3 Considerations before Making a Roth IRA Conversion

Welcome back everyone.

Peter, very good to see you. Today we get to talk through three considerations before making a Roth IRA conversion. Roth accounts are such an amazing tool when it comes to creating wealth.

Roth IRAs are not subject to probate and they can be passed on to your heirs tax-free. So if you are considering a conversion, here are a few things you need to think about first. What will your future tax rate be? And we talk about it now, Peter, taking a quick look at the rates that we are in right now.

Yeah. You have to future forecast here and what are your tax rates now versus what they may be in the future. And at a certain point in time, you have to also forecast out what the government is going to require your income to be in the future because of RMDs. We are, after all, talking about Roth conversions and a lot of people do this during their working career. Well, if you do that, then you got to look at your income now versus what your expected retirement income is going to be, right? Because retirement is not about replacing 100% of your working career income.

Retirement is about withdrawing only what is necessary to cover your comfort and lifestyle in retirement. And a lot of people have a big delta and disparity between the income that they're earning today might be significantly higher than what their actual expenses are, even with inflation projections between now and retirement. So are you going to significantly drop your income once you retire? I've got clients who are earning a pretty substantial amount, a healthy income today, and in reality, they don't need all of that income. They're saving and investing a substantial portion of it. So that tells me that their actual living expenses are quite lower.

You've got to forecast that out. You've got to do the math and say, well, does it make sense then if I'm going to be drawing out income later at a much lower rate than I'm earning it now? Am I in a significantly higher tax bracket today than I can forecast being in retirement? But the reality is most people aren't. So most people are in about the same tax bracket because they're pretty wide. Most people are in the same tax bracket today that we can likely forecast them being in retirement. But do those tax brackets remain the same between now and retirement? And a lot of people don't think they're going to stay the same. A lot of people think that taxes are going to go higher. And I'm sure we'll talk about the tax law and bracket changes that are already on the books that tell us taxes are going to be going higher. And then in addition to that, a lot of folks make these considerations for Roth conversions after they have retired.

Right. Because now their income is lower. And so they may be in those low tax brackets. Does that make it a good time to do these Roth conversions? Well, we've got to consider there not only what the tax bracket and the income that we have is today, but even if we might push that up a little bit today and pay higher taxes, does that make sense not only with those tax law changes that are on the horizon, but with the forced distributions that we project that we are going to have to take due to RMDs required distributions? The government is going to force you to take extra income.

Is that going to push you into higher tax bracket? So just a lot of math goes into this, Erin, a lot of projection. But there are some pretty good baselines that we can use to do those projections with pretty high level of competence.

Right. And we will get into all those taxes that you were hinting at later. But first, I want to talk through another consideration, which is you need to determine when you need access to those funds. Yeah, because when you're doing those Roth conversions before a certain age, there is a five year hold period.

Now, that has to go into the consideration here. If you are younger than fifty nine and a half, you probably are going to be deferring for five or more years regardless. And if you're older than fifty nine and a half, then the true value of doing the Roth conversion is not in the conversion itself.

That's actually an expense. So the true value of doing the Roth conversion is in the growth that happens thereafter. So it still should be if you're if you're considering this, it should still be mentally a long term time horizon before you intend to use those dollars, because the growth after you do the conversion is tax free and you want as long for those tax free dollars to grow for as much as possible. So really, I mean, even though that five year look back period does does end, I still think that when you're conducting a Roth conversion, five years should be the minimum that you plan to hold those dollars. And really, that should be the last bucket of money that you intend to use and utilize. Theoretically, with just a couple exceptions, if you retire early or you're looking for something to fill in the doughnut hole so that you can can cover health care costs between maybe when you retire in Medicare age.

There are a couple exceptions, as there are with everything in the financial world. But for the most part, Aaron, five year hold period or not, when you convert dollars to Roth mentally, you should be prepared to hold those dollars for the long term, because that's what gives them value. That's what is the cost benefit, the benefit side of the cost of the taxes of doing the Roth conversion.

And then one really important consideration. Somebody is going to need to pay the tax, right? It's either going to be you or it's going to be your beneficiary, which means you need to consider your beneficiaries future tax rate. Well, yes, except that for those tax deferred accounts, oftentimes if you have not paid tax during your lifetime, the IRS ends up being the largest beneficiary. Right. So your other beneficiaries, yes, they are going to have to pay the taxes that you had deferred and delayed, not paid during your lifetime.

And you know what? I get it. I've got some people that say, well, I'm leaving my children or grandchildren or beneficiaries this money that they didn't work to earn. I don't want to pay the taxes on it. If I leave it to them, that can be their problem. They'll just pay the taxes on it.

And I get that. But at the same time, all that money that you worked so hard to build that you didn't end up needing during your lifetime and then eventually are going to leave behind. You probably don't want the IRS as your largest beneficiary. And that's what might end up happening if you are not proactive and strategic in managing that tax liability.

So you leave that money behind and you say, well, I'm leaving money. I'm going to leave the tax bill as well. I don't like paying taxes, but you pay taxes. The dollars pay taxes regardless. So why not get that bill on the dollars down as low as possible and make it so that the IRS is not your largest beneficiary?

All right. Let's get down to brass tax, because we have to consider this when making this decision. We are living in a historically low tax rate right now due to the Tax Cuts and Jobs Act of 2017.

A lot of experts believe it reduced federal income tax rates to the lowest level they may ever be. And these cuts, Peter, as you know, are set to expire at the end of 2025. Again, we are all speculating here, but here is also a look at projected twenty twenty six income rates. Yeah. And the 12 percent bracket becomes the 15 percent bracket. So this is not just on the wealthy.

Right. The 12 percent is like the second lowest bracket. Only only a few dollars fall below the 12 percent bracket. Twelve percent going to 15 percent doesn't sound like a huge increase.

Oh, that's only three percent. That is a twenty five percent higher bill on those dollars. So that's that's like seventy thousand dollars for a married couple filing jointly thereabouts that would have a twenty five percent tax increase on it.

And really, for married couples filing jointly for the first two hundred thousand dollars or so of income, it's about an 18 percent higher tax bill. And there is speculation, Aaron, on whether or not that is actually going to hold true, whether we're going to see some extension of the twenty seventeen tax cuts and jobs act, regardless of who ends up in the White House. There's got to be some agreement and compromise that I don't think we're going to see happen for those tax increases not to occur. So in other words, there is already law on the books that the current tax rates sunset and go back to those former ones. Now, in order for that not to happen, new tax legislation would have to be proposed in Congress, passed by the House, passed by the Senate and then approved by the president. And those three branches just don't look as though they're going to all come together and kumbaya and agree on tax legislation. One side says that they're not going to extend them. The other side says that they'd like to, but they need to agree on on on things and compromise on them. And I just I don't see a lot of hope for that happening. Plus, we've got expenses we've got to cover as a country and ultimately we've got a debt and deficit that keeps growing exponentially.

Right. That we're going to need to collect more taxes down the road. So my concern, Aaron, is not for the coming tax code change, which I do think is going to happen.

It's not really in my mind to probably it is already law on the books. I don't think anything's going to happen to change that. But I worry about the next 10, 15, 25, 30 years.

The course of the next decades in front of us. I think taxes are going to go even higher than what this upcoming 2026 change is going to be, which in my mind means we need to be even more proactive with those rough conversions. And we do need to take in other factors aside from just the taxes that we would pay on the conversion as we are considering this. Yes, that is the baseline cost.

And we need to know what that is and understand it. But we also need to look at whether or not we're going to encounter Irma if we make these these conversions. So for a married couple, if if we've got income that is below 200000 or so, we might not want to cross the threshold over where Irma kicks in. Income related means assessment and adjustment. Your Medicare premiums become higher.

And so there is some minutia here. There's some fine detail that you really need to look at in order to make sure that you fully understand the cost and the expense of managing your taxes. But in the long term, I think that it is well, well worth it. And if you're already encountering Irma, then it probably makes sense to just maximize the tax brackets that you are in and do as much as possible. But again, you've got to sit down and crunch the numbers on this and understand the full cost, the full implications. And that's something that we do with our clients and where and when needed, bring in accountants and CPAs, either yours that you're already working with or we have some that we work with to confirm what we're looking at, to verify the numbers and to make sure that there's no unexpected, unintended consequences. But if you'd like to see the baseline potential tax savings, we've got a cool online Web site.

It's a calculator where you can crunch the numbers yourself. You can put in kind of your ballpark tax deferred IRA and 401K balance and your age and your assumed tax rate today. And then look at the numbers side by side that says, hey, if you do nothing and default to the IRS's plan, here's your likely lifetime tax bill and liability versus if you are proactive and take steps today. Here's what you could bring that down to.

And the difference is substantial, Aaron. I mean, it is worth taking a look at because if you've got any money that you have yet to pay tax on IRA or 401K, the government, the IRS has not forgotten about that. And if you just default to their plan, it's probably not in your best interest.

Your best interest is probably being proactive to use the tax code we have available to minimize that bill and control it. And you can see that calculator online at nine one nine retired dot com nine one nine retired dot com. And that is retired with a D like past tense nine one nine retired dot com is the online tax bill calculator. You can put in your own numbers, check out yourself.

It'll generate the report right there for for you to take a look at. Great. And Peter, how else can we get a hold of you with those questions?

Once you take a look at that retirement tax bill calculator, again, you need to understand the ins and outs and all that is going to go in that. And we're happy to talk that through with you. So give me a call at nine one nine three zero zero five eight eight six to set up a time to really plan strategically, strategically to make sure that we are doing things right.

Nine one nine three zero zero five eight eight six nine one nine three zero zero five eight eight six. And not too many websites here, but the website is rich on planning dot com. It's my last name. It's Roshan, but it looks like rich on planning dot com.

You can email me at Peter at Roshan planning dot com. All right, Peter, thanks so much for your time today. One of my favorite and I think one of the most important topics that we have, Aaron, being efficient with your taxes is as effective as shooting for help. As effective as shooting for higher returns.

But it has far less risk. So let's do it. Let's keep more of your money. All right, Peter, thank you. Thank you.

Roshan here with Roshan planning. So glad that you are enjoying the podcast Planning Matters Radio. You know, one of the tools that we've put out there that people really seem to appreciate and really are our finding of value is at nine one nine retired dot com. It is your retirement tax bill calculator. If you've got any kind of retirement account, your tax deferred 401K or IRA. This is the Web site.

This is the resource where you can go. You can plug in your own numbers, your information. You can slide the the the tool calculator up and down for your tax rate or your amount of savings and see what your tax bill is likely to be if you default and defer to the IRS's plan versus what you could potentially bring that tax bill down to. A lot of times it is a very significant savings.

So if you have not yet go to the Web site nine one nine retired dot com. Run your numbers on the retirement tax bill calculator. 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 seek investment tax or legal advice from an independent professional adviser. Any investments and or investment strategies mentioned involve risk, including the possible loss principle. 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.