on those dividends each and every year even if you're reinvesting them.
Caplinger: Hey, Bro, there's just one "gotcha" here that I just want to point out. And not every broker does this to their clients, but some of them do. You should check and see if the mutual funds that your broker sold you have what's called backend loads or deferred sales charges. Some mutual funds, they are set up so that you don't have to pay a sales fee when you buy them, but if you sell them within a certain number of years, it can be anywhere from, like, five to seven years, if you sell them then the broker claws back a percentage of your investment. And it generally goes down over time. So, if you buy the fund and then you sell the fund, like, the next day, you'll pay a high fee, if you wait, like, three or four years, it's less. If you wait five or six years, then maybe it goes away. But it is something to take a look at and you might be able to save some money in fees just by waiting until when the anniversary is. Even if you have one of these backend loan funds, waiting just a few days or weeks sometimes can get you down to the next lower tier, it avoids you having to pay an exit fee to get out of what's been an investment that you don't want to be in anymore.
Southwick: Next question comes from Derek. "I am currently a junior in college at Clemson University. I have a retail brokerage account that I have some stock in, about $3,000 dollars. Looking at the tax rate schedules, the long-term capital gains tax for people with a taxable income of under $39,375 is 0%. That being said, at the end of the year, would it be smart to sell off all of my long-term capital gains in order to lock in the 0% tax before I get a full-time job next year? Assuming my salary is $40,000 or more, could I immediately buy the stock back or would there be wash-sale rules even though it's a gain?"
Caplinger: So, Derek, I think it's awesome that you are investing in stock as a junior in college, I think that is a great deal. And unfortunately, though, the answer for you is a little bit different or maybe a little bit different than it is for somebody my age or Bro's age or Alison's age, because of a special provision in the tax code. Now, in general, tax gain harvesting is a really great idea and too few people do it, because you're right, there is that 0% bracket where if you have long-term capital gains and your income is below a certain amount, then you don't have to pay taxes on those gains. And if you are qualified for this, you can sell that stock, you can turn right around and buy it back, you can wait a day, you can do it the next hour, there is no wash-sale rule that prevents you from taking those gains, because IRS loves it when you take gains, even when it's a 0% rate, they still like that.
If you were trying to get benefits from capital losses, you're right, there would be a wash-sale rule, you'd have to wait 30 days before you can buy the stock back, but that does not apply here.
Now, the wildcard that applies to you as a college junior is what's called the kiddie tax rules. And this refers to basically a rule that the IRS has set up that prevents parents from putting investments in their kids' name and having the lower tax rates that apply to the kids cover what in essence is really the parents' money. And so, they set these rules up that basically say, once you get over a certain minimal amount of capital gains or any kind of investment income whether it's dividends or interest, once you get over a certain amount of unearned income then that money is going to get taxed at the rate that the parents would pay, not the rate that the kids would pay. So, the question you need to ask here, and it's a question that, you know, you're going to have to get your parents on board with this too.
The first question is, how much do you have in gains? You say, you have about $3,000 in stock. I assume not all of that's capital gains, but I don't know what the amount is. In general, if you're looking at more than, I think, it's $1,100 this year, then you may have an issue. You at least have to take a look at it and see, you may still be able to get some of those gains at the 0% rate even if the kiddie tax does apply, but above that certain amount, you might end up having to pay tax at your parents' rate. So, it's something to pay attention to, but in general, the idea is a smart one. And you're right, if you're going to be working and have regular earned income and be in a higher tax bracket, best to get those gains taken care of right now.
Southwick: Our next question comes from Neil. "In a previous episode, Bro said that in retirement you should take money out of taxable accounts before retirement accounts to allow the money to continue to grow on a tax advantage basis. I understand the concept, but recently, as I unfortunately inherited a few different accounts, I wonder if that is a good plan? When I take money out of an inherited IRA, which is mandated, though, maybe not for 2020, I will have to pay tax on all the principal and the growth, but the assets in the non-retirement accounts I inherited now have a stepped-up basis, so there will be significantly less of a tax liability. Shouldn't people in retirement liquidate the retirement accounts if passing on assets is in their long-term plans?"
Brokamp: Well, Neil, so you did remember correctly that the general rule is to liquidate your taxable accounts first and then your tax advantaged accounts. And that's based on many, many studies, Vanguard, many other folks, TIAA-CREF has done a study on it. But there's actually a lot of nuance to it, particularly, looking at your current tax rate today versus where you think you'll be in the future, whether delaying tapping your traditional IRAs would result in huge Required Minimum Distributions. So, like every rule of thumb, you should dig a little deeper into that.
You are also right that with a retirement account, traditional IRA, once you take that money out, it's all taxable, whereas, and Dan pointed this out earlier, you get a stepped-up cost-basis on your stock. So, if you paid $10,000 for a stock that's now worth $100,000, you pass away, you leave it to your kids, no one pays the taxes on that gain of $90,000. Their cost-basis is now $100,000, they could sell it out all right now and not pay any taxes.
It seems to me like you have a special goal, and that your goal is not necessarily to have your retirement money last as long as possible, your goal is to leave as much money on an after tax basis to the next generation. So, in that situation it does make sense, you may want to drain more of your traditional IRA, that type of money, and leave your stocks in your brokerage account, especially if they have large embedded gains, alone.
The one other thing I'll say, the best account to leave to the next generation is a Roth, because when they get that account, they won't have to pay any taxes on it, it can continue to grow tax free after they inherit it. Like all inherited accounts, you'll have to take a little bit out each year, and those rules were changed over the past year, but still you do get that tax-free growth after you inherit it.
Caplinger: I'd say, the other thing to keep in mind too is what tax rates your heirs are going to pay. If they're in especially high tax brackets, then you're right, inheriting those retirement accounts and having to take those distributions out is going to hit them more than maybe it would hit you if you're in a lower tax bracket then they are. Just keep in mind, you can't really predict what tax rates are going to be like in the future and so you, sort of, have to make an estimate rather than knowing that for certain. But it is something to keep in mind.
Brokamp: Yeah. I would just add that, if really one of your major goals is leaving as much wealth to the next generation as possible, then you certainly should be seeing a qualified estate planning attorney and hopefully someone who also knows a thing or two about taxes as well.
Southwick: Last question comes from Sam. "In a recent mailbag episode, I heard Bro speculate that with a coronavirus-related distribution, it would likely have to be put back into the same retirement account it came from, however, I've read in articles that the money could be put back into any retirement account, what's the latest?"
Brokamp: Yeah. So, Sam, when we first covered the CARES Act which allowed to take you -- and Dan explained this earlier too, you can take money up to $100,000 combined from IRAs and employer plans as long as you have suffered some kind of -- and there's a list of different things; you know, you had COVID-19, you lost your job to COVID-19, there's all kinds of reasons. But these coronavirus related distributions, take the money out.
The way, when I looked at the way the law was written and I read a couple of articles that came out right after, it implied that if you took the money out of one account you pretty much had to put the money back in the same account. Since then, the IRS has published an FAQ, there's been more analysis, some other articles. Now, it looks like that may not be the case. You can take the money out of one account and put it back into another account. What's interesting about that is for some people this could turn out to be a way to get money out of a lousy 401(k) and get it into an IRA.
But to get a second opinion on this, I actually slacked Dan earlier to say, like, "Have you been reading about this, because there hasn't been a lot of coverage on it?" And, Dan, the lawyer, gave me his professional opinion, what did you say, Dan?
Caplinger: Yes. So, you know, I was looking at the FAQ, you were talking about the IRS, and it actually pointed just back to a situation, like, more than 10 years ago when this came up before. Back when hurricane Katrina hit, they actually did a similar provision that allowed people who are affected by that to get money out of their retirement accounts and then they had that same question, how do you put it back in? And when you go through the IRS notice and official documents, there's an example there that actually says, you know, it has somebody taking money out of a 403(b) retirement plan and then putting it back in, instead of putting it into the 403(b), they put it into just a regular traditional IRA. And according to the IRS, that would qualify for getting the money back in, as a result, they wouldn't have to treat that as a permanent distribution, they wouldn't have to pay any taxes on that income, they will be treated as if they had never taken the distribution in the first place. So, that seems to apply here. But again, I've seen the same conflicting articles that, both, Sam and Bro have talked about, and so, there may still be an open question. But, I think, you have at least a defensible argument for treating it that way.
And, yeah, being able to use that as basically an excuse to get yourself out of a bad retirement plan into a good self-directed IRA, that would just be an extra bonus.
Brokamp: Yeah. And I'll just point out a couple of things. So, as we've talked about in the show before. If you take money out of an account, you have up to three years to put it back into an account. And, while this is all allowed by the law, every individual employer has to agree to it. So, even though you can take money out of a 401(k) legally, your plan provider may not have agreed to it, so that might also be a slight speed bump there.
Southwick: Alright. Well, that covers it for the part of the mailbag where people ask us stuff, now we get to move to my part of the mailbag where they tell us stuff instead. So, here we go.
First one comes from Deborah. "Hi, I was just listening to your latest episode. I was shocked to hear a pretty big mistake, the University of California, including UCLA and UC Berkeley, has not made an announcement regarding online classes in the Fall, that was the California State University system, which includes places like San Jose, State University, Cal Poly, San Luis Obispo, Fresno State, etc. Usually I'm a huge fan of your show, but I had to check the facts today." Thanks, Bro, you just lost us Deborah.
Brokamp: I think Deborah will still listen. Thanks, Deborah; I sent her a nice email, so hopefully she'll still listen. But the point was, you know, when we did the whole episode on college after Corona, I had pointed out that the California State University system has pretty much said it's going to cancel in-person Fall classes. The way I read The Wall Street Journal article about it, it implied that Berkeley and UCLA and some of those other University of California schools were also onboard with that, it turns out that that is not the case, so I apologize.
The bottom-line for all of that is, you should check with the individual schools and not with a podcast to find out what your school is planning to do next year.
Southwick: Alright. So, blame The Wall Street Journal is --
Brokamp: -- That's right.
Southwick: It is also our rule from here. Alright. I want to thank Rich, who sent in a photo of him and his son breaking out a board game, and not just any board game but The Motley Fool's board game. So, here's where I kick it to Rick to tell us the story, why is there a Motley Fool board game? I assume you know the story.
Rick Engdahl: Because David and Tom are friends with, and big fans of, a game designer by the name of Reiner Knizia. Reiner has come and spoken at the office a couple of times, and their relationship with him goes way back. They were able to convince him, or license from him, a previous out-of-print game of his and rebrand it and reconstruct it to be The Motley Fool Buy Low Sell High board game, which we kind of put out and barely marketed. And I think you can still find copies on eBay and secondhand stores. I know that there's one floating around our office. I do not have a copy myself, which I'm very bummed about.
Brokamp: When you bought the game, you also got a flyer of every newsletter service we offered and a picture of the advisor. So, I can say that my picture actually came as part of a board game.
Southwick: That's pretty cool.
Engdahl: It's like the poster you used to get with the LP, right. It's like that little folded up poster of sticks that went on the wall. You can open the board game, you get the poster of Bro.
Brokamp: I'm sure it's on many walls.
Southwick: Yeah, he's dreamy. Look at that, just right next to the posters of unicorns and other things like that of girls in love. Okay. Our favorite ballroom dancing instructors, Anthony and Susanna, reached out; they're posting YouTube videos with ballroom dancing lessons. So, you can check them out by going to YouTube and searching for Ballroom Blitz. So, I'll give you something to do there.
Brokamp: David Stone heard our episode where Bro talked about the Berkshire annual meeting and he wrote in to say that quite possibly the most entertaining line ever in a proxy statement was "A number of our directors, including Berkshire's Chairman, are very senior citizens and our board has recognized the need for new directors who meet our standards." They have such a great sense of humor there, don't they?
Alright. So, David Stone heard Bro's repeated pleas for Christmas and holiday traditions and he replied by saying, "Every year, since I was about age eight, we watched my father's favorite Christmas special A Wish for Wings That Work by Berkeley Breathed. I am a huge Bloom County fan and I had no idea this even existed; did you know that?
Brokamp: I didn't either, but the whole thing was on YouTube, he sent the link. I have it on my computer, I'm very busy this week, but this is my incentive. When I get all my work done for this week, I get to sit here and watch this Bloom County Christmas special.
Southwick: I've got the book, like, the children's book, but I didn't know they've made a special of it, so there you go, you can find it on YouTube.
And Jay, who is just next door in Arlington, Virginia sent over a virtual postcard of his birdhouse where he's busy watching his own house wrens build a nest. I was extremely excited to see that email. I am literally watching Kyle and Louise working on there, like, right now out my window I'm seeing Kyle and Louise flit into and out of the birdhouse repeatedly; I'm so excited.
Brokamp: Do you want to explain how you decided on the names of the wren.
Southwick: Kyle and Louise Wren? I think, if our listeners aren't big enough nerds to get it, then it's probably not worth explaining. [laughs] It's probably too embarrassing for me to explain it. So, if you're a nerd, you'll get it, if not, don't worry about it.
Alright. Well, that's the show. Dan, I want to thank you so much for joining us.
Caplinger: Thanks for having me, let's not make this a one-time thing. Invite me back, this is a lot of fun.
Southwick: Oh, I'd love to have you back, please, anytime. I know you and Bro are good friends, so I'll leave it to you to figure out what excuse we need to have you back, but I'm up for it.
Caplinger: Sounds like a plan.
Southwick: Alright. Well, our email is firstname.lastname@example.org. As always, we'll be doing another mailbag at the end of next month, so get us your questions and maybe it'll be Dan answering them again, I don't know, we'll see.
So, yes, our email is email@example.com. The show is edited fleetingly by Rick Engdahl. For Robert Brokamp, I'm Alison Southwick, stay Foolish everybody!