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This Is The Roth Conversion SWEET SPOT · Retirement Answers

• 0:00
  Jacob: There's a special period of time in retirement when you can benefit the most from doing Roth conversions, and it's what you might call the Roth conversion sweet spot. And unfortunately, most retirees miss out on this because they don't know what to look for or how to plan for it. So in this episode, I'm going be explaining what the Roth conversion sweet spot is and how you can use this period of time to your advantage. But first of all, if you're new here, welcome. My name is Jacob Duke.
• 0:25
  I'm a certified financial planner and I'm the host here of the Retirement Answers podcast, as well as the owner of a retirement planning firm where we help people just like you plan smarter and retire better. And one of our primary jobs as retirement planners is helping our clients lower their taxes throughout retirement and Roth conversions can be a powerful way of doing just that. Now, before we get into the Roth conversion sweet spot and what period of time this really happens in, I want to first go back just a little bit and say, well, what are the benefits of Roth conversions in the first place? You got to know what the benefits are before you start trying to do it, Because if you do this in a misaligned way, it ends up hurting you ultimately. So what are you actually trying to accomplish?
• 1:04
  Here's a few things that you might want to be doing and why Roth conversions could help you. Number one, is to be able to have those tax free withdrawals throughout the rest of your retirement. As soon as you've converted that money over to Roth, that conversion amount, you can then take that money from the account and live on that immediately, assuming that you are 59.5 or older. Additionally, you might want to think about doing Roth conversions because you want to either reduce or eliminate your RMDs completely. So an RMD is a required minimum distribution.
• 1:31
  It's how much money you have to take out or start taking out once you reach either age 73 or 75, depending on your year of birth. The IRS forces you to start taking money from your tax deferred IRAs or tax deferred 401ks. So those are required when distributions will start later on in your 70s. And so if those would be really high, or if your tax deferred accounts continue to grow over time, your RMDs could be very cumbersome and they could actually lead to having higher Medicare premiums through Irma in the future if those RMDs are so high because they would increase your taxable income. So there's kind of like a trickle down or a domino effect here.
• 2:07
  If you can do these Roth conversions, you can also have the tax free, you know, income or distributions whenever you'd like them in the future. You could also reduce your RMDs or the negative impacts of those which could be IRMAA, but also if you're married, by doing Roth conversions, you could reduce how much money you have tax deferred, which would help your surviving spouse not get hit so bad with the widow's tax trap, which is whenever a surviving spouse ends up having to pay higher taxes on those distributions, those RMDs, because now they're filing as a single tax filer rather than married filing jointly. So those are a few of like the pain points that Roth conversions can help solve, but in general, it creates flexibility in retirement income planning throughout the rest of your life, and it can help smooth out your total taxes paid over your lifetime in the tax brackets that you would be paying taxes at. So those are some of the benefits of Roth conversions. But I will say that Roth conversions are not the right answer for everyone.
• 3:01
  I've done episodes on this as well. I'll try to have those linked down in the description for you so you can go back and say, hey, what are some of the reasons I shouldn't be doing Roth conversions and take a listen to that as well. That way, know how to compare these two different episodes together and see maybe where you fit in these decision points of whether or not you should or should not do them. Now, another resource that I've created for you is a checklist to kind of answer some questions on your own to say, hey, are Roth conversions actually beneficial for me? So what you can do is you can go down in the description of this podcast episode, there's gonna be a link in the description where you can download your checklist to see if Roth conversions are the right thing for you or not.
• 3:37
  Based on how many questions you answer yes or no to, it can help you narrow down which way you should think about leaning so you can investigate further. So if you want that resource and that checklist, it's completely free. Download it yourself today here after this episode. Alright, so now that we know why Roth conversions can be helpful, when is the best time to do them? When is this sweet spot window?
• 3:58
  In general, just to answer it very plainly, it's going to be from the time that you retire until your Social Security begins and or your RMDs would kick in. So really, it's this kind of sixties and early seventies age timeframe. There's a few different factors and layers to kind of think about as you're evaluating it. But really, it's going to be early on in retirement whenever your income drops off after you've been working and before your Social Security and or your R and Bs would kick in down the road. Now, why is this so important?
• 4:26
  There's three main reasons. Number one, you're no longer earning a salary, which is gonna reduce your income significantly. You've stopped working in those high income years, they're behind you. Number two, your RMDs, they have not started yet. So you're not taking that money out of your tax deferred accounts, or at least you're not being forced to take that money out.
• 4:44
  Those would either begin at 73 or 75, again, depending on when you were born. And before your R and B's kick in, you can control how much taxable income you generate because you're not being forced to take money from anywhere unless you only have one option. I'll get to this here in just a second. And then number three, you've not yet taken your Social Security, assuming that you delay it. Having the flexibility to delay your Social Security, at least until full retirement age or perhaps even beyond, opens up this Roth conversion sweet spot even more that we have more time and more years to do these Roth conversions at these lower income brackets.
• 5:17
  Because even though at most 85% of your Social Security benefits would ever be taxable, you could by doing Roth conversions make 85% of your benefits taxable, which might not be what you want to do. So perhaps delaying your benefits would end up helping you convert more, but also reduce the total taxes you'll pay on your Social Security once you do start it. Now, whenever I'm talking about this, one of the questions in your mind is going to be, but Jacob, how do I live if I don't have any income during these years? How can I just do Roth conversions and have no money coming in? And this is just a normal question that everyone has.
• 5:48
  What am I gonna do, Jacob? I can't just do Roth conversions and have no money. I've got to have some sort of income. And the reality of the matter is, is you will have income, but it needs to come from the right accounts. And this is why tax diversification that I talk about often is so important if you want to make the most of Roth conversions and specifically this period of time that Roth conversions can be most powerful.
• 6:09
  Now, here's the key. Whenever you have tax diversification, you have money in three different account types. Most likely you've got tax deferred, which is most people's largest savings vehicle. You've been saving money into your four zero one ks or traditional IRA throughout your career. Most of that money is going to be tax deferred.
• 6:24
  Now, you also might have Roth IRAs or Roth four zero one ks money as well. Again, typically this is going to be on the lower side of your total portfolio. And then finally, we have this brokerage account side, this taxable account side of things where you put in after tax money, that money then grows. It is taxed annually if you have dividends, interest or realized gains, but the key there is that sometimes those realized gains, especially if they're long term or if you have qualified dividends, those can be treated in a more tax favorable manner. And so what you've got is you got this brokerage account, and then maybe you've got some cash on the sidelines in a money market or savings or high yield savings account.
• 6:59
  Those different account types, having money spread across these different places is important and it creates flexibility for you, because if you don't have options in terms of where your income or your living expense needs will come from, then you're kind of hands tied behind your back. If you want to do Roth conversions and you only have tax deferred IRAs to pull from, well, you've got to first take your money out of your IRA to live on, right? You got to have something to live on, but then do Roth conversions on top of that, which when you add those two things together, that might be pushing you into a tax bracket that you otherwise don't want to pay taxes at that rate on a conversion. So it kind of hurts or limits how much you can convert or actually makes it suboptimal to do the conversion at all. So maybe an example of this is you've got a retiree with a million dollars, that's all tax deferred, you've got another retiree that's got a million dollars with 600,000, you know, in a tax deferred IRA, you've got 200,000 and some cash and brokerage, another 200,000 and Roth IRAs.
• 7:52
  The second option there that that second retiree with the million dollars and also the spread out the spread of different accounts, they have more flexibility of their income, they can take money out of cash and brokerage and perhaps even out of their Roth if they'd like to, maybe not optimal at this point, but they could, and also do Roth conversions on the 600,000 that's left in their their tax deferred account at minimal tax rates, right, especially early before Social Security. And by having those different sources of income in their cash and their brokerage accounts, they're not paying much tax at all there. So they get to target the tax bracket they want to pay the on the conversions, and also have the income to meet their living expense needs as well. Now, if you go back to the first retiree that had all of their $1,000,000 saved in a tax deferred IRA, their hands are tied, they can only live off money out of their IRA, assuming they're not taking Social Security, and then whenever they do a Roth conversion, the money that they've already taken out of the IRA for living expenses, that's filling up the first little bit of tax brackets there, or at least using all of their standard deduction.
• 8:50
  And now the Roth conversions could be taking place at higher tax rates beyond what you would hope that they would be at. So, again, that's an example of why tax diversification is so important in this Roth conversion decision, because the only reason to do Roth conversions and they only make sense is if you can pay a lower tax rate today than you ever would in the future. In tax verification, it gives you that flexibility to live on that brokerage of the cash and keep your taxable income low and convert at lower tax rates. And without it, you're forced to pull money out of the IRAs, which create taxable income, and then that also raises the cost of the conversions. So I would very much encourage you if you're still in the saving phase of this thing, and you're not retired yet, and you want to prepare for these, this Roth conversion sweet spot and this opportunity is start saving extra cash and start building up that brokerage account.
• 9:37
  So you have after tax money that can be used and lived on at minimal taxes, and you actually allow you to do the Roth conversions more effectively. Now, another big question all this is, Jacob, who should actually be doing these Roth conversions? Who does the sweet spot really help the most? What how much money do I need to have in these tax deferred accounts for this to really make sense? And, and a few things you've got to do here is you've got to look ahead and plan ahead and see, well, how much do I have today?
• 10:02
  What is the expected growth rate on this? And then how much do I think I'm going to spend out of this particular account if it's all tax deferred, you know, moving forward throughout retirement? I'm only spending $1,002 out of this every single month. Well, that's very minimal compared to 10,000. So you've got to think about what your future looks like.
• 10:19
  But in general, Roth conversions help this type of person the most. Someone with high tax deferred balances, I'm talking north of a million dollars in tax deferred four zero one ks's and IRAs. If you have a little bit less than that, maybe you'd fall in the category too, but that's circumstantial. But if you've got a million dollars or more in tax deferred accounts, you should definitely be evaluating Roth conversions. Also, anyone who can delay their social security until 67 or even perhaps beyond, it again opens up that timeframe a lot more for you to do conversions over a larger or more amount of years.
• 10:49
  Also, if you're married, if you're married filing jointly, Roth conversions are that much more helpful and beneficial for you compared to single filers, because again, those larger tax brackets, they're very, very important. If you can pay taxes on a conversion at 1012% versus 22 or 24 as a single person, it makes a big difference. And again, not saying you can't do Roth conversions as a single person, you just have to understand that you might have less to work with in terms of room within the brackets, and it might reduce the effectiveness of them overall. So that's the type of person someone with large tax deferred account balances able to delay Social Security has after tax brokerage accounts or cash to live on while doing the conversion, someone who realizes they need to reduce those RMDs and wants to try to avoid Irma later on. That's the type of person that the sweet spot this period of time can help the most.
• 11:37
  Now, what gets in the way? Again, if we're trying to figure out what gets in the way of actually being able to use this time period effectively, one of the big components here is anyone who's pre 65, they're often trying to qualify for those Affordable Care Act subsidies and Roth conversions will increase your income and maybe eliminate your opportunity to get any subsidies on your health insurance before 65. So you've got to think about how this plays into your Roth conversion plan. Are you trying to get the subsidies no matter what? And is that what you're set out to do?
• 12:06
  Or do you see the bigger picture and say that, yeah, I know that I could get these subsidies by keeping my income really low, but doing these Roth conversions helps me that much more. I'm talking hundreds of thousands of dollars of potential savings rather than a few thousand dollars this year. That could be the difference and you've got to weigh that out and understand the pros and the cons of giving up the subsidies versus trying to get them. But it might mean there's a split approach. It might mean that you're 63 and you're going to try to get the subsidies for the next two years, and then do your Roth conversions from 65 to 68, and then take your Social Security at 68.
• 12:38
  Right? So there's so many ways to build this in and build a plan around it. But if you're trying to qualify for ACA subsidies and you're doing Roth conversions at the same time, it's typically not going to work out in your favor because those Roth conversions, they will push you into higher income brackets, which will eliminate or reduce how much subsidy you actually get. The number two thing that always gets in the way is again, not having any cash or after tax brokerage account money to live on, or to pay the taxes with on the conversions themselves. I'm not going to talk about that anymore.
• 13:05
  I've already talked about that a bunch. But if you're still in your 40s or 50s, and you're trying to save and work towards retirement, now's the time to be planning for this. Now's the time to be building up those after tax savings accounts. I know you might pay some taxes on the front end, right? Because you're in your higher earning income years, but you might think yourself a lot whenever you get to retirement and you can do conversions more effectively.
• 13:27
  If you had that after tax money to live on and also pay the taxes with. And number three, again, if you take your social security early, it's going to use up part of your tax brackets and use up your standard deduction, which you would likely want to use on the Roth conversions. By taking that social security early, if you have to do that, you would be using up those lower brackets resulting in a lower amount of conversion you can do or actually pushing your conversion or part of it into higher tax brackets with obviously which is not not favorable. So those are some different sticking points and things that you've got to pay attention to. Now to wrap all this up, I want you to think about a few things, right?
• 14:01
  You've got to map out your timeline. When are you retiring? When do you think you're going to turn Social Security on? When do your RMDs kick in? And how much time do you have to work with?
• 14:09
  How many years do you have to do Roth conversions with? Okay, so this is going to be building out what you're going do with your gap years. And also, you've got to estimate what your income would look like in your gap years and what different account types you're going to be taking money from brokerage, Roth, traditional IRA, and then see how much room you have in the ten, twelve or 22% brackets and know which bracket you're really trying to fill up. Because again, it really only makes sense to pay taxes electively by doing a Roth conversion. If the tax rate you pay today is going to be lower than what it would be in the future.
• 14:38
  And finally, run the projections. You've got to see what the benefits really are before doing them before you just start blindly doing conversions because someone like me says, hey, Roth conversions can be helpful. I want you to understand what the benefits are for you specifically. So build your plan, understand what your plan is saying, and then maybe it's not super large conversions, maybe it's 20 thousand here, 20,000 there, maybe it's 40,000 one year, it just depends and everybody's situation is different. And that's why we build comprehensive and tailored plans to each individual client that we work with is because everyone's situation is unique, everybody has different goals, wants and wishes, and the things that one person might do regarding their taxes or Roth conversions can be completely different from someone else.
• 15:17
  So if you're looking for help with your tax plan or trying to make the most of the Roth conversion sweet spot, you can click a link down in the description below, you can have a free intro call with me. Also, if you're looking for that PDF, that checklist that helps you make these decisions or kind of send you on the right path, you can download that it's completely free using the link in the description as well. Thanks so much for tuning in to this week's episode of Retirement Answers. We will talk to you again very soon. Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal or tax advice.
• 15:50
  Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. I look forward to talking with you again next week.