All About IRAs

February 19, 2021
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Finance With Frank Podcast Transcribed:  To listen to audio, click the link to go to our podcast pagehttps://financewithfrank.simplecast.com/episodes/all-about-iras

Frank Tehel:

Hello, and welcome to Finance with Frank. My name is Frank Tehel. Yes, I am a certified financial planner and a fiduciary. I work with October Effect Ltd, which is a registered investment advisor in the State of Virginia. My home office is in Virginia Beach. I work at Town Center, which is in the center of the city. And we do a free consultation, call us directly at (757) 390-3339 and you will be able to talk with myself or my staff.

Frank Tehel:

Today we're going to address IRA accounts and continuing the conversation from an earlier discussion. They are qualified money, but for special reasons. Jon is with me. Jon, say hello to the group.

Jon:

Hello to the group. Hi, I'm excited to talk about IRAs today, Frank, because it's a topic that a lot of people have heard about, and I know a lot of our listeners have questions about. So let's jump in.

Frank Tehel:

We want to do that. The direction we're going to go, and in an earlier discussion we talk about what's qualified money and what's non-qualified money. And in that discussion we learned that qualified money came out of tax deferred vehicles.

Jon:

Mm-hmm (affirmative).

Frank Tehel:

Non-qualified money already had the tax paid on it. Well in that discussion we said that qualified money had to come from a ERISA account. And we talked a little bit about the history of 403(b)'s and the history of 401k's. Well, there's a little bit of history to IRAs as well.

Jon:

Okay?

Frank Tehel:

And as this idea of retirement became a bigger and bigger movement in the community, and we're talking about the entire United States as a community. They meaning those in Washington realized many people did not work for a company that had a retirement program, and retirement programs were expensive. And then you have to tie that in with one of our former California actors turned president, one Ronald Reagan.

Jon:

Indeed.

Frank Tehel:

Ronald was a really good president, but he changed everybody's retirement life. And he did that when the air traffic controllers went on strike.

Jon:

Right.

Frank Tehel:

He told him to go home, and that ended their defined benefit plan. And that opened the doors for many companies to end what were called defined benefit plans. And defined benefit plans was that plan where if you put in X number of years, you would get a percentage of your salary for the rest of your life. The companies found those were very expensive. And about the time that Reagan was president, many companies were derelict in funding those pension plans, and it looked like they would never pull it out. And it looked like it would cause the companies to go out of business. And so rather than going out of business, the companies went out of business. What do we mean? They went out of business to go out of business, or to not go out of business.

Frank Tehel:

What they would do is they would close down one company and be bought out by another smaller company that did not have a defined benefit plan. And so they would get out from under the liability of the defined benefit plan, and then the company could survive.

Jon:

That's really interesting to have to work that system.

Frank Tehel:

Well, they created something at that time what the IRS called an individual retirement account.

Jon:

Okay, there we go.

Frank Tehel:

The IRA accounts came about as these other plans were disappearing while they created the 401k, which is a defined contribution plan. Meaning the money in the 401k came out of the employee's pocket with the employer putting in a little contribution. Then the IRA accounts were created where if you had no retirement plan, or your employer was under funding your retirement plan, or your income was of modest level, you could have both. You could have a company 401k and you could put money into your individual 401k. Then they expanded it to the spouse. Back in the '70s we still had a lot of spouses that were stay-at-home moms.

Jon:

Right.

Frank Tehel:

IRA accounts then could be set up for that stay-at-home mom, where you could put money into an IRA account for that person to have a retirement income, and so that became popular. And so the original retirement plans and the original qualified and non-qualified money was a function of an ERISA document. The IRA accounts were part of the Internal Revenue Service Code. It's actually part of the code itself. So it has a different feel from the 401k plan. It has a different set of rules, but the money in most cases is still pre-tax, meaning you put the money into your account, you get to reduce your taxable income by the amount of money you put into the plan. And then it grows tax deferred until you start taking money out of the plan.

Jon:

Got it, okay.

Frank Tehel:

And so that was the basis of the individual retirement account. And I think the original contribution limit was $2,000. $2,000 for you and $2,000 for yourself each year. And everybody's going, "Well, it's going to take me a long time to put a lot of money into that 401k or into that IRA account." 20 years later you've put the $2,000 a year contributions into it. You actually bought stocks rather than bonds. And the portfolio is now four times what your original contribution was, and it's a lot of money.

Jon:

Yeah, absolutely.

Frank Tehel:

Now we get into the IRA alphabet soup. So, as we saw the 401k become popular, the IRA became popular right behind it. And then all of the financial institutions wanted to get on board and be part of the IRA/401k money management business. What do we mean by financial institutions, Jon?

Jon:

That's what I was about to ask you. It sounds like those big boys on Wall Street that are interested in making some money.

Frank Tehel:

They are in the business of managing money. And at the time the IRA was enacted, the Glass-Steagall laws were still in effect. And so you had a separation of brokage business, banking business, and insurance business. They couldn't be owned by the same company.

Jon:

Got it, okay.

Frank Tehel:

Had to be three different companies. Now, in my own opinion, they should never have left that. We would have avoided the fiasco of 2008.

Jon:

Sure.

Frank Tehel:

But government always has a better idea. So, as the IRA became popular, we now have insurance companies wanting to sell IRA accounts. Well, they already have life insurance accounts, but that has no appeal. So they create something called an annuity IRA, which is just a, excuse the French, beat up life insurance contract that doesn't have a lot of death benefit, has a lot of cash value, and can be molded to fit the IRA rules.

Jon:

I see.

Frank Tehel:

So now they're able to sell IRA accounts. Well, if you go back in our discussion the other day where we talked about the 403(b), the original 403(b) contracts were almost entirely written by insurance companies as annuity contracts. And contrary does to current demigration of insurance companies, those original 403(b) contracts were efficient cost-wise.

Jon:

Okay.

Frank Tehel:

The cost were well within acceptable ranges. It's only over the last few years that this has been changed. So then you have banks being jealous. So they now create CDs that have IRA wrappers.

Jon:

They want in on the action.

Frank Tehel:

Absolutely. So now you can have a IRA at the brokerage count by stock. You can have an IRA at the insurance company, buy an annuity, it's insured and guaranteed. You can buy an IRA at the bank. It's in a CD. It has FDAC insurance. They're all different. They don't talk to each other. However, the IRS code that each of them is written from is exactly alike.

Jon:

Hah.

Frank Tehel:

In other words, they didn't each get a separate code. They each bastardized the same piece of IRS Code, which meant if you were an ingenious investor and you go down the road of, "I want to manage this myself." You could actually create a self-directed account at an online brokerage firm and move all the money from your broker IRA, all the money from your bank IRA, and all the money from your annuity IRA into that online brokerage IRA account.

Jon:

Hah, okay.

Frank Tehel:

Now we got Charles Schwab to thank for that.

Jon:

Talk to Chuck.

Frank Tehel:

He was the one who said, "You should have the right to do it online and do it yourself." Good, bad, or otherwise, small or big. He created that world. He created, if you remember in 2019, the next big evolution in online brokerage accounts. And what would that be? Free stock trades.

Jon:

Ah.

Frank Tehel:

Charles Schwab was the first one.

Jon:

I remember those Talk to Chuck commercials.

Frank Tehel:

Yes. And you have to understand, if Charles' stock trades are free, you got to have free stock trades or the money's just going to go away.

Jon:

Right. It disrupted the industry on that piece of it.

Frank Tehel:

Oh, completely disrupted the industry, and caused two or three of them to go out of business. And ultimately Charles Schwab brought TD Ameritrade, was the second largest one in the business. So now Charles Schwab is this monster. Anyway, so as we're looking at the demographics of IRAs, this thing continues to evolve. And what are some of the other issues that it had to deal with? Well, we had small businesses with multiple employees. They wanted to create an IRA account, but put money in from the company. So we now saw the SEP IRA be born, simplified pension plan/IRA.

Jon:

Now a lot of solopreneurs and small business owners look into those.

Frank Tehel:

Absolutely. They were actually dramatically different from the 401k, and the big driving differences that in a SEP IRA account, that IRA account is in the individual's name. There's no company tied to it at all. If we go back to our discussions when we were talking about pension plans, to qualify for that pension retirement, you had to be vested. What did vesting imply?

Jon:

You got to be with the company for so long, right?

Frank Tehel:

Absolutely. You had to stay there for some finite period of time.

Jon:

Five, 10 years, whatever it was.

Frank Tehel:

What were, and still are some of the best defined benefit plans that exist in 2021? The military.

Jon:

Yeah.

Frank Tehel:

Although it's changing all the time, and the government's still trying to find ways to do away with what they did. In the original government contract 20 years as an active service employee and you've got 50% of your pay.

Jon:

Wow.

Frank Tehel:

30 years you've got 75%. I had a good friend of mine who somehow was 16 and a half when he was asked to join the Navy, or go some other place that he didn't really want to go.

Jon:

Sure.

Frank Tehel:

So 30 years later he can retire at 75% of his Navy pay? And he's a master chief in the Navy. That's a really amazing income. And he then qualified for social security.

Jon:

Wow.

Frank Tehel:

And at 39 he could go out and get another job.

Jon:

49, right?

Frank Tehel:

49, right. 16 and 30 was 49.

Jon:

Yes, okay.

Frank Tehel:

But that's still 20 good years to now develop a whole nother pension plan. So the IRAs then continued to evolve. We saw SEP IRAs come into existence. We saw educational IRAs come into existence. We saw simple IRAs come into existence. What's the difference between a simple and a SEP? Well, in the SEP program there were hang over regulations from the pension/vesting cycle as to how much you could put in a plan for anyone person, and how much you could put in for the owner of the company.

Jon:

Okay.

Frank Tehel:

In the simple there were certain benchmarks that if you met those benchmarks, you could maximum fund for the employer and not have to test for the employees. So each one was designed with its own set of bells and whistles to accomplish certain needs. Well, they're not done. So then someone comes up with this great idea in government that, "Oh, we need a Roth IRA. Well, why do we need a Roth IRA? Well, some people don't want to have to pay taxes on the distributions out of the retirement account. So they're willing to put money aside as an after tax contribution into the retirement account called a Roth IRA. And then it goes forward and it's never taxable. It grows to whatever amount it grows to. It transfers on death to your children, and it's never taxable income.

Jon:

Pay the taxes on the way in instead of the way out.

Frank Tehel:

Correct. What's fascinating is that that Roth IRA plan actually existed in another form basically at the time the constitution of the United States was signed.

Jon:

Really?

Frank Tehel:

Yes. You have to understand. Insurance contracts were created by the Phoenicians to move freight around in the Mediterranean in like 500 BC. So insurance is not new. And if you have a life insurance contract, you put after that tax dollars into your life insurance contracts, it grows tax deferred. If you take the money out as a loan, it's not taxable. If you die, you take the money out and it's not taxable. How's that different from a Roth? I mean, it sounds the same. It feels the same. It's so much alike it's scary.

Jon:

I have a feeling you're going to explain it?

Frank Tehel:

It's not different, it's exactly the same. The differences are you can only put amounts into the Roth equal to the IRA maximum contributions. You can put as much as you want into a life insurance contract.

Jon:

Got it, okay.

Frank Tehel:

So you can put only $5,000 a year into your Roth. You could put $50,000 a year into your life insurance contract. And then they changed the life insurance contracts and they introduced something called variable universal life.

Jon:

Oh, boy.

Frank Tehel:

Where you can now buy stocks in your life insurance contract. And now we're in the year 2021 and everybody's socially adapted. And so now we can index everything. And so you now can have index variable universal life. The only person that wins with an index variable universal life is the attorney who wrote the contract.

Jon:

Billable hours.

Frank Tehel:

Billable hours, because neither the agent nor the company, and certainly not the investor can ever figure out what's really going on in any indexed product. So we're running out of hours. Let me finish up with some of the rhetoric that you really need to get your arms around. And this is exactly the reason why you need to call me.

Jon:

Yes.

Frank Tehel:

Call and set up a consultation, either Zoom or in-person. Call us directly at (757) 390-3339 and we will find that time. Here is the current rhetoric for IRAs. You can have an educational IRA, a traditional IRA, a Roth IRA, a SEP IRA, a simple IRA, a rollover IRA, a beneficiary IRA, a consolidated IRA, a 72(t) distribution IRA. Isn't that amazing?

Jon:

My head is spinning as you've ticked down that list, Frank.

Frank Tehel:

And it started with one account. Call your advisor, have a conversation.

Jon:

If you are on the fence about talking to an advisor, I think over these last 20 minutes, Frank, you have explained why it is so important to talk to somebody that can translate all these terms for the average investor, and really have them understand what the best vehicles and tools are for themselves. Because again, every individual situation of course is different.

Frank Tehel:

It really is. And I look forward to hearing from you.

Jon:

All matters discussed during this show are for informational purposes only. Opinions expressed are those solely of October Effect Ltd and staff. All topics covered are believed to be from reliable sources. However, October Effect makes no representations as to its accuracy or completeness.

Jon:

This podcast shall in no way be construed as a solicitation to sell securities or advisory services to residents of any other state than the State of Virginia, or where otherwise permitted. Topics should be discussed with your individual advisor prior to implementation. Advisory services offered through October Effect Ltd, a registered investment advisor in the State of Virginia. October Effect Ltd is not affiliated with or endorsed by the Social Security Administration or any government agency.