4 Signs You Should AVOID a Roth Conversion (Save on Taxes!)
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- เผยแพร่เมื่อ 11 มิ.ย. 2024
- The thought of taxes can be a bit daunting, especially when it comes to planning for your golden years. That’s why today, I’m going to walk you through some scenarios where Roth conversions might not be your best bet.
Roth conversions can be a savvy move in retirement planning when it comes to strategically managing your tax liabilities. By converting traditional IRA funds into a Roth IRA, you pay taxes now at potentially lower rates, shielding your future withdrawals from Uncle Sam’s grasp.
For instance, if you anticipate being in a higher tax bracket down the road, doing a conversion today could save you a bundle in the long haul. It’s like playing chess with your finances, making moves today to set yourself up for a win tomorrow.
Scenario 1: Future Tax Brackets Take a Dive:
The most straightforward reason not to convert is if you foresee your tax rate dropping in the future. In that case, it’s wise to hold off on those Roth conversions. After all, why fork out more in taxes now when you could pay less later? Play the waiting game and time your moves for maximum benefit.
Scenario 2: Downsize, Declutter, and Decrease Taxes:
When retirement is in full swing your spending habits will evolve. Maybe your mortgage is a thing of the past, and the grand adventures are winding down. With fewer expenses on the horizon, your taxable income could take a nosedive, landing you in a lower tax bracket. Before pulling the trigger on Roth conversions, understand your evolving lifestyle and spending habits.
Scenario 3: Charitable Hearts and Tax-Savvy Minds:
If you’re a generous person with a penchant for charitable giving, this could also influence your Roth conversion strategy. Enter qualified charitable distributions (QCDs), a tool that lets you donate directly from your IRA to charity-tax-free. By leveraging QCDs, you not only support the causes but also chip away at your required minimum distributions (RMDs). It’s a win-win that could spare you from unwanted tax burdens while making a difference in your community.
Scenario 4: Short and Sweet Life Expectancies:
None of us have a crystal ball when it comes to life expectancy. But if you find yourself on the shorter end of the spectrum, it might be time to rethink those Roth conversions. It doesn’t make sense to pay taxes on withdrawals you might never make.
There’s no one-size-fits-all approach to retirement planning. Each individual’s financial landscape is unique, shaped by personal goals, circumstances, and dreams for the future. Before making any hasty decisions, take a step back and assess your own situation. Consider consulting with a financial advisor to weigh the pros and cons of Roth conversions in light of your specific needs and aspirations.
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⏱Timestamps:⏱
0:00 - When Roth conversions make sense
1:04 - Lower future tax rate
3:18 - RMD projection
6:09 - Charitable giving
8:33 - Life expectancy
10:44 - The question to ask
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One additional issue that was not mention re: #4 "If you don't have a long life expectancy". At your death and your spouse inherits your IRA, he/she will be forced to take RMD's, but his/her tax bracket just changed from Married Filing Jointly to "Qualifing Surviving Spouse", to Single. The RMD's on a Single could cause him/her to be in a much higher tax bracket. Plus, the standard deduction for Single Taxpayers is much lower. Therefore, making Roth conversions if you don't have a long life expectancy makes sense.
Excellent substance. I appreciate the way you explain things with brevity. 🙏
This is great advice but I would like to point out that the RMD table is designed to liquidate the majority of your IRA assets over your lifetime. The fact that the percentage distribution increases as you age it assumes that the account balance has been reduced by previous distributions. Your 4% at age 75 vs 8.2% at age 90 example is misleading as it will likely be on a smaller balance.
Another excellent video. Lots of good points to incorporate into our planning.
Man thanks for the advice! Our clients are always asking these questions it’s good to know
Excellent discussion - particularly #4. Our father converted 100% their IRAs to Roth and while I do not know his before and after tax rates, that move simplified life for our surviving mother. She is far less financially sophisticated than he was.
And of course, he simplified life for his three kids, who already have their own tax complexities due to being in or near retirement.
Other factors: spouse dies and now you are tax filing as single instead of married filing jointly tax brackets.
Also pair up large ira withdrawals with large medical deductions such as long term care costs.
aka the Widow's penalty.
Thanks for the confirmation, James.
You bet
Thanks James for another very informative video!
My pleasure!
Watch you all of the time. Finally just subscribed so I am not a scofflaw anymore. Good video. I think reason 2 outweighs reason 1. If you stay invested in equities in retirement for the long haul, then it can be really easy to get into RMD trouble over time -- even if you don't need that much money to live on.
Thanks for supporting the channel
James, you are THE BEST!!! (even though my husband was confused by this; I know exactly what we need to do.)
I answered no to all 4 questions and am very happy that I have made substantial progress making strategic Roth conversions over the last 9 years! Thanks for your great videos!
This is EXACTLY what I needed to know. I’m 57 and will have a few million when I’m required to draw. I have ZERO heirs so I plan on donating to charities and could not find quality information that wouldn’t cost me thousands a year in taxes…Thanks for the info you consistently provide.
Glad it was helpful!
Similar situation for me @60 - I'll be doing conversions for the next decade. I agree with David McNight (Power of Zero channel) - i.e., taxes are going up (possibly doubling).
Same situation. I assume Roth conversion is a separate bucket than IRA distribution. We have millions in IRA/401k, but none in Roth due to high income. It is time to retire, take IRA distribution and do Roth conversion to minimize future RMD amount.
I have heirs but don't like how my kids spend money, so I will leave them some but donate most to charity. Probably won't do conversions
Good one. I didn’t know about QCD.
One other reason to not do a conversion might depend on where you plan to live. If a resident of California is considering a move to a low or no-tax state, it would make sense to wait to do the conversion until you are a resident of that state.
If you take into account the growth of a stock market portfolio, the tax aspect may change a bit. I expect my tax rate to drop significantly when I retire, but I would still be paying tax from pulling money out of my taxable stock brokerage accounts. The question then becomes one of what is the breakeven. I calculated that the breakeven in my case would be if the account grows more than 46%. If it grows more than 46%, then it is better to do the Roth conversion before it starts to grow. The probably of it growing over 46% in the stock market over a 20 year period is very high. I did Roth conversions over the last 2 years, and I am close to breakeven even after the recent drop in the stock market. Before the recent market drop, my account growth was 60% over the last 1.5 years. In this case, it has almost broken even, so was a good idea to convert. The key to this to pay the tax out of taxable accounts. If you don't, the breakeven percentage is significantly higher (e.g. 150% growth versus 46% growth). It is my sense that one has to consider expected portfolio growth as part of the determination.
Hi James:
I expect to continue full time or part time work making 300k to 500 K until age of 70
, so I don’t see my taxes going down significantly and I will not have that drop in income that most will have if they retire at 62 or 65.
Can you do a video about financial and tax planning for professionals who will continue to work until age 70 with a higher income,and does it make sense to stop investing in IRA or 401/403b for such individuals and just invest in a brockerage account.
Thank you for all that you do, I have learned a lot from your videos.
I'm trying to figure this roth conversion idea out... We definitely plan on being in the lower tax bracket when we retire and start pulling out.. Everything is paid off... Just keep it under that ninety two grand or what have you... And maybe convert the "difference" between the one tax bracket and the next 1 up if we do keep it low..
So glad 100% of my retirement contributions are 100% Roth IRA/Roth 401k!!! Being in the 12% US federal tax bracket makes 1000% sense!!! My retirement income will close to 100% income tax free!!!
Winning. Well done. I wish I had done ROTHs instead of conversions
You left out #5 - you have a very high income now, and you will have a very high income for the rest of your life. Converting an IRA will result in paying a lot of tax.
My taxes will be lower in retirement (I hope), but I still push money into a Roth because I'm counting on the growth to outpace all tax liability and then some - especially for the money I intend to use last.
Can you do more than one QDC per year?
James, In accurate comparison in the last point. 8.2 % RMD at 90-year old is not 2 times of 4% RMD at 75-year old because the balance at 90 year-old is (or should be) much lower than that at 75-year old.
If your IRA is growing @ 8% but the early RMD are ~ 4% - your balance at 90 may be higher than at 73/75.
Sorry where is the case study?
I had initially planned to retire at 62, work part-time, and save money, but the impact of high prices on various goods and services has significantly disrupted my retirement plan. I'm worried about whether those who experienced the 2008 financial crisis had it easier than I currently am. The volatility of the stock market is a concern as my income has decreased, and I fear that I won't be able to contribute as much as before, potentially jeopardizing my retirement savings.
James, you are the best.
Thank you 🙏🏼
There’s also the age factor. As one ages, there is less time/risk capacity to dollar cost average new contributions into a Roth to offset Roth investment losses. And the five year holding period for growth, if it even grows at all makes Roth kind of illiquid, sort of like Webull’s IRA match. Also older folks need to plan for mental decline that may all of a sudden happen in 60s-70s, at which point they may lose the ability to make wise shopping/purchasing decisions with the Roth tax free growth that you had to wait 5 or more years before accessing tax-free.
Hi James; for RMD planning, should one hire a CPA, a CRC, or a CFP for help?
A CFP that is good a tax planning is my (biased) recommendation
@@RootFP thank you
(4:42) "is all in brokerage accounts, you won't have any required minimum distribution in the future ... versus in a traditional IRA" I don't get this part at all. Maybe I'm missing something here, but whether or not the retirement funds are at a brokerage firm or a regular IRA doesn't matter. Both are subject to RMD....
You're confusing what he said. He is talking about types of accounts held verses the firm holding the accounts.
If you have a Traditional IRA and/or a Roth IRA you most likely have opened these types of accounts at a "Brokerage Firm" like Vanguard, Schwab, or Fidelity.
Another type of an account that can be opened at a Brokerage Firm" is a Brokerage Account. This is a type of an account which holds after tax money. You can invest in anything in this account that you can invest in an IRA at these brokerage firms. The good thing about these accounts is that if you have dividend paying stocks those dividends are typically taxed as qualified dividends depending on the stock you own, and are taxed at the capital gains tax rates which are lower than income tax rates. If you have money that earns interest then that interest on these accounts are paid at income tax rates. If you sell your shares of stock or bonds or whatever you hold in this account at a gain and you've held it for longer than one year then you are paying long-term capital gains. If you have a stock at a loss you can offset those gains by using a loss. So when he said that a brokerage account has no required minimum distributions that's what he meant. This account is all after tax money. If you take required minimum distributions out of your taxable ira or 401k and you don't use all the money or need that money at the time you can place the money into a brokerage account and continue growing that money and again pay capital gains rates versus the higher rate of the income tax rate you have to pay on a distribution from your 401k or IRA.
So actually the more money you can get out of your taxable accounts while keeping these withdrawals within your tax bracket range like if you're in the 12% tax bracket and you don't take any more out then what is going to go up to the top of your 12% tax bracket then you can maximize the money getting out of these taxable accounts at the 12% tax rate and then put that money into a brokerage account and continue growing it and being taxed at capital gains rates. By doing this before you take social security it can allow you to get the money out of these taxable accounts let your social security grow until your age 70 so your maximizing your social security and then you don't have to do Roth conversions and wait 5 years to be able to get your money out of the Roth conversions.
Hope this helps and answers your question
What you fail to mention is that ALL GAINs from a non Roth account will be taxed vs ALL GAINs from a Roth account are NEVER taxed
I think of doing roth conversion when i retire by maxing out 12% bracket over years before i collect social security. Is it a good idea?
Depends on the amount of social security income you collect
Yes
James, can dividend investing from a traditional IRA be counted against your RMD?
With respect your question makes no sense. Your rmd is calculated by your taxable ira balance at previous year end divided by “life expectancy” (table). How one obtains the year balance is irrelevant. Hope that helps.
Any withdrawal from an IRA counts towards your rmd
RMDs have to be withdrawn from your IRA, so dividends only count if withdrawn.
Assuming they aren’t immediately distributed, the dividends happen inside of your IRA and don’t count toward your RMD. Only the amount you take out of your IRA counts toward your RMD
I went the route of an annuity with a portion of my IRAs, so it renders doing a Roth conversion almost meaningless.
You will pay taxes on your annuity payments coming to you
Is inheriting a 5 year + old Roth IRA as a non-spouse a benefit?
Yes! Why wouldn’t inheriting tax free money be beneficial. You have to withdraw the funds over time, but you can reinvest it in a brokerage account.
Some states may have an inheritance tax, so you need to check your state laws.
Can it help me avoid IRMAA?
Yes. See the other video he linked.
I'd like to know the answer too. I got hit with the irmaa this year because I sold my house in 2022 and as a result, the capital gains jacked up my income big time. My ignorance of irs terminology made me think I was not going to have to worry about it. Turns out 'adjusted gross income' does not mean adjusted by subtracting your itemized deductions. Oops. It is line 11 of the form 1040. So, from what I see on the form, Lines 4a & 4b, the IRA distribution and the taxable amount of that are what are going to add to your income. My gut tells me if I take out whatever from my ira and convert it, that initial distribution is fully taxable. So I might save in future tax years with regards to income taxes, but then this year (or actually in 2 years time) I'm paying $400 or $500 more per month (4800 or 6000 for the year) for my Medicare premium.
I look forward to his answer.
Sure can when done correctly
A 🕊️ in the hand is better than 🕊️🕊️ in the bush.
Yes, deferring SS and paying taxes earlier can be a good strategy, all things being equal.
However, all things never end up being equal, so I say, take the money when/while you can and defer paying taxes while you can.
If living on dividends converting to Roth makes sense because dividends are tax free forever.
I can’t see a reason why anyone with a balance of 600k plus in a taxable ira wouldn’t do a Roth conversion. Case in point. If one does carry a relatively large 401k, one most likely will collect a relatively high SS check. Furthermore the 2nd level tax bracket is more likely than likely going to increase from 12% to 15%. My “break even” requires my taxable ira to be around 300k at the time of rmds.
Unless of course you’re one hell of a philanthropist. 😉
This sounds like a really useful way to convey when it makes sense to do a conversion, but it's wrong because you leave out a key detail: age. If you are 24 and have 600k, yes conversion makes sense. But what if you are 50, 60, or 80? Is it still so obvious?
Agree, nice summery.
This definitely makes sense to me especially when considering a high SS check...I'm ready now to start doing the Roth conversion but I get hung up on the 5 year clock and how much to actually convert in one year - With over 600k in an IRA, I could do the conversion in chunks spaced across several years or just bite the bullet and convert as much as I can now (limited by cash on hand to pay the taxes)
@@ChristopherCurtis at the time of RMD, meaning 73 and beyond
If you are a couple, an RMD on a $600k account starts at about $24k! That isn’t even going to get you to the 15% bracket. And likely won’t cause any of your SS to get taxed. I would say the number is closer to a million, and then there are still other options.
Remember that Roth money is not tax free!!! You have to pay taxes to create it! If I pay 15% to save 15% I didn’t get anywhere!