Peter, very good to see you.
Welcome back, everyone. Today we get to talk about the one money move that could add years to your nest egg. Let's address the number one fear of most retirees, running out of money. And one way to make your nest egg last longer, figure out how to keep all of it in your pocket as opposed to sharing some of it with the government.
So I want to show you this headline, Peter, from the Wall Street Journal. How can converting your tax deferred accounts to Roth accounts add years to your retirement nest egg? Yeah, well, you're never going to keep it all in your pocket because there's a cost to doing this. It is pay me now or pay me later. But a long, long time ago, the government figured out that allowing you to defer paying your taxes amounted to a larger nest egg of taxable dollars once you retired. So they ultimately would get to collect even more. So we do want to be tax efficient. That's going to help us to keep more of our money. Taxes are on sale right now. And you you you can be tax efficient and again, keep more of your money. Being efficient with taxes is as effective as shooting for higher returns, but with far less risk. So there's this great chart on the screen right now that those just listening to audio are not going to be able to see to follow along with.
So I'm going to try to explain it. And this chart essentially looks at a comparison during your working years and then in retirement and takes it at face value that we will be in a lower tax bracket or rate once we retire, which I I sort of I have some issues with that. But let's just take them at face value that what we've always been told that we will be in a lower tax bracket once we retire does hold true. And this chart compares saving in a traditional tax deferred account versus saving in, for instance, a Roth 401K. So your traditional 401K versus your Roth 401K. And during our working years, it pretends that we are in a twenty five percent tax rate.
So in order to get ten thousand dollars in your traditional tax deferred 401K, you only have to earn ten thousand dollars. You don't pay any tax on that. And ten thousand dollars goes into the account.
But you have not paid tax yet. Now, let's say that you did that over 10 years. You would have saved one hundred thousand dollars. And let's say over those 10 years you had pretty good returns and you doubled the money. That would take an eleven point four percent compound annual rate of return, by the way.
So we're keeping all of these variables absolutely uniform across the traditional versus the Roth. So in order to get the same ten thousand dollars in a Roth 401K in a twenty five percent tax rate, we would actually need to earn thirteen thousand three hundred thirty three dollars. We earn that money, we pay the twenty five percent tax on it, and then ten thousand dollars goes into the Roth 401K. Well, over the same 10 years with the same exact returns, that means we now have two hundred thousand dollars in a Roth and we've paid thirty three thousand three hundred thirty three dollars in taxes.
Now we flip the page and we retire. And again, taking them at face value, we drop from a twenty five percent tax rate to a twenty percent tax rate. So on one side, we've got our two hundred thousand dollars that we have not paid tax on yet and we need forty thousand dollars a year for income. Well, if we're in the twenty percent tax rate in retirement, that means we need to pull out fifty thousand dollars. We pay ten thousand dollars in taxes to net the forty thousand dollars that we want to spend. Well, out of our two hundred thousand dollar theoretical balance here, we could only do that four times. That means that we just paid forty thousand dollars in taxes out of our retirement nest egg for the thirty three thousand three hundred thirty three dollars that we could have paid during our working years to get that money over into Roth. And it's a lot easier to pay a bill while you're earning a paycheck than it is out of your retirement nest egg, trying to factor that in. So on the Roth side of things, if we want to pull and create the same forty thousand dollars, we only have to pull forty thousand dollars because we've already paid our tax on that. That means that out of two hundred thousand, we can pull forty thousand out five times. That's one full year of extra income that we've created by saving our money on the Roth side. So this is how, as The Wall Street Journal is talking about, it extends the time that our money will last in retirement, that by prepaying our taxes, we created one full extra year's worth of income. And there are additional tax deferral disadvantages as well. Can you talk through those, please?
Yeah. And again, there's another chart here. I'm not going to go into as much detail, but when you pull dollars out of that traditional tax deferred 401K or IRA, those dollars go into an equation that determines whether or not your Social Security becomes taxable. And there are a couple of different thresholds. So if a married couple filing jointly has income over forty four thousand dollars, then eighty five percent of your Social Security would become taxable. And again, we had to pull out fifty thousand dollars of taxable income to create the forty thousand that we wanted. So we hit that eighty five percent threshold and our Social Security then becomes taxable. Whereas we create that same forty thousand dollars over on the Roth side and our Social Security from from that transaction alone, from that income, because it's a Roth, it does not go into that equation and therefore we get to keep more of our Social Security. So in addition to the taxation on the account withdrawal itself, in addition to the money lasting longer on the Roth side, there are additional implications for Social Security and oh, by the way, with Medicare premiums.
Now, this example would not encounter Irma. But if you get up to certain levels of income, then your social your Medicare premiums rather are means tested with Irma income related means assessment and adjustment. And you would also potentially cause your Medicare premiums to increase. Yeah, that's a lot.
It's a lot of math that goes into this. And by the way, it also impacts capital gains. So there are a lot of implications to saving on a tax deferred basis versus prepaying that tax on the Roth side. So Roth conversion saw a forty four percent jump in twenty twenty four. People want to take advantage of today's historically low tax rate that you mentioned a second ago, Peter. However, Donald Trump has pledged to extend his twenty seventeen tax cuts. So should we still be considering a Roth conversion? Well, it just gives us more time to buy something while it's on sale. Yes, absolutely. I think that we still consider it.
And we we try to accelerate the pace as much as possible. We've done a lot of Roth conversions with our clients over the past several years. And I feel like anybody should be looking at the numbers, crunching the numbers and considering them, because, again, you get to pay your taxes at discounted rates. I think that maybe these tax cuts and Jobs Act of twenty seventeen rates get extended, but that's not guaranteed as the tax laws stand today. Right now, those tax rates expire January 1st of twenty twenty six and all of the tax brackets from the twelve to the thirty seven percent bump up. Well, maybe they get extended and hopefully they do.
And I think it's more likely than not that they will. But that doesn't change the fact that at some point in the future, taxes are likely to go up. And so why not take advantage of not only this year and next year, but potentially those extra additional years that we have that we could make those conversions at a discounted rate? So, again, this does not like forgo taxes or eliminate taxes. It just extends the amount of time that we have to pay those taxes proactively at the most advantageous rates and brackets.
I think we're going to see here. So what are some risks or downsides to Roth conversions that retirees should keep in mind? Well, I mean, number one, you've got to pay the tax on the conversion. So there's the expense of it. Right.
You've got to be prepared for that. You've got to have that either cash or it's deducted from the account balance itself there. There's kind of two ways to do that.
There is one that is technically better than the other, but either is probably a good move if it makes sense for your situation. And again, we help people crunch the numbers on that. We've got an online calculator, 919 retired dot com, which can show you your numbers.
You can take a look. But you do have to be prepared that there will be a tax cost. You also need to be aware that those there's a two year look back. Those Irma income related means assessment premiums, your Medicare costs, they look back two years. So if you do a Roth conversion this year, two years from now, you could be paying higher Medicare costs. And there are ways to appeal Irma. But voluntarily doing a Roth conversion usually is not one of those things that does get approved on appeal, like going from your working career where you are earning high income to retirement and saying, hey, that's not my life circumstances moving forward. Yes, I was earning a lot of money, but now I'm not.
Now I'm retired. That more often than not, at least as grounds for an appeal to Irma. But but because I voluntarily did a large Roth conversion probably is not. And then you've got to worry about the five year look back as well. Technically, to pull money out of a Roth IRA, the Roth needs to have been established for at least five years. And I know that there's like some exceptions and the original principle can come out at any time.
And after fifty nine and a half, there's some leeway. But the point is that a Roth's true value is the growth over time while it's invested, occurs tax free. The value is not in moving the money to the Roth. The value is in the growth that happens thereafter. So if you have not mentally earmarked that these are dollars that I do not need for probably five years or more, at least, then maybe that's those are not dollars that you should consider with the Roth conversion, because, again, the real value of the Roth conversion is not the conversion itself. It's the growth on the account that happens thereafter. And you want that to happen for really as long as possible.
So there are some exceptions to this, but generally your Roth money is kind of the last money in the order of operations on the accounts that you should be accessing for income purposes. Well, I'm really glad we got to talk this through. Clearly, a specialized conversation with you, Peter, would help clarify this for a lot of people plug in their own unique numbers. If somebody wants to run the math with you, what's the best way to reach you? Give me a call. Nine one nine three zero zero five eight eight six nine one nine three zero zero five eight eight six. You can go online. Again, we've got an online calculator that is available on a one off site. It is nine one nine retired dot com nine one nine retired dot com.
You can enter in your your information, your age, your approximate tax deferred account balance, your anticipated tax rate. And you can see the numbers side by side right there. But do not act on that without consulting a professional or maybe a team of professionals. We actually work with accountants. We've got some and we work with those that our clients work with as well to verify the numbers before we execute on things. But you can reach me to get that conversation started again. Nine one nine three zero zero five eight eight six is the phone number.
Nine one nine three zero zero five eight eight six. We run those numbers. We have those conversations. No cost, no obligation. You can also get the conversation started at our our main Web site.
It looks like rich on planning dot com or Sean planning dot com or email me, Peter, at Rashaan planning dot com. All right, Peter, thank you. One of our best opportunities. Rothoff conversions. Aaron, thank you.
Hey, folks, Peter Rashaan here with Rashaan 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 plan versus what you could potentially bring that tax bill down to. A lot of times it is a very significant saving. 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 take investment tax or legal advice from an independent professional advisor. Any investments and or investment strategies mentioned involve risk, including the possible loss of principal advisory services offered through Brooks own capital management or registered investment advisor. The 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.
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