2023 EP0318 | Financial Updates | 5 Reasons You Should Consider a Roth Conversion Now

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Peter, good to see you. Today we're talking about five reasons people should consider a Roth conversion now. And I was telling you, I started coming up with this topic and the reasons just kept growing and growing because we've talked before about the real tax benefits of Roth accounts.

So let's walk through those reasons. Many financial experts believe that the Tax Cuts and Jobs Act of 2017 reduced federal income taxes to the lowest level they may ever be. So as we take a look at where we are right now, which is historically low, that's a pretty strong argument to pay those taxes now. Yeah, indeed. And you know that I love this topic and Aaron, you're on top of it talking about the expiration of the Tax Cuts and Jobs Act.

I talk about that all the time. And I love when we do these topics that are sort of like the David Letterman top 10. Because people need to remember when we bullet point the issues or the reasons why. So top five reasons to consider Roth IRAs right now. Number one is that Tax Cuts and Jobs Act is set to expire if nothing else is done. So all of the politicians could actually say, well, I didn't increase taxes, but yet taxes might still increase and if nothing is done, they will increase. We are at historically low tax levels. And Aaron, you're throwing a great graphic up on the screen right now, which actually shows the highest marginal tax rate. And we can see that it's at one of the lowest points since the 1930s.

They have been much, much higher. In fact, the reason why Ronald Reagan got into politics in the first place is that he was paying an above 90 percent tax rate if he made more than three movies in a year. But that's actually not the effective tax rate that most Americans pay. That's the highest marginal rate. The effective tax rate that most Americans pay is significantly lower.

Another great graphic on the screen showing that. And again, at the lowest point it's been since the 1930s. Now, over the course, the lifespan of most of today's savers and investors, taxes have come down.

And we've been told that they would, right? We started saving in those 401ks under the thinking, under the belief that taxes would be lower in retirement in order to be in that highest effective tax rate. In 1986, you only had to be making about $68,000. That was the 39 percent bracket. Today, our highest bracket's the 37 percent. And you have to be making near $600,000 to get into that bracket.

However, I think we're at a pivot point here, Erin. And $31.5 trillion in debt and clocking every second. We've got to come up with some revenue somewhere. And the more than $30 trillion in yet-to-be-taxed, tax-deferred retirement accounts have a big bullseye crosshair on them. So why not take advantage of the next several years where we know what our tax rates are and we can look back with historical perspective and say, wow, taxes are a pain, but it's still historically a low, low rate. And it's a compulsory purchase, right? If we look at this, it is mandatory that sooner or later we must pay taxes.

So why not pay them now while they're on sale, essentially, Erin? Right. The next point here, there is a silver lining to all of our depreciated portfolios right now. We can pay taxes on a smaller value now and then allow that future growth to happen tax-free. Yeah, you are a glass half full kind of girl, aren't you?

Yeah. This is the optimistic look at a negative kind of situation. Nobody loves seeing losses in their portfolio value. But number two reason here on why to consider Roths or Roths conversions is that when there is a lower balance in the account, there is a lower tax bill. Nobody likes seeing their retirement accounts lose value.

Nobody likes seeing down markets, but looking for the good and the bad, looking for the opportunities as every investor should do. There's one significant opportunity right now, and that is to go ahead and realize that tax liability and pay it while the account value is down to pay a lower tax bill ultimately on the account balance. Okay, now we're going to talk about backdoor Roths. High income earners are prohibited from contributing directly to a Roth IRA. Instead, those investors fund a traditional IRA and then convert that IRA to a Roth. That strategy is known as the backdoor Roth. So while this legislation has not become law, there were rumors in the Build Back Better Act that they were going to eliminate backdoor Roths.

So is there an expiration on these? Should we be considering them now? Well, there is not necessarily right now, but it is discussed and the Build Back Better was not the first time it's been discussed. It has been discussed almost every year on whether or not we get rid of the backdoor Roth conversion. It's really one of the most arbitrary, nonsensical set of rules.

I guess you could say that about a lot of things about the government, but this one in particular is especially asinine and arbitrary to me. It's that if you earn less than a certain amount, you can put money directly in your Roth IRA. If you earn more than a certain amount, you can't, except that you can. It simply takes two days instead of one. You put the money into a non-deductible traditional IRA and then immediately thereafter convert it over to the Roth IRA. Net-net, it accomplishes the same thing and the fact is, Aaron, that they have not only not disallowed this or banned it, but they have legitimized it by not doing it and yet discussing it repeatedly, basically reinforcing the fact that this is an absolutely legitimate strategy.

Now, I do throw a word of caution to those that may consider this. A, higher income earners, right? You are going to have to pay tax because it's a non-deductible initial contribution to your IRA. You can't deduct that. And when you are executing that second step, the conversion over to the Roth, it's not just those dollars that you put in that are considered. If you've got a balance in that traditional tax-deferred IRA, they look at the conversion only as proportional to your total existing balance. So, just for very simple math, if I have a $100,000 traditional IRA and I want to do this backdoor conversion, I could contribute $6,000 as a non-deductible contribution. But when I convert over that $6,000, they're only going to look at that as a 6% of it being the after-tax contribution I just made and so the 94% of it might be taxable again. So, just be cautious and what we are doing is rather than making that contribution, that $6,000 might be able to afford to convert over a much more significant portion of the tax-deferred IRA balance if you have one. So, that's a lot of information there, but very, very important that you look at this specifically for your situation if you want to consider it. And I am saying that you should consider it, right? It's a great time to consider it.

Here's the fourth reason why you should consider it. Congress eliminated the lifetime stretch IRA rules, which essentially eliminated the option to pass along generational wealth. However, assets in Roths are not subject to probate and can be passed along to your heirs tax-free. Yeah, so through the original SECURE Act back in 2019, it was enacted in 2020. You're right, Congress basically said that retirement accounts are not generational wealth transfer tools. They reinforced the fact that your retirement account is for your retirement and ended the stretch IRA. Now, I talked to a lot of people that seem to be worried about the death tax or the estate tax.

Honestly, the levels right now are so high and even if you've got a significant amount of wealth, there's the possibility of taking advantage of today's levels, which if you sort of meet that criteria or think that your wealth is going to grow to a point that you might encounter that. Again, this is something to take advantage of today, but most people won't experience the death tax or estate tax, quite honestly. However, if we've got money in traditional tax deferred accounts, traditional IRAs or 401ks, you haven't even paid income tax yet.

And so it is a pay me now or pay me later. And if you don't pay that income tax, then your heirs and beneficiaries will. And what the end of the stretch IRA said is that they will pay that over a much shorter period of time, increasing the amount they have to distribute to themselves each year over a shorter span, and therefore likely pushing many beneficiaries into even higher tax brackets. It is a significant advantage and opportunity to look at managing the taxes, not only on your lifetime income withdrawals from those IRAs, but what you may end up leaving to beneficiaries.

Okay. And then the fourth reason, excuse me, the fifth reason, Roth accounts don't have any required minimum distributions. And I had toyed with putting this on our list or not, Peter, because they never had RMDs. I know that there's a rumor that they will have RMDs, but you're saying, no, this is still a timely reason to consider a Roth. Why? Yeah, it is.

And you're right. They don't have those required minimum distributions during our lifetime. And that's the key here is that there is no incentive for Congress to say you must pull that money back out of your account because it's not going to be taxable as income when you do. But man, oh, man, would they like that money back in taxable circulation?

And when's the best time to do it? When the person who owned it and made the original arrangement with the IRS is no longer around to complain. So that benefit does not pass on generationally. And there is an RMD, in fact, on Roths, Aaron. And it is that Roth accounts, just like traditional IRA accounts, must be liquidated by a beneficiary, second generation beneficiary within 10 years of receiving and inheriting that balance.

Now, it won't be taxable, but it does require that you liquidate 100 percent of the balance within that 10 year period and get that money back into taxable circulation so that it can't keep growing and growing and growing tax free. The IRS wants to collect their money some way, somehow. And even with those dollars that we've made the arrangement to be tax free forever, they've got a plan for how to get it a few more dollars of tax out of those accounts eventually.

That seems to be the theme that is running through all five of these reasons, Peter. Yeah. Manage that tax bill. Manage that tax bill now. So if somebody wants to talk to you about any of these strategies, what's the best way to reach you?

Yeah. And I encourage you to do so because this may be one of the best financial opportunities over the course of the next several years, not just a tax opportunity, one of your best financial moves and considerations. So if you are not talking about this, please give us a call or give somebody a call and have the conversation about controlling and managing the tax liability on your retirement accounts and tax deferred assets. If you'd like, you can reach out to us.

Nine one nine three zero zero five eight eight six nine one nine three zero zero five eight eight six. You can email me, Peter, at Rishan planning dot com. You can visit the website rich on planning dot com is what it looks like. Rishan planning dot com. And we've got the ability to run some pretty sophisticated illustrations on converting to Roth versus not converting to Roth.

And what the expense of either looks like. And it is it is shocking most of the time how much we can control that tax liability that none of us love to think about. That's what we should do next, then. Peter, thank you very much. Absolutely. Always pleasure.

And thank you. This has been planning matters radio. The content of this radio show is provided for informational purposes only and is not a solicitation or recommendation of any investment strategy. You are encouraged to take investment tax or legal advice from an independent professional adviser. Any investments and or investment strategies mentioned involve risk, including the possible loss of principal advisory services offered through Brooks own capital management. A registered investment adviser fiduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance or broker dealer services. Advisory clients are charged a quarterly fee for assets under management while insurance products pay a commission, which may result in a conflict of interest regarding compensation.