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I Tested 4 Roth Conversion Strategies on a $2M IRA for a Single Woman · Align Your Retirement

0:00
SPEAKER_00: Welcome back to Line Your Retirement.
0:01
SPEAKER_00: I'm Hazel Secko.
0:03
SPEAKER_00: Today I want to walk you through something I tested recently because the result surprised me.
0:07
SPEAKER_00: I ran four Roth conversion strategies on a$2 million IRA for a single woman.
0:13
SPEAKER_00: The one most advisors would call aggressive cost her$605,000.
0:19
SPEAKER_00: The one that won made her$51,000.
0:23
SPEAKER_00: And then I changed the one thing about her situation and the winning strategy became the losing one.
0:29
SPEAKER_00: If you're single or you expect to be, this is the version of the math nobody runs for you.
0:34
SPEAKER_00: Let's get into it.
0:55
SPEAKER_00: And why your best Roth conversion strategy may depend less on your own tax bill than on who gets the account after you.
1:02
SPEAKER_00: I'm Hazel Secko, certified financial planner, CDFA, and a fee-only fiduciary at Aligned Financial Solutions.
1:08
SPEAKER_00: And before we start, this is education, not personal advice.
1:12
SPEAKER_00: So please talk to your own tax and financial professionals before acting on any of it.
1:17
SPEAKER_00: And the woman in this analysis is a hypothetical composite based on situations I see regularly.
1:22
SPEAKER_00: If you want to see how the ideas here apply to you, start by gathering your own key numbers, your IRA balances, your current spending, your estimated social security, and an honest guess at who will inherit your account and their likely tax brackets.
1:38
SPEAKER_00: These are the pieces you will want to have on hand, whether you are doing on your own or bringing them to a professional.
1:44
SPEAKER_00: Here is what we're going to look at.
1:46
SPEAKER_00: For a conversion path, modeled year by year from 65 to 90.
1:52
SPEAKER_00: Convert everything, convert nothing, convert half, and a banded approach that converts up to a line each year.
1:59
SPEAKER_00: 1.
2:00
SPEAKER_00: Why this is a different problem when you're single.
2:03
SPEAKER_00: Before we get to her numbers, I want you to see something.
2:07
SPEAKER_00: Much of the Roth conversion guidance you see is illustrated using married couples.
2:12
SPEAKER_00: Listen to what happens to these numbers when you file as a single person.
2:16
SPEAKER_00: The first Medicare surcharge starts at$218,000 for a couple.
2:21
SPEAKER_00: For a single filer,$109,000.
2:25
SPEAKER_00: That one is measured on modified adjusted gross income from the tax return you filed two years earlier.
2:31
SPEAKER_00: The 22% bracket ends at$211,400 for a couple.
2:37
SPEAKER_00: For single filer,$105,700.
2:41
SPEAKER_00: That one is measured on taxable income after your deductions come off.
2:46
SPEAKER_00: The net investment income tax starts at$250,000 for a couple.
2:51
SPEAKER_00: For you,$200,000.
2:53
SPEAKER_00: Modified adjusted gross income again, and that line has not moved since 2013.
2:59
SPEAKER_00: And there's an enhanced deduction for people 65 and older.
3:03
SPEAKER_00: For a married couple where both spouses qualify, the$12,000 deduction starts phasing out at$150,000 of modified adjusted gross income and is gone at$250,000.
3:16
SPEAKER_00: For single filers, the$6,000 deduction phases out between$75,000 and$175,000.
3:24
SPEAKER_00: There are three different ways income is measured and four separate thresholds to track.
3:30
SPEAKER_00: Most single filer limits are set at around half the thresholds used for couples.
3:35
SPEAKER_00: So while the advice isn't exactly wrong, it's designed for people who have double the flexibility.
3:40
SPEAKER_00: It's the right idea, but the scale is off by about half.
3:44
SPEAKER_00: Two, meet Joanne, let's call her Joanne.
3:47
SPEAKER_00: She's 65 and single.
3:49
SPEAKER_00: She was divorced at 52, and about half of her IRA came to her in that divorce, transferred from her ex-husband's account.
3:57
SPEAKER_00: A quick and important distinction here.
3:59
SPEAKER_00: When an IRA is divided in a divorce, the process is typically handled as a transfer incident divorce.
4:06
SPEAKER_00: This is not the same as quadro.
4:08
SPEAKER_00: Quadros are used only for employer-sponsored retirement plans like 401ks or pensions, not IRAs.
4:15
SPEAKER_00: For example, if you're awarded half of your ex-spouse's IRA in the divorce agreement, the money moves directly from their IRA to yours through this process, and there's no tax as long as it's done correctly.
4:28
SPEAKER_00: A quadro, on the other hand, stands for Qualified Domestic Relations Order, and it is used to divide employer-sponsored retirement plans like a 401 or a pension.
4:38
SPEAKER_00: For example, if you're awarded part of your ex-spouse's 401k, a quadro is required to tell the plan administrator to divide the account.
4:46
SPEAKER_00: Here is what Joanne has:$2 million in a traditional IRA,$400,000 in a taxable brokerage account, of which roughly$200,000 is unrealized gain, and$150,000 in Roth.
5:01
SPEAKER_00: She spends about$85,000 a year.
5:04
SPEAKER_00: She plans to claim Social Security at$70,000, which will be around$48,000 a year.
5:09
SPEAKER_00: Now the assumptions.
5:11
SPEAKER_00: A model is only as honest as the assumptions you can see.
5:15
SPEAKER_00: We run from age 65 to age 90.
5:18
SPEAKER_00: 6% growth on the account, 2% dividend yield from the brokerage, 2.5% inflation with all tax brackets indexed, including the Medicare threshold.
5:28
SPEAKER_00: The bonus senior deduction expires on schedule after 2028.
5:32
SPEAKER_00: And for fairness, we assume Congress leaves the brackets themselves alone.
5:37
SPEAKER_00: We score all four strategies the same way after tax value at age 90, counting the brokerage account at its stepped-up basis and assuming her heirs pay 24% on whatever is left in the traditional IRA.
5:51
SPEAKER_00: Joanne was born in 1961 under secure 2.0.
5:55
SPEAKER_00: That means her required minimum distributions begin at 75.
5:59
SPEAKER_00: If you were born between 1951 and 1959, yours start at 73.
6:05
SPEAKER_00: Check which one applies to you.
6:07
SPEAKER_00: Model 1.
6:08
SPEAKER_00: Convert nothing.
6:09
SPEAKER_00: Let's start with doing nothing at all.
6:11
SPEAKER_00: She funds her lifestyle from the traditional IRA because it is her largest account.
6:16
SPEAKER_00: She never sells anything in the brokerage for 25 years.
6:19
SPEAKER_00: That detail is important and I'll show you why in a moment.
6:22
SPEAKER_00: At 65, her reported income is$85,000 and her federal tax is about$7,700.
6:29
SPEAKER_00: At$0,000, Social Security turns on, her income is about$100$1,000, and her tax is about$11,100.
6:39
SPEAKER_00: Notice that her income barely moved because the benefit replaces IRA withdrawals almost dollar for dollar.
6:46
SPEAKER_00: By the time she reaches$75, her IRA has grown to about$2.57 million, even though she has been spending from it for 10 years.
6:55
SPEAKER_00: Divide that by the IRS factor of$24.6 and her first required distribution is about$104,000.
7:03
SPEAKER_00: Add Social Security, where up to 85% of a benefit can become taxable depending on your provisional income.
7:09
SPEAKER_00: At her level, it is the full 85%.
7:13
SPEAKER_00: At the brokerage dividends, her modified adjusted gross income at$75 is$162,500 and her tax is$23,000.
7:22
SPEAKER_00: By$90, her income is$331,000 and her tax is$55,000.
7:29
SPEAKER_00: Now look at that number at$75 again.
7:32
SPEAKER_00: $162,500.
7:34
SPEAKER_00: The Medicare threshold by then, indexed forward for inflation, is around$139,000.
7:40
SPEAKER_00: She's well past it.
7:42
SPEAKER_00: In the plan where she does nothing at all, she is paying a Medicare surcharge every single year from$77 to$90,000.
7:48
SPEAKER_00: Because of the two-year look back, it is her income at$75 that triggers it.
7:53
SPEAKER_00: A married couple has much more room before reaching that first Medicare threshold.
7:58
SPEAKER_00: Same portfolio income, same strategy.
8:00
SPEAKER_00: The difference is the filing status.
8:02
SPEAKER_00: And under the no conversion strategy, her final after tax estate comes to about$5,366,000.
8:10
SPEAKER_00: Three constraints working against Joanne.
8:13
SPEAKER_00: Before I show you the conversion strategies, I want to explain why doing nothing is genuinely competitive here.
8:19
SPEAKER_00: The first constraint is a hidden spike in her marginal tax rate.
8:23
SPEAKER_00: Remember that senior deduction,$6,000 for anyone 65 and older, on top of the standard deduction.
8:29
SPEAKER_00: For a single filer, it starts phasing out as$75,000 of modified income.
8:34
SPEAKER_00: It is gone entirely by$175,000.
8:38
SPEAKER_00: Inside that range, she loses six cents of deduction for every extra dollar of income.
8:44
SPEAKER_00: So every additional dollar she converts does not raise her taxable income by$1.
8:49
SPEAKER_00: It raises it by$1.06, which means her real cost on that dollar is not 22%.
8:58
SPEAKER_00: It is closer to 23.3%.
9:01
SPEAKER_00: In the 24% bracket, closer to 25.4%.
9:06
SPEAKER_00: So why is this worse for her than for a couple?
9:09
SPEAKER_00: For a married couple where both spouses qualify, that phase out zone runs from$150,000 to$250,000.
9:18
SPEAKER_00: Their spike is actually steeper, 12% of deduction loss per dollar because each spouse loses six.
9:26
SPEAKER_00: But it starts at$150,000 above where most couples sit before they convert anything.
9:34
SPEAKER_00: Joanne's run from$75,000 to$175,000.
9:38
SPEAKER_00: That is not a zone she can easily avoid.
9:41
SPEAKER_00: That is much of the income range this particular single woman with$2 million actually lives in.
9:47
SPEAKER_00: She does not suddenly step into the penalty only when she converts aggressively.
9:52
SPEAKER_00: She's already standing in it before she starts.
9:55
SPEAKER_00: The second constraint is Medicare.
9:58
SPEAKER_00: You already know the number:$109,000 of modified adjusted gross income.
10:03
SPEAKER_00: And it is a cliff, not a slope.
10:06
SPEAKER_00: So$1 over and she pays the entire next tier for the year.
10:10
SPEAKER_00: The first tier costs about$1,148 a year.
10:16
SPEAKER_00: It climbs sharply from there.
10:18
SPEAKER_00: And remember, the two-year look back.
10:20
SPEAKER_00: Well she converts at 65% sets her premium at 67.
10:24
SPEAKER_00: So if you do Roth conversions, keep track of the conversion year and what it may do to your Medicare premiums two years later.
10:32
SPEAKER_00: The third constraint is one that often gets missed.
10:35
SPEAKER_00: It is the cost of selling brokerage assets to pay the tax the conversion creates.
10:40
SPEAKER_00: Joanne's$400,000 brokerage account holds about$200,000 of gain.
10:45
SPEAKER_00: Assets like that generally receive a step up in cost basis at her death.
10:50
SPEAKER_00: Left alone and with her surplus required distributions reinvested into it after 75, that account is worth over$2.8 million by age 90.
11:01
SPEAKER_00: And her heirs can receive it without paying capital gains tax on the appreciation that occurred during Joanne's lifetime, assuming the normal step-up rules apply.
11:11
SPEAKER_00: Any strategy that sells those shares to pay a conversion tax bill gives some of that advantage up permanently.
11:18
SPEAKER_00: Quick question before we get to the comparison.
11:21
SPEAKER_00: Has anyone ever shown you the single filer version of a retirement projection?
11:26
SPEAKER_00: Not the couple's version with your name on it.
11:29
SPEAKER_00: The actual single filer brackets and thresholds.
11:32
SPEAKER_00: Based on what I've seen, the answer to this is usually no.
11:36
SPEAKER_00: If that's been your experience, I'd like to hear it.
11:39
SPEAKER_00: You can reply to any of my emails and it comes straight to me.
11:42
SPEAKER_00: The comparison.
11:44
SPEAKER_00: Model 2.
11:45
SPEAKER_00: Convert everything.
11:47
SPEAKER_00: We convert everything left in the IRA over five years, about$1.66 million after her spending and tax withdrawals finishing before Social Security turns on at$70, which avoids stacking the conversion income on top of her benefit.
12:03
SPEAKER_00: This is the kind of aggressive conversion strategy that can look attractive when the goal is to move a large pre-tax balance into Roth as quickly as possible.
12:13
SPEAKER_00: At 65, she converts$400,000.
12:17
SPEAKER_00: Her income that year is about$446,000, and her federal tax is$111,200.
12:26
SPEAKER_00: To pay that bill, she has to sell out of the brokerage account.
12:30
SPEAKER_00: At$66, she sells nearly$200,000 of shares, which realizes about$100,000 of gain on top of the next conversion.
12:40
SPEAKER_00: Her tax that year is$130,000.
12:43
SPEAKER_00: At 67, it gets worse.
12:45
SPEAKER_00: The brokerage account runs dry that year and she has to pull from the IRA to pay the tax on the conversion itself.
12:52
SPEAKER_00: Her income that year is$582,000.
12:57
SPEAKER_00: Her tax is$150,500.
13:00
SPEAKER_00: And the year after that is higher still,$160,800.
13:05
SPEAKER_00: Across those five years, she pays$632,000 in federal tax.
13:11
SPEAKER_00: After that, it looks wonderful.
13:12
SPEAKER_00: 21 years of almost no tax at all.
13:15
SPEAKER_00: Final score:$4.761 million.
13:20
SPEAKER_00: $4,761,000.
13:23
SPEAKER_00: That is$605,000 worse than doing nothing.
13:27
SPEAKER_00: More than 11% worse.
13:29
SPEAKER_00: Model 3.
13:31
SPEAKER_00: Convert half.
13:32
SPEAKER_00: $200,000 a year for five years.
13:35
SPEAKER_00: Gentler, smarter looking, and it still loses.
13:53
SPEAKER_00: Each year from 65 through 74, she converts only the amount that brings her income up to just under the Medicare line.
14:02
SPEAKER_00: One detail matters here, her living expenses and her tax bills still come out of the IRA exactly as in Model 1.
14:10
SPEAKER_00: Those withdrawals already use up most of the room under the line, so the conversions themselves are small.
14:16
SPEAKER_00: If you see a plan with much bigger banded conversions, ask where the spending money is coming from.
14:23
SPEAKER_00: Paying the bills from a Roth and converting more produces the exact same tax result.
14:28
SPEAKER_00: It only changes what the word conversion means.
14:31
SPEAKER_00: And notice what she cannot do.
14:33
SPEAKER_00: A couple can run a first phase of conversions up to the point where the senior deduction starts phasing out,$150,000, and only then worry about Medicare.
14:44
SPEAKER_00: Joanne's phase out starts at$75,000 below where her income already sits.
14:50
SPEAKER_00: So for her, there is no first phase.
14:53
SPEAKER_00: The Medicare line is the only line.
14:56
SPEAKER_00: At$65, that is$28,000.
15:00
SPEAKER_00: At$66, about$15,000.
15:03
SPEAKER_00: When Social Security turns on at$70,000, the benefit replaces IRA withdrawals.
15:09
SPEAKER_00: So the room under the line stays about the same, roughly$23,000 to$25,000 year through$74.
15:17
SPEAKER_00: Across the whole decade, she converts$208,000.
15:21
SPEAKER_00: That is about a tenth of the balance.
15:24
SPEAKER_00: Final score,$5,417,000.
15:29
SPEAKER_00: It comes out ahead by$50,900.
15:33
SPEAKER_00: So what does that$51,000 actually mean?
15:36
SPEAKER_00: $51,000 on a$5.4 million estate is less than 1%.
15:42
SPEAKER_00: So realistically, that is almost a tie.
15:45
SPEAKER_00: And that tells us something important.
15:47
SPEAKER_00: A married couple often has more room to make Roth conversions before running into higher brackets or Medicare surcharges.
15:54
SPEAKER_00: Joanne does not.
15:56
SPEAKER_00: As a single filer, she's already much closer to those limits before she converts anything.
16:02
SPEAKER_00: Run this same bandit strategy for a married couple with the same$2 million and it converts over$800,000.
16:10
SPEAKER_00: Joanne converts$208,000, a quarter of the room.
16:15
SPEAKER_00: That leaves very little room to convert enough to make a meaningful difference without creating another tax cost or triggering Medicare surcharge.
16:23
SPEAKER_00: So if the question is whether converting will make her meaningfully richer under these assumptions, probably not.
16:31
SPEAKER_00: But that is not actually the question.
16:33
SPEAKER_00: The input that changes everything.
16:35
SPEAKER_00: I ran the analysis again and changed just one assumption.
16:39
SPEAKER_00: Who inherits the IRA and what tax bracket they are in?
16:44
SPEAKER_00: If the IRA goes to charity, a church, a donor advice fund, anyone who pays no tax, doing nothing wins by about$33,000.
16:53
SPEAKER_00: Every dollar she converted was tax paid on money that was never going to be taxed.
16:59
SPEAKER_00: If her heirs are in their 12% bracket, the bandit strategy wins by just$9,000.
17:06
SPEAKER_00: A rounding error.
17:07
SPEAKER_00: Call that a tie.
17:09
SPEAKER_00: At 22%, it wins by$44,000.
17:13
SPEAKER_00: At 24%, which is what we modeled,$51,000.
17:17
SPEAKER_00: At 32%, the bandit strategy wins by$78,800.
17:22
SPEAKER_00: At 37%, it wins by$96,200.
17:27
SPEAKER_00: Everything else stayed the same, and the strategy went from a$33,000 mistake to a$96,000 win.
17:35
SPEAKER_00: Whether this is worth doing at all depends on a number that has nothing to do with her.
17:40
SPEAKER_00: And here's why that has different implications for a woman who is already single.
17:45
SPEAKER_00: For a married couple, one major reason to convert is the survivor.
17:49
SPEAKER_00: One of them may outlive the other.
17:52
SPEAKER_00: The survivor goes from filing jointly to filing single with much narrow break, gets a lower threshold.
17:59
SPEAKER_00: Conversions can serve as insurance against that future tax compression.
18:04
SPEAKER_00: It is a strong argument, and I have a whole episode on it.
18:07
SPEAKER_00: Joanne does not get that argument.
18:09
SPEAKER_00: She's already filing single.
18:11
SPEAKER_00: She has been the entire time.
18:13
SPEAKER_00: There is no survivor event coming that moves her from joint brackets to single ones because she's already there.
18:21
SPEAKER_00: Those lines will drift up slowly with inflation, and Congress can change anything it wants, but nothing in her own filing status is going to widen them suddenly.
18:31
SPEAKER_00: So one of our biggest reasons to convert may not be about her own lifetime tax bill at all.
18:37
SPEAKER_00: It may be about who gets the IRA next.
18:40
SPEAKER_00: Whatever is left in the IRA goes to her children or her nieces or whoever she names.
18:46
SPEAKER_00: Under the Secure Act passed in 2019, most non-Spouse beneficiaries have 10 years to empty it.
18:54
SPEAKER_00: And because Joanne would have died after her required beginning date, many of them also have to take something out every single year along the way.
19:02
SPEAKER_00: Some beneficiaries are treated differently, a surviving spouse, her own minor child until age 21, someone disabled, chronically ill, or someone not more than 10 years younger than her.
19:14
SPEAKER_00: For most adult children, it is 10 years, 10 years potentially during their pick earning years at their brackets decked on top of their salaries.
19:24
SPEAKER_00: So ask yourself the question the model is really asking.
19:28
SPEAKER_00: Is your IRA going to your daughter, the teacher, your daughter, the partner at a firm, or your church?
19:35
SPEAKER_00: Because in this analysis, moving from a charity to a top bracket heir creates roughly$129,000 of swing in the result.
19:45
SPEAKER_00: That is the difference between a strategy that costs her money and one that makes it.
19:50
SPEAKER_00: I have a full episode on exactly how that 10-year rule works and what it costs a family.
19:56
SPEAKER_00: It's linked in the show notes.
19:57
SPEAKER_00: One more thing the model showed.
20:00
SPEAKER_00: There is a second variable worth knowing about, and it surprised me.
20:04
SPEAKER_00: At 6% growth, the bandit strategy wins by about$51,000.
20:09
SPEAKER_00: At 4% growth,$34,000.
20:13
SPEAKER_00: And in this model, at 8% growth, it wins by$92,000.
20:19
SPEAKER_00: The better your portfolio does, the more the conversion can matter.
20:23
SPEAKER_00: Because a bigger balance at$5,000 means a bigger forced distribution, potentially a higher bracket, and potentially larger Medicare surcharges for the rest of your life.
20:33
SPEAKER_00: Doing well is what creates the problem.
20:36
SPEAKER_00: Three things you can do this week without hiring anybody.
20:39
SPEAKER_00: First, find your own single filer lines and write them on one page.
20:45
SPEAKER_00: The Medicare threshold, the top of your 22% bracket, the point where the senior deduction starts phasing out.
20:52
SPEAKER_00: Note which measure of income each one uses because they're not the same.
20:58
SPEAKER_00: If you have been planning from a couple's numbers, this is where you will feel it.
21:02
SPEAKER_00: Second, write down who inherits your IRA, and next to each name, write your honest cast at their tax bracket.
21:10
SPEAKER_00: You do not need a perfect number, just a ballpark.
21:12
SPEAKER_00: And if any of it is going to charity, write zero.
21:16
SPEAKER_00: Think about what they do for a living, whether they're in early in their career or established, or if you know their approximate income range.
21:24
SPEAKER_00: For example, a teacher who is single might be in their 12% to 22% bracket, while someone in a leadership or executive role could be in a much higher bracket.
21:34
SPEAKER_00: Getting close is enough to help you understand the impact.
21:38
SPEAKER_00: That is not just an estate planning detail.
21:40
SPEAKER_00: In this analysis, it was one of the numbers that mattered most.
21:43
SPEAKER_00: It decided whether the winning strategy won at all.
21:47
SPEAKER_00: Third, look at where your spending will come from between the year you stop working and the year your required distributions start.
21:55
SPEAKER_00: If the honest answer is the IRA, some of your conversion room may already be getting used by the withdrawals you need for spending.
22:03
SPEAKER_00: And that is one of the first things a plan has to solve.
22:06
SPEAKER_00: The sequencing behind all of this is in my free guide, the Executive Woman's Tax Playbook.
22:12
SPEAKER_00: It's in the show notes along with a link to book a short 15 minute call if you want your own numbers run.
22:18
SPEAKER_00: I'll see you next episode.