We Fix Bad TikTok Advice
By J.R. Robinson, Financial Planner (September 3, 2024)
The past decade has seen the rise of the “finfluencer” – a person who uses social media to share financial advice with followers. This movement originally started on weblogs and expanded to YouTube, Instagram, and TikTok. The idea of people with no formal academic or professional financial planning experience anointing themselves as personal finance experts is hardly new. Robert Kiyosaki and Dave Ramsey have built financial empires out of providing questionable financial advice to consumers for decades. What is different, however, is the shear number of finfluencers that social media has spawned, particularly on TikTok.
A common thread among many TikTok personal finance gurus seems to be that they seek to establish credibility by flexing knowledge of tax planning rules. Another common thread is that they often fail to understand the nuances of the concepts they are presenting and end up giving advice that is potentially harmful to their followers. This has come to my attention because I receive a fairly steady stream of calls and emails that begin with, “I heard on TikTok that…” In this essay, I highlight the bad advice phenomenon by featuring several TikTok videos promoting backdoor Roth IRA conversions.
“Backdoor” Roth IRA Conversions are a Popular Topic on TikTok
This strategy enables people whose high incomes preclude them from being eligible for Roth IRA contributions to exploit a popular tax loophole to still get money into a Roth IRA each year. It involves making a non-deductible traditional IRA contribution that is immediately converted to a Roth IRA. By funding the traditional IRA contribution with after-tax money, the Roth conversion may be tax free. This two-step process effectively provides a legal “backdoor” way to get money into a Roth IRA.
However, there are a number of key elements to this strategy that often go unmentioned in the TikTok videos. One is that the non-deductible contribution must be recorded on IRS Form 8606. Another is that the non-deductible IRA contribution cannot be made in the same tax year as a deductible IRA contributions. A third extremely important and often overlooked backdoor Roth rule that is that the conversion of the non-deductible IRA is only tax-free if the taxpayer has no other pre-tax IRAs. If the taxpayer has pre-tax IRA money in a traditional IRA, Rollover IRA, SEP IRA or SIMPLE IRA, the conversion will be taxable on a pro-rata basis in proportion to total value of all the taxpayer’s IRAs. Failure to properly report the conversion may result in taxes and penalties. These rules are described in greater detail in the following two articles –
About Form 8606 (IRS.gov)
Backdoor Roth IRA Baggage (TheSlottReport)
A Few Examples of Misguided TikTok Backdoor Conversion Advice
Here are two examples of TikTok videos offer in naïve backdoor Roth conversion advice –
https://www.tiktok.com/@humphreytalks/video/7003776427636067589
In these videos, neither TikToker mentions IRS Form 8606 and both appear to be unaware of the pro-rata rule. In the first video, the TikToker, Humphrey Yang, incorrectly refers to the conversion as a rollover.
It bears mentioning that a legal way to get around the pro-rata rule may be to transfer pre-tax IRA money into a qualified retirement plan such as a 401(k) or 403(b) prior to processing a backdoor conversion. For more on this, read: Backdoor Roth IRA? Avoid these 5 mistakes (Morningstar)
Here is another backdoor Roth conversion fail from a TikToker using the moniker “007ofwallst” - https://www.tiktok.com/@007ofwallst/video/7366683753193737514
I included this one because 007 adds a unique twist to his misinformation. Instead of making an after-tax contribution, 007 suggests making a pre-tax contribution to a traditional IRA and then immediately converting to a Roth IRA and paying tax on the conversion. First, not everyone is eligible to make pre-tax IRA contributions. Second, he seems oblivious to the permissibility of non-deductible traditional IRA contributions.
And the Award for the Worst TikTok Backdoor Conversion Advice goes to…
https://www.tiktok.com/@campgagnon/video/7340806116810558763
When I first saw this video, I thought this might be a parody video. Sadly, the speaker appears to be sincere in his beliefs and guidance. There is an awful lot of bad advice to unpack here. First, the perception that everyone should convert pre-tax IRA and 401(k) money to a Roth IRA regardless of tax bracket does is ludicrous. If you are already in a high federal marginal income tax bracket (e.g., 32% or higher) and you anticipate that your tax bracket upon retirement may be lower, it is probably not a great idea to process a Roth Conversion. The speaker’s advice that pre-tax contributions are “stupid” and that conversions are advisable even at the 37% federal tax rate are not empirically supported. Additionally, the conversion of pre-tax 401(k) money to a Roth IRA is not a “backdoor conversion” it is just a regular Roth conversion and it is not subject to 10% IRS early withdrawal penalties. In fairness, I believe the TikToker who recorded this piece has carved out a niche in posting outrageous commentary. Nonetheless, this a video that has thousands of likes and comments.
For related reading on the merits of Roth Conversions at higher tax brackets, read –
Limits Of Tax Diversification and The Tax Alpha Of Roth Optimization (Kitces.com)
When is a Roth conversion beneficial? (Journal of Accountancy)
Parting Thoughts – Did TiKTok Finfluencers Eliminate the AI Threat to Financial Planners?
In closing, as entertaining as this exercise in highlighting awful financial planning guidance on TikTok has been, tax planning rules are complicated and even professional financial planners (myself included) sometimes make mistakes and oversights. It is for this reason that in my written commentary, I provide links to high credibility sources that support my positions. In this article, I have cited Ed Slott, Kitces.com, IRS.gov, Journal of Accountancy and Morningstar as high authority sources.
As a point of related interest, I have written two articles in the past year chronicling my frustrating experiences in using generative AI to assist with content creation for the Financial Planning Insights newsletter and blog.
Why Financial Planners Have Nothing to Fear from AI
A Financial Planner Takes Chat GPT for a Test Drive
My frustration stemmed from my observation that ChatGPT had a surprising predilection for churning out bad planning advice. In producing this article, it dawned on me that if the AI search algorithms are using crowd sourcing to produce content and a preponderance of the content is sourcing is produced from low domain authority sources such as TikTok videos, then bad advice in AI generated content should be no surprise. Simply put, if the prevailing wisdom is wrong, then AI generated content will likely be misguided too.
This sentiment is echoed in a recent white paper on the impact of generative AI on journalism titled, “Generative AI brings Wrongness at scale.” An excerpt from the paper reads,
“For all its promise, generative AI can get more wrong , faster - and with greater certitude and less transparency - than any innovation in recent memory.”
From this perspective, not only do financial planning professionals have little reason to fear being replaced by AI, but perhaps we owe a debt of gratitude to TikTok finfluencers for quashing the AI threat.
John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru and the new personal finance website NestEggPF.com.
