Announcer:
It’s time now on KROS for Financial Focus, brought to you by NelsonCorp Wealth Management. The opinions voiced in this show are for general information only, and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly.
Registered representative securities offered through Cambridge Investment Research, Incorporated, a broker-dealer, member of FINRA, SIPC. Investment advisor representative, Cambridge Investment Research Advisors, Incorporated, a registered investment advisor. Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. Now here’s today’s Financial Focus program.
Nate Kreinbrink:
Good morning and welcome to this week’s Financial Focus, brought to you each and every Wednesday morning right here on KROS. Well, it is the third Wednesday. We have Andy Ferguson with NelsonCorp Tax Solutions joining us today. Thanks for coming down, Andy.
Andy Fergurson:
Good morning. I’m glad to be here.
Nate Kreinbrink:
It is third Wednesday. It is back to school week for those, I think, on this side of the river. I think the Illinois side started last week.
Andy Fergurson:
Think so.
Nate Kreinbrink:
A lot of the area’s schools go back Friday.
Andy Fergurson:
High school starts Friday for us, and then elementary school starts on Monday.
Nate Kreinbrink:
Yes. And a lot of the teachers are back in school getting classrooms ready, seen a lot of unpack the backpacks, open houses, all that fun, exciting…
Andy Fergurson:
Yeah, the sports meetings, the back to school nights, all that stuff.
Nate Kreinbrink:
It is that time of the year. It is fall, it is getting there. I did see this… We will have no more weekends without football until after the Super Bowl.
Andy Fergurson:
I know. I heard somebody on the radio say that we were going to be playing or watching football until February.
Nate Kreinbrink:
Yeah.
Andy Fergurson:
So that’s awesome.
Nate Kreinbrink:
So if you are a football fan, it is right up your alley time. College, NFL…
Andy Fergurson:
The most wonderful time of the year.
Nate Kreinbrink:
I think a lot of the area, high schools have scrimmages set up coming up here in the next couple of days. Volleyball season, fall activities. It’s just fun time of the year.
Andy Fergurson:
Yeah.
Nate Kreinbrink:
But I did see this weekend, back to nineties. Just in time for school.
Andy Fergurson:
Oh really?
Nate Kreinbrink:
Yes.
Andy Fergurson:
Well, that’ll be fun. I love the first day of school when kids get their new outfits and stuff and they’re walking to school, or you’re driving your kids to school and you see kids in hoodies and jeans and stuff, because that’s what they feel like is their best new outfit. And I’m like, “It is a hundred degrees today, and you’re wearing a sweatshirt and jeans.”
Nate Kreinbrink:
But they got their new outfit on them. They have to wear that first day of school. So today’s program, again being the third Wednesday of every month, wanting to look at taxes and try to relate it to where that falls into play. And we get the question a lot of times that “Hey, I’m looking to save a little bit more. I’ve got a little,” maybe raise at work, or, “We paid off a bill. I want to start saving that money.” But then it always follows up with, “Where should I save it at?” And that kind of is, again, one of those, “Well, it depends” answers, because it does depend on a lot of different factors given your individual situation. But it’s important to know that where you start saving is probably going to impact your taxes, and it’s important to understand the pros and cons of one account versus another type of an account, and how it’s not only going to impact your taxes today, but how it’s going to impact your taxes down the road as well.
Andy Fergurson:
Sure, yeah. A lot of people think that taxes are inevitable. They think that it’s a consequence that happens to them, there’s nothing they can do about it, and it’s just going to happen and they got to deal with it. Well, taxes are inevitable in the fact that everybody has to pay taxes, but you can control a little bit of how you pay taxes, and even how much you pay in taxes, when you understand the code, understand the laws, and how that works.
And so I thought it was important that you and I maybe spend some time talking about different strategies that exist that allow us to reduce tax or to choose to pay tax at a lower rate, and help us avoid just reacting or accepting whatever comes our way. One of the strategies that you and I have talked a lot about is relatively new. It comes from… Well, it’s new in Iowa. It’s existed for a while in Illinois. And that is the difference between contributing to a traditional 401(k) or IRA versus a Roth IRA or a Roth 401(k). And there’s a difference, obviously, in taxation, but what’s interesting about that is if you’re over 50 in Iowa or if you live in Illinois at all, because Illinois doesn’t tax retirement income, and because if you’re over 55 in Iowa, you don’t tax retirement income, there’s an opportunity to reduce maybe your state tax by the way you make contributions.
We talked about it before. A lot of people maybe who are still working want to contribute to a Roth through their 401(k), or a Roth outside of work, so that they can pay tax today and then leave that for tax-free growth. Well, if you fit into those categories I just talked about in Iowa and Illinois, if you make that contribution to a traditional IRA or 401(k) first and then make a conversion to that Roth, what happens is you end up having the opportunity to save on state taxes. The way it works is if you make a contribution to a Roth directly, that money is counted in your adjusted gross income. Your adjusted gross income is higher, that means effectively you are paying the state tax on that Roth contribution. Whereas if you are over 55 in the state of Iowa, or if you live in Illinois, if you make that contribution to a traditional IRA, you reduce your AGI in the state.
And people say, “Well, when you make the conversion, it’s going to go back into your AGI.” Well, it does on the federal form. Absolutely, it goes back into your AGI. So putting it into the traditional and then converting to the Roth on the federal form is exactly the same net result on your federal form. But in Iowa and Illinois, if you fit this criteria, what happens is when that money goes back into your AGI, when you make the conversion from a traditional to a Roth, it counts as income, but it gets exempted off by the state of Iowa because it’s retirement income, and it gets exempted off by the state of Illinois because it’s retirement income. And so effectively, you save whatever you’ve now put into that Roth by… You’ve saved the state tax rate on that income by putting it into the traditional purse, and then even the next day, converting it into the Roth.
Nate Kreinbrink:
Right, and I think too, when you start looking at this, when we go through this scenario with some of our joint clients that we have, we’ve kind of harped and pushed Roth and Roth and Roth, and, “Get it to a Roth, and pay tax once, and then as long as you meet the criteria, you’ll never pay tax on this again.” And so when we bring this up and say, “Well, let’s maybe look at putting it in a pre-tax,” we kind of get a funny look at some point. But when you go through this scenario, the endgame is we are still getting the money into the Roth account.
Andy Fergurson:
Right, right.
Nate Kreinbrink:
Our feelings on a Roth account have not changed given taxes and some of the benefits to it. The difference is, we’re not going from just A to B. We are going from A to C to B as far as how we are getting that money into the Roth.
Andy Fergurson:
Right.
Nate Kreinbrink:
And by adding that one little step, like you said, you are essentially saving. Whatever money you convert, you are saving that state tax on any money you do to benefit you on your tax return.
Andy Fergurson:
Well, and then people say, “Well, what’s the real difference in that contribution? What am I actually saving in that process?” And if you live in Illinois, you’re saving 4.95%, right? Because Illinois has got a flat tax. So on $10,000, that’s $495. Lot of people contribute $10,000 to their IRA or to their…
Nate Kreinbrink:
401(k)?
Andy Fergurson:
… 401(k) or 403(b). And so if your company allows that option to where you can make the contribution and then make a conversion, or if you can make the contribution through your company, but you have an outside IRA that you could then convert that same amount, $500 is a lot of money. You know? And I mean, it’s worth doing. If I told somebody that they could make an investment into their 401(k) and immediately make $500, everybody that you talk to would do that.
Nate Kreinbrink:
Right. Well, and I think too, it’s simply that conversion to get it over there to save that. And again, you are still getting this money into the Roth account, into the Roth world. The benefits of a Roth and the way we look at a Roth from a long-term perspective have not changed. Like I said, it is how we’re getting that money there.
Andy Fergurson:
Right.
Nate Kreinbrink:
And I think when you start looking at things like that, it is, and understanding some of these laws and how you can use them to our benefits. Like you said, in Iowa, this just came into effect two years ago.
Andy Fergurson:
Right.
Nate Kreinbrink:
As far as being able to exempt retirement income, obviously that’s pension income, that is distributions from a pre-tax retirement account, and Roth conversions are included as part of retirement income in the way that that bill is written. So.
Andy Fergurson:
Yeah. There’s other strategies that work like that. You know, just the idea of going directly… or the path that your money flows, you know? We talked about something else, but a QCD strategy is a similar topic. That is a qualified charitable distribution, and we probably don’t have time to cover all of that, but that’s the idea of taking advantage of your charitable contributions, you know?
If you live in Iowa or Illinois… If you live in Illinois, you probably haven’t itemized in five or six years, because it’s very hard to itemize in Illinois. And if you live in Iowa, you aren’t itemizing more than likely now because of the change in their standard deduction. And so maybe you think that charitable contributions don’t matter anymore. Well, if you meet certain requirements, maybe you can still take advantage of a tax benefit there through a qualified charitable distribution. And that’s another strategy for another day that we’ll have to talk about, but it’s the idea of doing the same thing that you wanted to do, but just maybe going a different route to get there, can save you in taxes.
Nate Kreinbrink:
Right. I think it’s all important to do, and again we come down to all this time tax planning. Every time people think of taxes, they always think of tax season and filing your taxes, but this stuff is where the meat really gets into it a little bit.
Andy Fergurson:
Yeah.
Nate Kreinbrink:
And you can save on those bottom lines when you do file your taxes. It’s this time where you can do some tax planning, understanding what’s out there, understanding how to use it to your advantage, and again, implement these things so they do have some impact on that bottom line.
Andy Fergurson:
Yeah, it’s the difference between accepting what is ever coming your way and kind of dictating what’s going to come your way.
Nate Kreinbrink:
Right.
Andy Fergurson:
And choosing what tax you’re going to pay and how you’re going to pay it, and whether or not you want to get a better return for your money.
Nate Kreinbrink:
All great stuff. We are getting close to running out of time. You have a list here in front of me. I cannot wait to start checking these off over the coming months when we tackle some of these. But I did want to mention before we run out of time that every Friday, NelsonCorp Wealth Management and NelsonCorp Tax Solutions are wearing jeans for charity. Money raised in the month of August will be donated to the Skyline Center here in Clinton. As always, Andy, appreciate you joining me.
Nate Kreinbrink:
Andy Ferguson, NelsonCorp Tax Solutions, Nate Kreinbrink with NelsonCorp Wealth Management, bringing you this week’s Financial Focus. Thanks for tuning in, and have a great rest of your week.
Announcer:
Financial Focus is a production of NelsonCorp Wealth Management in Clinton and Davenport. The opinions voiced in this show are for general information only, and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly.
Registered representative securities offered through Cambridge Investment Research, Incorporated, a broker-dealer, member of FINRA, SIPC. Investment advisor representative, Cambridge Investment Research Advisors, Incorporated, a registered investment advisor. Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. For more information, visit our website at www.NelsonCorp.com.