From the Desk of Podcast
Coffee, Tea, Taxes, and Roth Conversions


Allen Gillespie: Welcome. My name is Allen Gillespie, and I’m the Chief Investment Officer for FinTrust Capital Advisors and today’s host. You’re listening to FinTrust: From the Desk of Podcast; our podcast about markets, life, and things financial.

As we end the second quarter and approach the July 4th holiday, I thought we might focus today’s podcast on coffee, tea, and taxes. Globally, tea is the second most consumed beverage after water. In the United States, however, only 25% of us drink tea, while 50% of us drink coffee. I, myself, consume two to three cups of fully caffeinated coffee daily. It all makes me wonder, why do Americans consume so much coffee? In researching the root cause of America’s anomalous tea versus coffee consumption pattern, I was led directly to the issue of taxes in the American Revolution. In the years just prior to the signing of the Declaration of Independence, the British Crown sought to pay for the defense of the colonies through taxes on everyday items like paper, china, and tea. The colonists, however, began to reach their breaking point with the Tea Act of 1773, which sought to raise £40,000 from tea taxes. In response to this increase in taxes without representation, the Sons of Liberty led a revolt or threw a party in Boston Harbor, depending on one’s perspective. During the Boston Tea Party, the Sons of Liberty, pitched 342 chests of tea into Boston Harbor, and American tea consumption patterns have never been the same since. After the Boston Tea Party, American patriots, began switching from tea to coffee as a form of tax protest. My coffee habit research also found that years later, President Andrew Jackson would accelerate America’s coffee drinking trend. First, he reduced coffee tariffs, and later, he ordered that the army substitute coffee and sugar for a soldier’s daily rations of rum and brandy, citing complaints from military officers of insubordination and accidental injuries from overindulgence. With this modification, the importation of coffee into the U.S. rose from 12 million pounds to over 38 million pounds per year. Coffee became the alternative to alcohol consumption, helping soldiers refuel, stay focused, and push through difficult situations. Today, coffee is one of the most traded commodities in the world, and the global coffee market is valued at over $100 billion, and it is expected to grow to $155 billion by Starbucks made coffee a lifestyle brand by becoming that third place between home and work, and other companies and brands that compete for our coffee dollar include Dunkin’ Donuts, McDonald’s, Tim Hortons, McCafé, Nescafé, Folgers, Keurig, and Maxwell House. After the worst first half of the year for the stock market since 1970, I think most of us could use a little caffeinated pick-me-up before we pitch our stocks and bonds overboard into the harbor to protest the inflation tax which has descended upon the nation. So, with me today to discuss better forms of tax protests are FinTrust Director of Financial Planning Cassidy Murphy, and Will Kibler, Investment Advisor with FinTrust, who works with retirement plans, retirement plan participants, and personal wealth clients.

Allen: Will, the first half of the year has brought declines in nearly every type of asset apart from oil, stocks, and cash. Both stocks and bonds are down, so diversified portfolios are off their highs. At this mid-year, what are some of the things investors should be considering?

Will Kibler: Let’s talk about the easy stuff first. First, it is not atypical for markets during midterm election years to show early weakness. Historically, markets then recover from midterm election year lows to higher prices the following year. Next, don’t wait until the year-end to tax loss harvest. Investors should be seeking smart assets to maintain their exposure while booking the tax loss asset. This might help save some money down the road if prices recover. Another option for investors to potentially benefit from the market downturn is to do what’s called a Roth conversion. Cassidy, how does a Roth conversion work?

Cassidy Murphy: Yeah, of course. So, the thing about a Roth conversion is that your goal is ultimately to take money out of a pretax retirement account, so think of a traditional IRA, and you’re moving it into a Roth IRA wrapper instead. Now, the benefits of the Roth IRA are that you’re getting tax-free growth there because you’re paying the taxes upfront with that conversion, which allows the funds to then grow tax-free, and then they’re ultimately tax free later on when you withdraw them. This can be particularly advantageous in helping you save money for when you’re retired if your retirement tax bracket would be higher than where you’re at currently. And that is especially common for people with large pensions that are going to pay out or deferred compensation, or even people with really significant IRA or 401(k) balances that might eventually be forced to take out really large required minimum distributions, later on, all of which is going to be taxable at that point in time.

Another benefit can be if you’re not really sure what your tax rate might look like in retirement, you’re removing that unknown by paying the taxes up front, you know, what you’re going to owe now, and then it’s growing tax-free, and you don’t have to worry about it. There’s another benefit to be said for just having more diversity as far as your tax flexibility, those tax buckets to pull from in retirement. So being able to have taxable pretax and tax-free options for where you want to pull income from later on is a big plus. And then I also like to remind people that Roth IRAs are really one of the best assets that you can pass on to heirs as well, if that’s a priority for you because they won’t enter into those income taxes on the Roth IRA funds when you eventually pass away.

Cassidy: As far as how the conversion itself actually works. So, like I mentioned, you pay those ordinary income taxes on the amount that you convert when you convert them, and what that does is it moves it into that Roth IRA wrapper where it can then continue growing tax-free. Now, this becomes a really beneficial idea strategy in a down market because you’re kind of really getting a discount on that conversion.

Cassidy: So, to put that into some numbers, let’s say that you’ve got a $500,000 IRA and you want to convert $100,000 of that into Roth. So you do that, you’re converting 20% of the balance into a Roth IRA to grow tax-free, and let’s say you owe maybe $30,000 in income taxes on that conversion. Well, if instead, let’s say the market is temporarily depressed, that balance drops to $400,000. That same $100,000 conversion lets you get 25% of that account out and growing tax-free, and your tax liability is the same. So, when the market eventually comes back up, all of that growth has now occurred tax-free in that Roth IRA rather than within the IRA, where it’s going to be taxed at higher rates later on.

Will: You mentioned paying taxes on the amount that you convert to the Roth account. What’s the best way for an investor to pay for the Roth conversion?

Cassidy: You know that’s a great question that’s often overlooked. And really, in a perfect world, the best money to use to pay taxes on the conversion is going to come from cash at the bank, cash reserves that aren’t already invested because any money used to pay those taxes becomes money that’s not going to be rebounding and growing tax-free. The next best choice would be taxable investments, particularly if you have something with high-cost basis or some assets that can be sold without generating significant additional taxes due.

And that way, you’re able to minimize your tax liability with the conversion but also maximize how much you’re able to set aside to continue growing tax-free.

Allen: Well, Cassidy and Will, thank you for joining me today, and thank you for that little financial planning pick me up. I feel much better, and I will certainly consider everything that you shared today over my next coffee. Thank you.

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