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How tapping home equity can pay the taxes on a Roth IRA conversion

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The benefits of incorporating a Roth IRA into your retirement strategy are often praised by financial advisers, citing the ability for money to grow tax-free for decades and provide tax-free income in retirement. While a Roth IRA conversion is one way to take advantage of this savings tool, the tax implications of converting investments from a traditional retirement account to a Roth IRA typically deter most people. Yet the effects of new legislation and persistent market volatility make a Roth IRA conversion worth considering, and paying for it doesn’t have to break the bank.   

A Roth IRA conversion uses assets from a traditional or rollover IRA, 401(k), SEP or Simple IRA to fund a Roth IRA. Unlike regular contributions to a Roth IRA, which are constrained by income limitations and annual contribution caps, there are no restrictions when converting retirement assets to a Roth IRA. Any amount can be converted regardless of your age, income, or employment status. But the Roth IRA conversion doesn’t come without a cost. 

When you convert pre-tax assets in a traditional retirement account to your Roth IRA, the conversion is treated as income and you must pay taxes on the assets converted. The amount you pay in taxes depends on your income tax bracket for the year. In some cases, a substantial conversion in one year could boost taxable income by multiple brackets. To help manage that liability, a series of partial conversions over several years could be planned to keep the distributions within a targeted tax bracket.

For many retirees, income from a traditional IRA or 401(k) can create a tax headache, especially when required minimum distributions (RMDs) raise their tax bracket. That’s where a Roth IRA comes in.

A Roth IRA provides the flexibility to take tax-free withdrawals in retirement when you want and in whatever amount you want. This is unlike other retirement accounts that have RMDs beginning at age 72. The RMDs are taxable income, which means that in addition to your tax bracket they can also impact your Medicare premium bracket and the taxation of your Social Security benefit, whereas distributions from the Roth IRA will not.  

This year the CARES Act temporarily pauses RMDs from traditional retirement accounts. So, if you are 72 or older and you don’t take your RMD then your income will be lower. This provides a potential opportunity to make a larger conversion while maintaining the same income tax rate. 

Additionally, since the Secure Act of 2020 eliminated the stretch provisions for inherited retirement plans, the Roth IRA is also a great estate planning tool. Non-spousal heirs can no longer take distributions over their life expectancy, but rather all distributions must be taken within 10 years. While this is true as well for an inherited Roth IRA, the distribution would not be a taxable event. 

The cost of an IRA conversion can be daunting, but it doesn’t have to be. Conventional wisdom is to pay the resulting tax bill with non-taxable assets from outside the retirement plan. Using plan assets would defeat the purpose of the conversion as you will permanently give up a portion of the capital that is accumulating on a tax-free basis. In addition, if you’re under age 59 ½, the portion of plan assets used to pay for the conversion could also be subject to a 10% tax penalty. 

If you have the cash on hand, that’s likely the best way to cover the tax implications. But depending on the size of the conversion and your tax bracket, the up-front costs could be significant. Another option is to take out a loan against your life insurance policy. While this permanently reduces the policy value if not repaid, the loan doesn’t count as taxable income so long as the policy isn’t surrendered, doesn’t lapse, and the amount owed doesn’t exceed the premiums paid. If any of these do occur then the tax implications will likely be even larger than the taxes paid on the Roth IRA conversion.

Considering a reverse mortgage

Alternatively, tapping into your home equity can provide the means to pay the taxes. You could leverage current low interest rates and get a home equity line of credit (HELOC), though many banks have stopped accepting applications for HELOCs in recent months. Additionally, a HELOC will require a monthly mortgage payment, decreasing your cash flow.

For homeowners age 62 or older, a reverse mortgage could pay the tax liabilities from the Roth IRA conversion, creating tax and cash-flow flexibility and potentially a higher net worth.

With a reverse mortgage, the available line of credit grows and compounds at a value that is tied to current interest rates. This can be particularly beneficial with a series of partial Roth IRA conversions as it provides a growing resource to pay future tax bills. The line of credit also provides flexibility to convert a greater portion of your retirement assets during market plunges, so you only pay taxes on the lower value at the time of the conversion and not on any gains in the Roth IRA when the markets recover. 

Since there are no principal or interest payments required for as long as you live in your home, the line of credit from a reverse mortgage provides the liquidity to pay for the Roth IRA conversion with no impact on household cash flow or the need to sell other invested assets.


Use a reverse mortgage if your home equity is less than or equal to the value of the retirement assets you plan to convert.

A good rule of thumb is to use a reverse mortgage if your home equity is less than or equal to the value of the retirement assets you plan to convert. If the home represents a major portion of your net worth, a reverse mortgage may not be the best option to cover the tax bill. In this case, the reverse could better serve as a tax-free source of supplemental income, or to pay for in-home care, or other retirement expenses that distributions from the smaller invested assets may not be able to cover. 

Evaluating the use of a reverse mortgage also depends on the projected costs in comparison with the projected returns. For example, if interest rates on a reverse line of credit are at 3%, and your home appreciates at a 3% rate, you could borrow 50% of your home equity and still maintain a 50% retained equity position throughout the duration of the loan. Even if the home only appreciated at a 1% rate, you would still have a retained equity position. 

Projected returns on the Roth IRA conversion would also need to be evaluated. For simplicity’s sake, let us assume you borrow a total of $250,000 from your reverse line of credit to pay the tax bills on $1 million conversion. If you accrue interest on the line of credit balance at a 3% rate and the Roth IRA grows at a 6% tax-free rate, the return could be quite compelling over time. 

Of course, there are no guarantees on any projections, which is why you should consult a financial professional and evaluate your specific situation. A number of “what if” scenarios should be considered including changes in interest and tax rates, home and investment growth rates, and legacy desires. These considerations will help determine if using a reverse mortgage to take advantage of the benefits of a Roth IRA conversion could be a retirement strategy that makes sense for you. 

Stephen Resch is an independent investment advisor and vice-president of retirement strategies at reverse-mortgage lender Finance of America Reverse.

More:Here are your odds that stock prices will be higher at the end of 2021

Plus: 7 advantages a late starter has over the FIRE world in saving for retirement



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This 57-year-old said ‘screw this’ to San Francisco — and retired to ‘delightful’ Albuquerque, where she slashed her expenses by 70%

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When Roberta Reinstein moved to the Bay Area roughly 30 years ago to go to law school, it felt to her like a different place than it does now.

“It was possible for a student to live there…it was filled with artists,” she says. But Reinstein, 57, watched as real-estate prices skyrocketed (in just the past decade or so, home values have nearly doubled, according to Zillow) and many artists and less wealthy people had to move out. Nowadays, “San Francisco is only for the wealthy — the super wealthy — unless you’re willing to live with five roommates,” she jokes.


Do you have an interesting retirement story? Email helpmeretire@marketwatch.com with your story.

As she was watching San Francisco become a hub for the rich, she had a financial setback of her own: a divorce, in which she and her spouse had to split up their assets. And the divorce necessitated she move out of the family home, so she was spending $4,000 a month on a tiny pad to share with her daughter, Eva, she says.

“When Eva was in high school I started to think, do I really need to be here? There are lots of other places I can go.” And the more she thought about it, the more she realized: “Screw this, I gotta get out of here,” Reinstein says with a laugh. “I was ready for a break from the high cost, crowds and Google-fueled insanity of the Bay Area.”

Plus, she loved to flip houses (she’d done a couple in California years ago, before the real-estate prices were so high) and knew that was out of the question for her to do in the Bay Area — so she and her new partner, Peter, considered where else they could live. “We thought for a microsecond that Arizona might be the place, but it was way too hot in the summer.”

Roberta Reinstein and her partner, Peter.


Roberta Reinstein

They settled on Albuquerque for a number of reasons, including the weather, affordability of real estate, access to outdoor activities and the fact that Reinstein’s best friend had recently moved there.

Here’s what life is like in ABQ.

The area: Though it’s perhaps best known for its annual hot-air balloon festival and being the setting for AMC’s hit show “Breaking Bad”, ABQ — which has a population of roughly 550,000 — has a lot more going for it than that. “Albuquerque is a delightful, quirky hidden gem,” says Reinstein.

The Albuquerque Skyline at dusk.


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It’s an artsy spot — there are hundreds of galleries and art studios; monthly art crawls, and a robust performing-arts scene — and a city where outdoor enthusiasts flock to. That’s helped along by the miles of hiking and biking trails in the adjacent Sandia and Manzano Mountains, as well as the roughly 300 days of sunshine. (Though January average lows are in the mid-20s, and July highs hit the low 90s.) And Reinstein tells MarketWatch she loves that it’s a diverse city with its own unique cuisine and celebrations.

Of course, there are downsides: Overall crime is high, though Reinstein says that while there are some not-so-desirable neighborhoods, there are plenty of areas that are safe. She adds that she’s never been the victim of a crime other than someone stealing a hose from one of the homes she was flipping. And there is “a fair amount of poverty,” says Reinstein. Plus, she says, the city can feel like it has a lot of sprawl, and she misses great Asian food.

View of the mountains from Reinstein’s yard


Roberta Reinstein

Here’s what MarketWatch recently wrote about Albuquerque.

The cost: Though Reinstein doesn’t keep a strict budget, she estimates that she probably spends about $3,000 a month to live in Albuquerque — despite having pricey hobbies like owning two horses — it costs her $1,250 a month to board them, which is her most significant expense. She says that most things are cheaper in Albuquerque than they were in San Francisco, including energy and gas, and estimates that she spends roughly 70% less a month than she did in the Bay Area.

Reinstein at the nearby stables.

The biggest way she saves money is by not having a mortgage on her home: She bought the four-bedroom, three-bath home that sits on an acre of land for $240,000, using a combination of savings, her divorce settlement and proceeds from homes she bought and flipped in Arizona and New Mexico, she says. And she adds that you can get a “nice house in a decent neighborhood for under $200,000” with smaller homes to be had for $100,000 or so, and can rent a nice place for $700 to $800 a month. Plus, she drives an older car — “a ratty Toyota Tundra truck” — she explains, so she doesn’t have a car loan.

The sitting room in Reinstein’s home.


Roberta Reinstein

Indeed, the cost of living and property taxes in Albuquerque are slightly below average for the U.S., median homes cost under $200,000, according to Sperling’s Best Places — and you can read about New Mexico’s tax situation here.

The bottom line: Reinstein says she plans to stay. “People are super friendly,” she adds, noting that it’s easy to make friends and get involved in things here. She’s part of a ladies walking group in the neighborhood and has made friends from her barn. “I have like two people I still correspond with [from the Bay Area],” she jokes, adding that “I was so wrapped up in my own world there.” But in ABQ, she says: “I had to go back to managing my schedule because I can’t get stuff done. I have so much to do here.”



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This investment mix beats the S&P 500 — by a mile

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This article is the core of my best advice for long-term investors. If you want the very best equity portfolio, you’re about to learn what it is and how to put it together.

This article has three parts. The first is what might be called an “executive summary” of key points. The second outlines the step-by-step process of creating my recommended portfolio. The third digs deeper into a few related topics.

This is one of a series of articles I’ve written and updated annually for many years. Together, they outline a lifetime wealth accumulation strategy for do-it-yourself investors.

The other articles will tackle how to accumulate investment savings, how much to hold in bonds, and how to plan retirement withdrawals.

Part one

“Ultimate” isn’t a term to toss around lightly. But in the case of the ultimate buy-and-hold strategy, it fits. I believe this is the absolute best way for most investors to achieve long-term growth in the stock markets.

This strategy is based on the best academic research I can find — and it is the basis of most of my own investments.

Here are some key takeaways:

Because nobody can know the future of investment returns, massive diversification gives investors the highest probability for long-term success.

Most investors rely almost exclusively on the S&P 500
SPX,
-0.48%
.
But by adding equal portions of nine other equity asset classes, long-term investors can double or even triple their returns.

The additional return comes primarily from taking advantage of long-term favorable returns of value stocks and small-cap stocks. Taking this step involves only minimal additional risk.

The ultimate buy-and-hold portfolio works best for investors who don’t want or try to predict the future, time the market’s inevitable swings or pick individual stocks.

By investing in passively managed index funds or exchange-traded funds, this strategy offers investors a convenient, low-cost way to own thousands of stocks.

Read: Will Social Security still be there if I wait to claim it?

Part two

This “ultimate” all-equity portfolio automatically takes advantage of stock-market opportunities wherever they are.

It’s best to roll this out in steps so you can see how it goes together. To help you follow along, here’s a table showing the components.

The base “ingredient” in this portfolio is the S&P 500, which is a good investment by itself. For the past 51 calendar years, from 1970 through 2020, the S&P 500 compounded at 10.7%. An initial investment of $100,000 in 1970 would have grown to nearly $18 million by the end of 2020. Keep that figure in mind as a benchmark to see the results of the diversification I’m about to describe.

For the sake of our discussion, think of the S&P 500 index as Portfolio 1.

The next step involves shifting 10% of your portfolio from the S&P 500 to large-cap value stocks, which are regarded as relatively underpriced (hence the term value).

This results in Portfolio 2, which is still 90% in the S&P 500. Assuming annual rebalancing (an assumption that applies throughout this discussion), the 51-year compound return rises from 10.7% to 10.9%. That would turn $100,000 investment in 1970 into $19.4 million.

In dollars, this simple step adds nearly 15 times the amount of your entire original investment of $100,000 — the result of changing only one-tenth of the portfolio. If that’s not enough to convince you of the power of diversification, keep reading.

Read: We want to scale back to an up-and-coming town out West where we can retire — where should we go?

In Portfolio 3, we move another 10% into U.S. small-cap blend stocks, decreasing the weight of the S&P 500 to 80%.

This boosts the 51-year compound return to 11%; an initial $100,000 investment would grow to $20.7 million — an increase of nearly $2.8 million from Portfolio 1.

To create Portfolio 4, we move 10% of the portfolio into U.S. small-cap value stocks, reducing the weight of the S&P 500 to 70%. Small-cap value stocks historically have been the most productive of all major U.S. asset classes, and they boost the compound return to 11.4%, enough to turn that initial $100,000 investment into $24.4 million — with more than two-thirds of the portfolio still in the S&P 500.

Read: Is COVID-19 a preview of what retirement will be like?

To continue diversifying, we create Portfolio 5 by shifting another 10% into U.S. REITs funds. Result: a compound return of 11.4% and an ending cash value of just under $25 million.

I understand that many investors are uncomfortable with international equities. But I believe any portfolio worth being described as “ultimate” must venture beyond the U.S. borders.

Accordingly, to create Portfolio 6, we shift another 40% of the portfolio to four more important asset classes: international large-cap blend stocks, international large-cap value stocks, international small-cap blend stocks and international small-cap value stocks.

This reduces the influence of the S&P 500 to 20%. The result is a compound return of 12% and a 51-year portfolio value of $32.4 million — an increase of 81% over the S&P 500 by itself.

The final step, Portfolio 7, comes from adding 10% in emerging markets stocks, representing countries with expanding economies and prospects for rapid growth.

This boosts the compound return to 12.4% and a final value of $34.4 million.

This massively diversified 10-part portfolio is as far removed as possible from any effort to predict the future. Over 51 calendar years, it met all the asset-class predictions of academic researchers—and more than doubled the dollar return of the S&P 500.

Here are my specific recommendations:

Asset class

Recommended ETF (ticker)

Standard & Poor’s 500 Index

AVUS

U.S. large-cap value

RPV

U.S. small-cap blend

IJR

U.S. small-cap value

AVUV

U.S. real-estate investment trusts

VNQ

International large blend

AVDE

International large-cap value

EFV

International small-cap blend

FNDC

International small-cap value

AVDV

Emerging markets

AVEM

Unfortunately, this portfolio has an important drawback: It requires owning and periodically rebalancing 10 component parts. Relatively few investors have the time or inclination to do that.

Fortunately, we have devised a four-fund alternative that’s much easier to implement.

Since 1970, this “lite” version of the ultimate buy and hold strategy would have produced virtually the same compound return, dollar return and standard deviation as the 10-fund portfolio I outlined above.

In an upcoming article, I’ll roll out this new version.

Part three

It won’t surprise you to learn that there’s much more to say about this portfolio.

In 2020, we recalculated results from the 1970s to reflect new data we did not have in previous years. We also changed our assumptions about fund expenses that investors would have been charge in the 1970s. We believe our recalculations will better reflect what 21st century investors can reasonably expect.

Yet even after all these calculations, the returns did not change materially, and there’s no change in my beliefs or recommendations.

This updated data is as good as I can make it.

To learn more about these changes as well as some other reasons I think so highly of this portfolio, I hope you’ll tune in to my latest podcast.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.



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‘She is a financial idiot and partier’: I loaned my sister $4,780 for a lawyer during her divorce. I am still chasing repayments

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Two years ago, my sister called me from a divorce-settlement meeting without a lawyer. Her soon-to-be ex-spouse had a lawyer there. She was being pressured into giving up her portion of his pension that she was legally entitled to (their marriage was over 20 years). She was freaking out, in tears and realized she needed a lawyer.

I told her to leave that meeting and get a lawyer. Afterward, she asked me for money to pay for the lawyer and promised to pay me back. I testified for her regarding other marital financial issues (I was executor of our father’s estate, in which her husband had made false statements on his entitlements to some of her inheritance). She thanked me again and again in front of her lawyer and promised to repay me.


‘She borrowed another $5,000 from an aunt for a child-custody battle, which she lost.’

I am not wealthy and did not have $4,780 on hand, but I have good credit and used my line of credit. It will be two years in May and I have not received any payment. She was supposed to give me some monthly payments and lump sums at tax-refund time. Last year’s excuse for no tax-refund reimbursement was that she borrowed another $5,000 from an aunt for a child-custody battle, which she lost.

She earns $90,000 to $95,000 a year, but this year’s excuse is that she is in arrears for child-support payments. She is not destitute; she is a financial idiot and partier. I do have texts saying she will pay me back and others that say she has no money. She swore before Thanksgiving this year that she would start paying me in January. January came and went, no payment.

During a text discussion in early February, she informed me about her child-support arrears (so no lump payment from her tax-refund again) and is only planning $25 per month repayments when she could. That plan doesn’t cover the interest on the loan, and even if I was OK with covering the interest, it would be more than 20 years.

I told her that was not acceptable, and that she left me no choice. I didn’t say what action I would take. So I am planning to take her to small-claims court, and garnish her wages. The Virginia statute of limitations is two years, so I need to do this by early May. Now the financial idiot sent me a check for $25.

If I cash it, would it extend the statute of limitations? Should I cash it? What is the best approach? Also, she is a social-media junkie; on her Facebook and Instagram, there are multiple examples of vacations, drunken outings and other expenditures since May 2019 that could have helped to dig her out of the financial heap.

There is a capability to reimburse, but zero will. Any advice is appreciated.

Deadbeat’s Sibling

Dear Sibling,

Only gamble what you can afford to lose. Only invest what you can afford to lose. Only lend what you can afford to lose. I don’t believe you will be getting this money, so I advise you to write it off as a bad debt sooner rather than later. Sure, try the small-claims court, but failing that there will come a time when you will have to say enough is enough: “I tried to do the right thing, she didn’t repay it, and I can’t change her.” I do have questions about what you hope to achieve.


‘I see two unhealthy patterns: Your sister’s grifting and your gifting. Each serves a purpose.’

If she repaid you the principal sum, would you then start to feel similar rumblings of injustice over the interest? If she repaid you with interest, would you then suffer pangs of annoyance over the hoops of fire she made you jump through in order to be repaid? After all, you were doing her the favor, right? How dare she put you through this. And, thirdly, what is this $4,780 worth to you? It’s already been two years of self-righteous fury, stress and anxiety.

None of this should come as a surprise to you. I see two unhealthy patterns: your sister’s grifting and your gifting. But each of these serves a purpose. Yes, your sister reactivates the statute of limitations by repaying a small part of the loan and, thereby, acknowledging that she still owes you money — five years for breaching a written contract or three for an oral contract, but talk to a lawyer about that. When it does, this tortured game of cat and mouse begins anew.

How far are you willing to go to retrieve this debt? How long will you pursue it? And aside from the prospect of knowing that you are still in with a shot of getting the $4,780 back, what do you get out of feeling perpetually angry and frustrated at your sister? Does it reaffirm that you are the principled, upstanding one in the family? Or does pursuing your sister for this money remind her on a daily basis that she appears to be incapable of keeping a promise?


‘In order to truly move on, you too need to take responsibility for lending it to her in the first place.’


— The Moneyist

I ask you these questions for a reason. Of course, she’s behind on child support. You already know that your sister is a dramatic (and possibly irresponsible and/or reckless) person who has learned how to leverage her alleged victimhood to her advantage. She may see herself as a victim of a bad marriage, cruel husband, biased judicial system, and any other circumstance that does not include her own choices and actions.

Your sister may or may not accept responsibility for borrowing this money, but in order for you to truly move on, you too need to take responsibility for lending it to her in the first place. Few could fault you for wanting this money back. But in the game of life, you already win. You are the sister who endeavors to keep her word, look out for others, and be the adult in the room. Your sister loses. You get to be right. Your sister is wrong. And, for exactly $4,780, everyone else will see that.

I understand that you would like this money back, but many people lead uneven, tumultuous lives. You may also ask yourself if this unrelenting pursuit of money from such a person serves you and does what I hope you originally had intended to do by telling your sister to walk out of those divorce talks and hire a lawyer: help your sibling and, in some small way, help make her chaotic life easier.

You are not a credit company or debt collector. You are, for better or for worse, her sister.

You can email The Moneyist with any financial and ethical questions related to coronavirus at qfottrell@marketwatch.com

The Moneyist: ‘Warren Buffett and Harry Potter couldn’t get those two retired early’: Our spendthrift neighbors said our adviser was ‘lousy.’ So how come WE retired early?

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