Transcript

Stephen Jarvis:

Hello everyone, and welcome to the next episode of the Retirement Tax Services Podcast: Financial Professionals Edition. I am your host, Steven Jarvis, CPA. In this show, I teach financial advisors how to deliver massive value to their clients through tax planning. Really excited for today’s episode, my guest is Matthew Jarvis. Yes, he is related to me, but in addition, he’s the co-founder of The Perfect RIA and is a CFP with his own financial planning practice in the great state of Washington. Matt, welcome!

Matt Jarvis:

Steven thanks for having me on the show. It’s fun to be back!

SJ:

Yeah, always enjoy having you. I feel extra special today because tomorrow you have another podcast episode releasing with the one and only Michael Kitces! This is your second interview on his show, so congratulations on that!

MJ:

Yeah. Really excited to be back on his show. I get to on his show,  announced my new book – Delivering Massive Value: The Financial Advisors Guide to a Highly Profitable, Hyper Efficient Practice. So Michael and I had some great conversations and of course on Wednesday, I get to be on a webinar with you to dive even deeper into the topic that we’re going to discuss today.

SJ:

Yeah, we’ll make sure we link everything to your book and the Kitsis episode in the show notes, but everyone’s here to learn about taxes. So let’s focus on the webinar, really excited! We’re going to be talking all about getting cream out of the coffee. And for those of you who don’t refer to it like that all the time, what we’re really talking about is backdoor Roth contributions, and what we do with those Roth conversions, when we have other balances that the IRS wants to apply the pro-rata rules to.

MJ:

Steven, I love that you kicked off this segment with really excited to talk about the tax code. And I just mentioned that not just to poke fun at you, but of course, to do that. But also, I actually really love talking to other people who are excited about the tax code, who say like, ‘oh, well, let’s dive into the tax code!’ Like those are my people, because that’s who I really learned from, that’s who can apply it and say like, ‘okay, there’s this thing in the tax code, and it’s kind of weird and obscure. In fact, today, 8606. Kind of weird, kind of obscure- let’s nerd out on this.’ But most importantly, let’s translate this and how we’re going to deliver value to clients.

SJ:

That last piece is really important. And for me kind of differentiates whether I’m excited to talk to people who are excited about taxes, because it’s kind of this spectrum. On one end, you have people who want to talk tax politics, and they want to talk about the nuances of how things are structured and worded. That’s not what I nerd out on. I get excited to talk about the tax code when we’re talking about areas that we can either individually do something about, or we can help our clients do something to help not leave the IRS that tip that none of us want to give them. And this is definitely an area where if we commit to it and learn what we need to, we can really help our clients.

MJ:

Yes. Steven, I know you’ve talked about this on the show. We talked about this a lot on The Perfect RIA podcast. One of the reasons I love to nerd out on taxes, one of course as you mentioned – deliver massive value to clients, right? That’s my number one. Number two is, and Warren Buffet always talks about buying companies that have a moat around them that are, that are hedged or insulated from competitors. By being a financial advisor who can provide real value in taxes, you create this enormous moat around your clients and your prospects, because I can go up against any other firm, almost any other firm in the country. All I have to say is, ‘Hey, what did they say when they looked at your tax return?’ And immediately I win because they’ll say, ‘well, they didn’t look at my tax return.’ What did they say when they noticed that there was cream in your IRA coffee? What did they say when they noticed that? ‘I don’t know what that means. They didn’t say anything about this.’ Suddenly I win. So, I win because I can deliver massive value. I win because nobody else is doing it in this area.

SJ:

Yeah the next time you have a prospect come in and you’ve got their tax return because of course, listeners to this show are getting prospect tax returns. Just look through and if you find a form 8606, it’s a, ‘Hey, you know, what is your current advisor? What is the other advisor you’re considering have to say about your strategy around Form 8606.’ This is a big topic. And we aren’t going to get through every last detail of this today. Matt and I are joining up for a webinar this Wednesday, September 22nd at 8:00 AM Pacific, that we will dive into it more and really get into the, the, how you’re going to implement this. So, definitely come along and join in on that. And we’ll make sure that links are in the show notes. So, we’ll get more information on how you can sign up, but we’ll get you some really great stuff to get started and then point you in the direction for learning more.

Looking at Form 8606 And Non Deductible Contributions [4:38]

MJ:

Yeah, for sure. So I think you mentioned one of two groups that are really impacted by this. The first of course is if you see a form 8606 and a client or prospect’s tax return meaning that they typically have some non-deductible contributions in their IRA accounts. The other group is any clients or prospects whose adjusted gross income and retirement plan status – that’s another discussion – whose adjusted gross income makes them ineligible to make traditional deductible IRA contributions. That group Stephen is especially powerful because they usually know that they’re not able to do it, and they’re a little upset by that. So when you can show them back to a Roth, things like that. The first group, the one that had 8606, ninety-nine times out of a hundred, they don’t know what that means. They just don’t know what that form means. They don’t know that it’s going to be an issue down the road. No one has really explained it to them.

SJ:

Yeah. A lot of times that form gets filed on their behalf because they got to tax time in a year where their income went up or they’ve tripped that threshold and their tax preparer recognized that they were no longer in that income limit. And so they filed this form because some of those contributions became non-deductible. And so yeah, to your point, they probably don’t really understand what that means for them now or in the future. Just real quick for our RTS members. Our September newsletter was all about this topic. So, go to the website and pull that up if you want to follow along or have a good reference for this stuff we’re talking about.

MJ:

Yeah. Yeah. That’s for sure. So, I think the other part of this is – you do end up with people who are intentionally making non-deductible contributions. So I’ve definitely met with these people. I’ve had them as clients, they’re making non-deductible contributions and they don’t understand the Roth conversion aspect of it because prior to 2018, it was kind of this dubious strategy or they have other IRA money. And so they can’t necessarily do the conversion. The other thing I run into and I apologize that we’re muddying this up is people that are making non-deductible contributions into one account and have all their pre-tax money in another. And they think that by doing that, they’re keeping them separate. Like they think that the IRS will view those accounts separately, but that is Steven, as you know, is not the case. The IRS looks at all IRA accounts in your name. So, just because you’re putting the non-deductible one in a set account, that means nothing to the IRS.

SJ:

Yeah, if you think you’re clever by keeping it with a different custodian? The IRS doesn’t care. But you’re right, Matt, that really illustrates that this is a big topic and there’s a lot of intricacies here, which is really why we have a whole webinar on it. Well, I want to circle back really quick to your comment about this being a dubious strategy. And really, I think that comes from the fact that this really was created on accident. I don’t remember the exact timing of when backdoor Roth contributions became something that you could do, but up until 2018, the IRS hadn’t really said anything about their views on it. And they still haven’t codified it. But in 2018 a representative from the IRS, very publicly said, ‘Hey, you know, basically we don’t love that you call it backdoor, but yes, this is an acceptable strategy.’

MJ:

Quick note on that. I would never in writing tell a client ‘backdoor’ because it implies that you’re doing something dubious, right? And that’s something that the IRS in an audit is going to look at and SIG I don’t work for the IRS where they’re gonna say, ‘wait a second, that sounds suspicious.’ Now this one is such a widely used vernacular. It’s not going to be an issue, but if you’re sending an email saying, ‘Hey, we’re getting the upper hand on the IRS.’ Don’t ever send that email. That’s asking for trouble.

SJ:

Yeah. That’s why we talk about not leaving the IRS a tip. We don’t talk about shorting the IRS or underpaying the IRS. We want people to pay every dollar they owe. We just want them to be intentional and use these strategies to make sure they don’t owe quite as much.

MJ:

Perfect. Perfect. Well, the easy situations with 8606 would be if the client has no other IRA money, except for these non-deductible contributions. Like all the other qualified money is inside of retirement plans, or that’s in a spouse’s name because those are viewed completely separately. Those ones are pretty easy. You can just do the conversion, right? You can say, all right, there’s $10,000 of nondeductible contributions. There’s been $2,000 of growth. We’ll do the conversion; we’ll owe tax on the 2000. But now all 12,000 is growing tax free. That’s pretty straightforward. Where it becomes a problem – and I run into this pretty often in my practice – client comes in, they have $10,000 in nondeductible contributions and they have $500,000 of IRA balances. Therefore, if we did a conversion, as many of you know, it would be pro-rata, it would be primarily taxable and just a sliver would come from that non-deductible. And for the rest of time, until that IRA account is zeroed out, we have to deal with this non-deductible money has to report it every year on the 8606.

SJ:

Yeah, just real quick I want to highlight in there, you commented on it, but the 8606 gets files for each individual. Even if you’re married – filing jointly, this is an individual form. So that’s an important to keep in mind. The IRS doesn’t make anything for us. So, like I said, you might be filing a joint 1040, 8606 is still separate for each taxpayer as it applies to them. And yeah, that’s really, that’s how the cream gets in the coffee. That’s why we use that terminology of this pro-rata rule is going to come back on you every time to say, ‘okay, wait, this isn’t exactly what you thought.’ And like you said before, Matt, it doesn’t matter if you have it in a separate account or the separate custodian. Really the only kind of differentiator the IRS cares about is – is it in an employer sponsored plan? Is it in a 401k plan?

MJ:

Correct. Now I want to just take one step back. You mentioned how the 8606 has filed for each person individually. So, if I’m dealing with a married couple or a couple of any kind, and I’m looking at their tax returns and there’s only one 8606, this gives me an opportunity to ask, ‘why is there only one?’ Sometimes people don’t realize that if one spouse is working and the other spouse is not, that they can still do contributions for the non-working spouse. Now for most of us listening, that’s a no-brainer, but for clients, that’s not necessarily a no brainer. So, if I’m pointing it out and saying, ‘Hey, I noticed that only one of you is making these interests in IRA contributions. Just curious about the other person.’ It may be because it got messed up on the tax return. It may be that they just hadn’t thought about it. Either way, I’m the first financial advisor who’s gone deep enough to say, ‘Hey, hang on a second. Did you, did you know this, could you help me understand this?’

SJ:

Yeah, and to go on just a quick little tangent here of this is why it’s so important to have good systems and processes for how you approach things. There are so many different tax topics that may be applicable to a client or prospect now. It might change in the next year or two or ten. And so, having a great system, both for you to review and say, ‘okay, is this applicable now?’ And to let your client know – we’re going to use the dishwasher rule – to say, ‘Hey, here’s the 20 things we review for every year. Great news! These 18 aren’t applicable. Here’s the 2 we’re going to focus on, and we’re going to make sure that we’re really delivering value through these two and kind of sanding off the rough edges on your eventual retirement tax.’

MJ:

I love that because that’s not a hypothetical idea. That’s literally something you and I were working on the other day. Something that we’ve used in my practice several times, that’ll be, I think, available to RTS members soon.

SJ:

It already is.

Getting The Cream Out Of The Coffee [11:00]

MJ:

Yeah. Perfect guys, you’re doing great. Okay. So, you’ve got cream in the coffee, right? You’ve explained to the client, ‘Hey, you’ve got this issue. You’re going to have to report on this thing forever.’ And in a way there’s only one way to eliminate an 8606, I suppose there’s a second way. You could just stop filing it, which is illegal by the way. But you could do that. No you could, I’ve seen that happen. CPAs, there’s people I won’t name anybody specifically. They’ll tell the client, listen, just quit, you’re paying more to have this form filed every year than it’s worth. So you could just quit filing it.

That basis just reverse, essentially reverts back to non-deductible contributions, whatever. That’s not legal by the way, but you could do it. The only other way to get the cream out of the coffee is to zero out their IRA accounts. That’s it! That’s it. You have to zero out their IRA accounts. There’re a couple ways to do that, but that’s the only way to get rid of having to do an 8606 for a client. Even if they died, by the way, the beneficiaries still have to deal with an 8606. Like that basis doesn’t go away. There’s no step up.

SJ:

Yeah. Cause form 8606 isn’t just about reporting activity in a year. It carries that basis. And so, if you make a non-deductible IRA contribution in 2010, and then there’s no activity until 2021, you’ve still had to file an 8606 every single year to track what your basis was.

MJ:

That’s correct, so to get that basis taken care of like I said, you have to zero out the IRA account. So, you could, if you want it to, you could zero out the IRA account. I would not recommend that, that can get expensive unless it’s a small dollar amount, right? If they have a half a million in IRA accounts for you to zero, that thing out, that’s not a good plan, that taxes would kill you on that. So the other way to zero that out is by moving all of the IRA money in that taxpayer’s name back into a company retirement plan. Steven, let me explain to you briefly how we’ve done this for clients. So, we have clients and they say, ‘Hey, I want to retire next year.’ So perfect. Let’s plan on retiring in January. In December, let’s roll over all of your IRA money, except for the basis into your company 401(k) plan. This assumes that the company 401(k) plan will allow inbound rollovers. They almost all do. So, you roll that all over. You then do a Roth conversion of the non-deductible amount before the year ends. And then on December, the key is on December 31st, you have to have zero balance in your IRA accounts. And then once the new year rolls over, you could then roll the 401(k) back into an IRA. Assuming the 401(k) provider will allow that.

SJ:

Yeah, this is definitely an area where you want to have a checklist for how this process is going to work. I mean, you’re highly, even a lot of things in there that are very specific and can blow this whole thing up in a real hurry. And so there’s also a good reminder of how important it is to set clear expectations with clients when we bring this topic up, because just because someone has a form 8606 doesn’t mean you can confidently say, ‘oh yeah, we can do this a 100% of the time. We can make this work for everyone. Here’s the benefits, right?’ We need to set clear expectations and you need to have this checklist that walks us through kind of the fact finding of, ‘okay, do we have a 401k? We can roll this into, does that 401(k) allow it?’ Even though that’s really common, we still want to double check that, don’t want to take these things for granted. Do we have our timeline set so that we’re doing these things on the right days and we’re not setting ourselves up for failure later by making them happen too close together. That one day apart is really, really critical.

MJ:

Yeah. And you’ve got to make sure that the client is on board and they follow it. This is a tough thing for even advisors and tax preparers to follow. We actually had one of these kind of blow up. Luckily, it was many years ago when you could still recharacterize Roth conversions, you can’t do that anymore, right? But you used to be able to. What we did, We did the strategy for a client and then he decided without telling us, because it didn’t cross his mind that instead of retiring January 15th, he was going to retire December 15th and roll the money back over. It was this whole issue. Anyway, he ended up with money in his IRA account on December 31st. So when you went to file the 8606, it counted all of his money that was in his IRA account. So, it’s not the day that you do the conversion. It’s 1231 that the IRS is looking at. They’re looking at all IRA account balances. So, in that case, the client blew it up. Well, I’m going to take accountability. I blew it up because I didn’t make sure the client understood it. We were able to recharacterize the Roth, but now they’ve got this cream in the coffee they have to deal with forever.

SJ:

Yeah. When you look at form 8606, these dates become so important because you can make contributions for the previous tax year through the tax deadline in the next calendar year. But 1231 is the important date for this cream in the coffee. So there’s, there’s a lot of moving pieces here. That’s not to dissuade you from doing it. You just need to be really, really intentional.  And you need to make sure that you’re talking to the client’s tax preparer ahead of time. Right? Don’t surprise them with this. Let them, I would, I would recommend you have your plan in place that you’re not coming to them and saying, ‘Hey, we’ve got this great theory, walk through it with us.’ Make sure that you know how this should work for this client and then proactively communicate with the tax preparer. So everyone’s on the same page.

Why Working With A Tax Preparer Is Essential For Advisors [15:34]

MJ:

Yes. Steven, I remember I was in a class. I go to a lot of tax training classes because as you mentioned, the stuff can get complicated. And that’s the reason not many advisors do it. But I was in a tax class with Bob Keebler, CPA, does great tax training. And he said, ‘Hey, listen, as a financial advisor, always bring the CPA in because if this strategy goes sideways, you need, you want somebody else to be on your side of the table when it goes sideways. So, if the IRS or whomever comes back after this.’ So, I just, for a defensive position, I want to make sure the tax preparer’s involved, but also to deliver massive value to the client. Why would I want to keep the CPA out of the loop? This is where I go to the CPA and I say, ‘Steven, Hey, I’m kind of getting ready to recommend this strategy to the client. Can I pay, can I pay for an hour of your time? Let’s walk through the strategy, tell me what I’m missing here. Tell me what you see that I don’t see so that we can make sure this really works.’ And that is going to both help the client. But it’s also going to get me a better relationship with a tax preparer.

SJ:

Yeah. You know, we talk on this podcast. I know you talk on yours about doing like a year in tax letter, a 1099 letter and communicating with CPAs about things that have already happened. But this is a really important example of how you can make the difference on these relationships with CPAs. If you talk about some of these complex things ahead of time, because it completely changes my reaction. If you come and say, ‘Hey, here’s what we’re planning. Am I missing something?’ As opposed to, if you in January, send me a letter that says, ‘oh, by the way, we did this cream from the coffee thing.’ And if at that point I noticed that something’s wrong. Now it’s me against you in front of the client because you screwed it up and I’m not taking the fall for it. But if you come to me ahead of time, great, here’s somebody who wants to proactively work on this. Who’s going to take my input. And even if there’s things that we disagree on a little bit, we can sort it out when there’s time to do something about it and so it’s just going to be a much more positive experience for everyone.

MJ:

Yeah, for sure. Now, Steven, for a lot of people listening to this podcast, they’ll have clients with cream in the coffee, right? Non-deductible contributions on the form, 8606. And either their clients are long since retired. So they don’t have a company plan that they could do this role of with, or their clients are well below- let’s call it age 55 where they can do in-service rollovers back over, and the financial advisor is hesitant to roll the client’s IRA balance into the company retirement plan and have it stuck there for years, decades, maybe. So there is one other strategy for doing that. It involves solo 401(k) plans where the details get pretty deep, but you and I are going to go into a lot of detail on this. How to separate the cream from the coffees and solo 401(k) plans on our webinar later this week.

SJ:

Yeah. Really looking forward to that, diving deep into this stuff. And as much as we talk about, you know, how investments are a matter of opinion and taxes are a matter of fact, the tax code is huge and complicated and always changing. I mean, between the time we recorded this episode and the time it releases who knows Congress might’ve changed tax laws again. I just pointed that out to say, work with professionals, but be practically thinking about how you apply these things. This isn’t all set in stone, right now today that nothing’s ever going to change that there’s never going to be a new strategy. So make sure you’re really intentional, make sure you’re putting the client’s interests and value to them first, but explore these things, talk to other professionals and see how these can be applied.

MJ:

Yeah. As we mentioned that again, this episode I talked about how tax planning creates such a moat around my clients and prospects. It’s because tax planning is really hard, like the easy stuff, right? Contribute to an IRA and make a Roth contribution that stuff’s being done by everyone everywhere. The stuff like how to separate cream from the coffee, how to use a solo 401(k) plan, not being done because it’s hard and it’s tough stuff to learn, right? Like you said, the tax code is very dense, it’s very difficult to translate into action items. Steven this is a shameless plug for you and Retirement Tax Services. But I think that’s why your newsletters are so powerful is they say, ‘great, here’s the tax code and here’s the nuanced stuff and here’s the code and all of this. And then here’s how you translate it to a client. And then here’s literally what you say to the client word for word. Here’s literally what you say to the CPA or tax preparer word for word.’ That translation is very tough to find, there’s very few advisors I’ve met. I don’t mean this with any ego. There’s very few advisors I’ve met who can do that effectively and to become one is an incredibly valuable tool. Yeah.

SJ:

Yeah, no, I appreciate the shameless plug for what we’re doing. I think it’s pretty great stuff too. I have had a couple of advisors say, Hey, why don’t you just stop sharing this? So that only those of us who are doing it can benefit from it. And you know, I’m just not worried at all. It is a growing number of advisors who take this stuff seriously, but it is still a very small number because to your point, it is difficult. It takes a real commitment, but your clients are going to benefit from it. Your practice is going to benefit from it. I mean, everything you do is going to be better off because taxes apply to everything you do in financial planning.

MJ:

Yeah. That’s funny. I guess there is sort of that scarcity mindset of like, ‘Hey, let’s not give away our trade secrets kind of thing.’ What my experience has been those Steven, and I know this is yours as well. Anytime I meet an advisor, who’s very versed in tax planning. They already have way more clients than they can handle. In fact, at over at The Perfect RIA, we’re actually developing a program for those advisors to refer their extra clients out. Because if you’re versed in tax planning and let me make a nuanced distinction here, if you’re versed in a way that you can communicate it effectively with clients, there are lots of advisors who know way, way, way more about taxes than I do. Lots of them, much smarter on taxes, but their ability to communicate it to clients effectively is limited. So, the ones who can communicate effectively to clients, those people universally have way more clients than they can ever handle. Thus, the lack of concern about telling everybody else like, ‘Hey, listen, there’s so many people that need tax help. I’m already tapped out, go for it, take these strategies. Knock yourself out!

SJ:

If we could pause tax law right now and never change it, it would take us decades to get everyone caught up on what’s out there right now. And we know it’s going to constantly change. So, you’re totally right. There’s no need for a scarcity mindset on this. There is plenty of opportunity for any advisor who wants to really lean into this and embrace it

MJ:

I love it.

Matthew Jarvis’ Action Items For Financial Advisors [21:50]

SJ:

All right. Well, Matt, similar to The Perfect RIA. We like to make sure that we are taking the information we were sharing and turning it into action. So there’s real value. So let’s talk about some action items from this conversation we’re having. I’ll let you go first.

MJ:

Yeah, my action item number one for all things tax planning is, and we’re used 8606. That’s a specific example. Any time I’m attending a conference, anytime I’m with other advisors that I respect, whose practice I respect, I ask them, how do you handle this situation with your clients and prospects? So I would say specifically 8606, how do you deal with a client or prospect that has nondeductible contributions report on their 8606? Now two thirds of the advisors I ask might say, I have no idea. What do you do? That’s fine, but some advisor, and there’s going to say, aha, you know what I do. I open a solo 401k plan for them and I take care of this. We’re gonna talk about on Wednesday. Wow. That’s what I need to know. So my action item number one, those people that are meeting with clients, ask them how they handle certain tax situations. Yeah.

SJ:

I love that. I’ll kind of combine these two, but so that you’re taking specific action related to this topic, review your CRM for clients who are over the income limits for making deductible IRA contributions, and also make sure that you’re reviewing your client tax returns for that form 8606. So these together, you’re looking for specific clients who this applies to so that you can narrow down your focus and that you’re not wasting client meeting time talking about 8606 with clients who its never going to be applicable to yeah.

MJ:

Now if your CRM does not report this right, which most of them don’t holistic plan is a great option for that. If you’re not versed in taxes and you’re looking kind of for an easy solution, great tool to, uh, to look out there and use in fact, but I know that retirement tax services will be rolling out their own tax tool shortly because I’m on the development team for that. So I’m really excited to see that come up.

SJ:

Yeah. We’re going to talk more about that on Wednesday as well. So our last action item then is to make sure you attend this webinar that we’re hosting on Wednesday, September 22nd. We’re going to dive more into this specific topic. And then we’ve got some really exciting announcements about things coming out for our members and for new members related to retirement tax services. So to get signed up, you can go to our website, retirementtaxservices.com. You can click on the link in the show notes, or just go ahead and send an email to advisors@rts.tax with the subject line of webinar. And we’ll get you signed up.

MJ:

Love it. Hey Steven, thanks so much for having me on the show and to all of our advisors listening that 8,606 can be a powerful tool or it can be a giant headache. Really just depends on how well versed you are with strategies on both ends of that spectrum.

SJ:

Thanks for being here, Matt. I really appreciate it. Thanks everybody for listening until next time. Good luck out there. And remember to tip your server, not the IRS.