This channel is a gem. I sort of doubt that a regular person without a decent foundation in personal finance can listen and grasp the lessons, but once 'high school' level is sorted out, this is the place to go to reach the next level. As Eric says, it is all too common a mistake to make decisions such as Roth conversions based on the effective tax rate. The next most common mistake is to make these decision based on the marginal tax bracket. While the marginal tax bracket is applicable to the last dollar, I find it most helpful to consider the marginal cost of (for e.g.) the Roth conversion. Eric calculated marginal cost in this video, but I don't think he was explicit is pointing out how this tax rate may be different than the marginal tax bracket. Follow-up video, Eric ? P.s., my wife has asked me to find a financial advisor for when I am no longer they guy. I've been searching for a while, and Eric leads the pack.
Great video! I actually use marginal and effective tax rates and include the IRMAA in the calculation. Eventually someone has to pay for the pre-tax retirement accounts unless they are gifted away through QCD. Since we don't know our future tax brackets, nor do we know what tax brackets that beneficiaries might be in the future, it's anyone's guess. I am glad that we did Roth conversions but who knows if it was the best financial decision. Thanks very much. This was by far the best presentation I have seen on this subject.
Eric, from the comments, it looks like a lot of people didn't fully grasp the big picture. Maybe you do a full real example using that last scenario. The person could do a 5k Roth conversion at 22% tax bracket. Then later you show how having that money available allows them to pay less total taxes/premiums. Might need to show it in actual total tax dollars paid vs. percentages? Good luck and thanks for continuing to put out good stuff.
THANK YOU for reiterating this. Never have understood why so many people focus on overall effective rates. I care more about what is happening with my next marginal dollar
6:00 Realistically, the social security marginal tax bump at about $20k is unavoidable unless one decides one year to take nothing out of taxable accounts over $20k. That bump is at such a low level that it's almost not worth discussing. Please explain how to avoid it without completely emptying one's tax-free accounts.
I've said this before, but at 4:00 in the video, it's not quite that simple. The taxes paid later have way less purchasing power due to inflation. Those present-day tax dollars "saved" have way more purchasing power. So inflation eats at those Roth dollars. Would love to see a video that explains this better, thanks.
After plotting out marginal cost (tax + IRMAA + NIIT) vs. Roth amount converted, something that I have a hard time quantifying is how much more one should be willing to pay up front in a Roth conversion, to avoid/lessen the possibility of Single Window's Penalty down the road, where sudden jumps over IRMAA cliffs and higher brackets are involved.
I agree. This is referred to as the Widow Tax Torpedo. Wish there was a tutorial in how to estimate future tax torpedo effects using a simple spreadsheet. I think the biggest challenge is determining all of the assumptions accurately (like year-by-year account growth rates, tax Bracket COLA adjustments, etc, etc). Without accurate forecasts, it just becomes a ‘garbage in - garbage out’ analysis and hard to make the correct choices, especially if forecasting far into the future.
I plan to create a no earned income window of time, between 60 and 63, and use this window to convert a large portion of tax deferred funds to Roth. After 63, it gets difficult to convert around Irmaa and retirement income.
After a cancer scare, we hedged and did a one time chunk and have laddered ever since. I saw how the CPA didn't offer any tax advice on a widow's final year of being able to file MFJ and have been overly concerned with the widow's penalty. Thankfully things are OK for us (in other words we didn't need to go so heavy in year one) but it could have paid off handsomely if things went south.
the biggest benefit to converting to Roth for many is that after converting, the money compounds in a non-tax environment (leave it in traditional and your tax keeps increasing). Also the benefit of not having to mess with RMD's (or trying to evaluate how much RMD is in the future), limited IRMAA impact, being able to cover a big expense without it becoming a big tax event.
6:52 would graphing the effective tax rate on that graph be helpful in showing the effect of maxing out the bracket (including irmaa as a tax). I would expect to see it decrease to the right until it reached the next bracket or Irmaa threshold.
Wouldn't marginal tax rate matter less if someone was qualifying for tax credits? Tax credits could reduce their effective tax rate to zero, depending on income and what they qualify for: CTC, EITC, Saver's Credit, etc.
I would say it matters more. If effective tax rate is zero, then the marginal tax rate will also be zero on that income. You can't have a non-zero marginal rate that adds up to a zero effective tax rate. The reason I say marginal tax rate matters more in this situation is because those credits will start phasing out at certain income levels. So the marginal cost on that income as the credits phase out will be higher than what you probably think you are being taxed at
Eric, why does your Retirement Tax System graph (and many others in past videos) show the first IRMAA threshold at ~$58,000 when the 2024 IRMAA single person threshold is $103,000 of 2022 income?
@@polymath5119 I believe it is because the X-axis is not the total income you earn, but rather it is the incremental income you add to your base case scenarios.
@apeel2008 is correct. In the background of this graph, I'm already assuming Social Security benefits and dividends. So ~$58,000 would be the marginal income added in.
We all understand trading our time for money. If you have to trade a day of you life for a dollar, so be it. But what if the next day you trade it was for only 50 cents? On Monday you get a dollar, on Tuesday 90 cents, on Wednesday 88 cents, on Thursday 78 cents, on Friday 76 cents, and the next Monday you only get 68 cents. Oh, and if you live in California, take an additional 1 cent to 13 cents off for them so that second Monday you are only getting 55cents while doing the same work that used to get you a dollar. And it keeps going down from there. I've never understood "effective tax rate" people. The critical number is how much tax on the next dollar of income. The government depends on people foolishly looking at effective tax rate so they stay motivated. Knowing that I was going to be paying the gov't 50% on the next dollar I earned meant I was not being compensated for the additional stress and aggravation that came with the promotion. Why put up with it? Instead I took a pay cut and reduced my hours to 32/week the last few years for the best return on my time. Considering anything other than marginal rates is simply combining disparate data - the 0% dollars, the 12% dollars, the 22% dollars, etc. are not equal, yet "effectively" would be thought of as the same. It's just bad thinking.
I watched this video a couple more times and it seems to be missing important points. It wants to compare effective tax rates and marginal tax rates but doesn't take into account the effects of not doing a Roth conversion and having all the effects of RMDs, higher social security taxes and IRMAA penalties. I learn a lot from this channel but it seems to me that this current video is just simply wrong.
People are facing a tough retirement. and it's even harder for workers to save due to low-paying jobs, inflation, and high rents. Now, middle-class Americans find it tough to own a home too, leaving them without a place to retire in.
It is for both. Part of the point is to have Roth assets in retirement to give you flexibility to manage your taxes. You achieve in part by doing Roth contributions pre-retirement, but you can also make conversions pre-retirement depending on your tax bracket. Once retired, depending on your age of retirement and IRA balance, you may still have a window for conversions before Medicare/IRMAA and SS kicks in, assuming that conversions make sense for you based on future tax brackets, additional taxes, RMD amounts, and goals such as future spending or inheritances.
Sorry, but still I think effective tax rates is more crucial in retirement. For example, in your example where a retiree withdraws $3,000 more and ends up with a 58% marginal tax rate. But that %58 applies only to the $3,000. With everything considered (IRMAA, windows tax trap, etc.), still the retiree pays only about 16% of his total income. That’s much better than 24% marginal rate he would have had to pay during Roth conversion. Sure, it would be the best if the retiree plans in advance and plan not to withdraw $3,000 more
You are comparing the 16% effective rate of his overall income to the marginal 24% tax rate of a conversion of a much smaller amount of money done several years ago, that grew to $3000 over those years. That would not be an apples to apples comparison. Yes, from an effective tax rate view, the additional tax seems to be not that much more ($1700 additional over the original $15,000, or about 11% more tax) but it is significant especially when you consider that this bump was due to just $3000 more of income, or just a 2.5% increase in income. The main point is that, if you definitely need that additional $3000 in income, it is better to have the flexibility of having it available in Roth assets, to avoid the tax impact. Otherwise, say that this extra income is to make an urgent home repair, if you take it from pre-tax it’s like paying $4,745 for the repair rather than $3000.
I usually enjoy learning from this channel, but unfortunately I don't see any real proof provided in this video about why using marginal tax brackets in my retirement tax decision-making process is so much better than using my effective tax rate. It's kinda like the professor already knows the answer (and keeps repeating it), but it is left to the students in his class to derive the actual proof. And I think the IRMMA example provided is a poor one given that IRMMA are tax cliffs that are piled on top of our progressively-taxed income. I can make tax-related income decisions like a Roth Conversion knowing where those IRMMA cliffs are, regardless of whether I track effective tax rates or marginal tax brackets. And since I tend to concern myself with the total taxes paid, I see more value in understanding the impact to the effective tax rate (both federal & state combined) to give me insight to help make the best decision possible, versus whether knowing that something like an extra $5 of income is being taxed at some incredibly high marginal rate. Full transparency: I have always been an effective tax rate kind of guy - that is how I currently figure out my current withholdings - but I am new to the retirement scene so I would be willing to convert, if provided enough data to make a decision that is best for my particular situation.
If you change 1 variable while holding the rest constant, the marginal rate is the slope or proportional response to that change. They're not talking about $5. They're talking about $10's or $100's of thousands. Someone who perhaps over saved in non-Roth 401k/IRA, got lucky on their stick picks, and has a sizable qualified account such that they're worried about RMDs. They worry that after one spouse passes, the remaining spouse will change to the single filing status, significantly increasing their taxes (marginal and effective). A strategy is to perform several years of large Roth conversions at the right time to minimize overall taxation, do it before the spouse passes. Project what marginal bracket the remaining spouse would be in. You might fill up a bracket today at 22% or 24% so that they don't pay 32% later. The $10s of thousands of dollars saved overall on taxes can benefit the grandchild or charity of your choice.
You can pay 20% tax today or 10% tax next year, on the same amount of money. Which do you choose? Why would the average rate you paid on all previous money impact that decision? What average rate on past money would make paying 20% better than 10%? It’s a sunk cost. Also conveniently, paying a higher marginal rate will result in a higher effective rate, all else being equal.
I think he didn't spend enough time on the last example, which was the key point of the video. In that case, if you had money available in both Roth and Traditional accounts, taking out the last 3000 from the Roth would have saved a huge marginal tax hit. Way beyond a 22% or 24% tax rate. Planning for that specific scenario is really hard 20 years out, but planning for it during that year is quite doable with tax planning.
The irony of your video saying retirees should only worry about marginal tax brackets, and then your graphic at 3:50 proves that Roth conversions are beneficial by using effective tax rates.. :-) That graphic was based upon an effective tax rate of 15%, not the marginal 22/24% (depending on the tax year you used).
@ *jerry* Chart at 3:50 is not a "proof" about effective vs marginal taxes; it merely demonstrates that if identical tax rate is applied for Roth at contribution/conversion and traditional at distribution, then end result is identical. While Roth contribution/conversion is paid at marginal rate, this hypothetical scenario uses only a single tax rate of 15% for both Roth and traditional so there is no meaningful argument regarding marginal vs effective tax rates. There is no irony here.
eh just check the tax bracket there is only 2% difference between 102K and 197K for a single taxpayer. I think you should focus on effective. You don't actually show which strategy is better. Marginal rates don't demonstrate what you are arguing for.
You are only focusing on federal income tax rates. You have to look beyond that which is the point. Did you check your Medicare premiums? What about Capital Gains? Or even more impactful if prior to 65, your Obamacare subsidy. The jump may be much higher than 2% if you do total tax planning.
That’s the point. You are paying 58% tax on just a 2% of additional income taken. So, you just needed $3000 more money, but you paid a extra $1750 in taxes just to get those $3000 out of your Trad IRA!
![I.N "HALLUCINATION" | [Stray Kids : SKZ-PLAYER]](http://i.ytimg.com/vi/n5B5q1Hwt_U/mqdefault.jpg)
Eric is easily the best retirement tax strategist on YT.
Best channel for income tax/tax planning
Eric, always appreciate your videos. Always well done, some of the best Ive ever seen.
This channel is a gem. I sort of doubt that a regular person without a decent foundation in personal finance can listen and grasp the lessons, but once 'high school' level is sorted out, this is the place to go to reach the next level.
As Eric says, it is all too common a mistake to make decisions such as Roth conversions based on the effective tax rate. The next most common mistake is to make these decision based on the marginal tax bracket. While the marginal tax bracket is applicable to the last dollar, I find it most helpful to consider the marginal cost of (for e.g.) the Roth conversion. Eric calculated marginal cost in this video, but I don't think he was explicit is pointing out how this tax rate may be different than the marginal tax bracket.
Follow-up video, Eric ?
P.s., my wife has asked me to find a financial advisor for when I am no longer they guy. I've been searching for a while, and Eric leads the pack.
Your videos are great. I have learned so much in my first year of retirement! Thanks Eric.
Great video! I actually use marginal and effective tax rates and include the IRMAA in the calculation. Eventually someone has to pay for the pre-tax retirement accounts unless they are gifted away through QCD. Since we don't know our future tax brackets, nor do we know what tax brackets that beneficiaries might be in the future, it's anyone's guess. I am glad that we did Roth conversions but who knows if it was the best financial decision. Thanks very much. This was by far the best presentation I have seen on this subject.
I know that concept, but didn’t know the technical term of “marginal tax.” That’s what kills wealth building. Thanks!
Thank you so much! Learned a lot from your videos
Eric, from the comments, it looks like a lot of people didn't fully grasp the big picture. Maybe you do a full real example using that last scenario. The person could do a 5k Roth conversion at 22% tax bracket. Then later you show how having that money available allows them to pay less total taxes/premiums. Might need to show it in actual total tax dollars paid vs. percentages? Good luck and thanks for continuing to put out good stuff.
THANK YOU for reiterating this. Never have understood why so many people focus on overall effective rates. I care more about what is happening with my next marginal dollar
6:00 Realistically, the social security marginal tax bump at about $20k is unavoidable unless one decides one year to take nothing out of taxable accounts over $20k. That bump is at such a low level that it's almost not worth discussing. Please explain how to avoid it without completely emptying one's tax-free accounts.
I've said this before, but at 4:00 in the video, it's not quite that simple. The taxes paid later have way less purchasing power due to inflation. Those present-day tax dollars "saved" have way more purchasing power. So inflation eats at those Roth dollars. Would love to see a video that explains this better, thanks.
Great video as always. One topic I'd love to see you discuss is how to calculate the optimal Roth conversion amount for a given year.
After plotting out marginal cost (tax + IRMAA + NIIT) vs. Roth amount converted, something that I have a hard time quantifying is how much more one should be willing to pay up front in a Roth conversion, to avoid/lessen the possibility of Single Window's Penalty down the road, where sudden jumps over IRMAA cliffs and higher brackets are involved.
I agree. This is referred to as the Widow Tax Torpedo. Wish there was a tutorial in how to estimate future tax torpedo effects using a simple spreadsheet. I think the biggest challenge is determining all of the assumptions accurately (like year-by-year account growth rates, tax Bracket COLA adjustments, etc, etc). Without accurate forecasts, it just becomes a ‘garbage in - garbage out’ analysis and hard to make the correct choices, especially if forecasting far into the future.
It’s tough because tax keeps changing to fit whatever situation we’ll be in, in the future. 🤦🏽♂️
I plan to create a no earned income window of time, between 60 and 63, and use this window to convert a large portion of tax deferred funds to Roth. After 63, it gets difficult to convert around Irmaa and retirement income.
After a cancer scare, we hedged and did a one time chunk and have laddered ever since. I saw how the CPA didn't offer any tax advice on a widow's final year of being able to file MFJ and have been overly concerned with the widow's penalty. Thankfully things are OK for us (in other words we didn't need to go so heavy in year one) but it could have paid off handsomely if things went south.
@@JohnWisconsin ditto here. We are getting the cancer results next week. Glad things are going well for you!
the biggest benefit to converting to Roth for many is that after converting, the money compounds in a non-tax environment (leave it in traditional and your tax keeps increasing). Also the benefit of not having to mess with RMD's (or trying to evaluate how much RMD is in the future), limited IRMAA impact, being able to cover a big expense without it becoming a big tax event.
6:52 would graphing the effective tax rate on that graph be helpful in showing the effect of maxing out the bracket (including irmaa as a tax). I would expect to see it decrease to the right until it reached the next bracket or Irmaa threshold.
Wouldn't marginal tax rate matter less if someone was qualifying for tax credits? Tax credits could reduce their effective tax rate to zero, depending on income and what they qualify for: CTC, EITC, Saver's Credit, etc.
I would say it matters more. If effective tax rate is zero, then the marginal tax rate will also be zero on that income. You can't have a non-zero marginal rate that adds up to a zero effective tax rate.
The reason I say marginal tax rate matters more in this situation is because those credits will start phasing out at certain income levels. So the marginal cost on that income as the credits phase out will be higher than what you probably think you are being taxed at
Eric, why does your Retirement Tax System graph (and many others in past videos) show the first IRMAA threshold at ~$58,000 when the 2024 IRMAA single person threshold is $103,000 of 2022 income?
Good point
@@polymath5119 I believe it is because the X-axis is not the total income you earn, but rather it is the incremental income you add to your base case scenarios.
@apeel2008 is correct. In the background of this graph, I'm already assuming Social Security benefits and dividends. So ~$58,000 would be the marginal income added in.
Happy New Year Eric.Good video and discussion, very helpful. Have a blessed week and I'll see you on the next one. Larry, Central Vlley, Ca.
We all understand trading our time for money. If you have to trade a day of you life for a dollar, so be it. But what if the next day you trade it was for only 50 cents? On Monday you get a dollar, on Tuesday 90 cents, on Wednesday 88 cents, on Thursday 78 cents, on Friday 76 cents, and the next Monday you only get 68 cents. Oh, and if you live in California, take an additional 1 cent to 13 cents off for them so that second Monday you are only getting 55cents while doing the same work that used to get you a dollar. And it keeps going down from there.
I've never understood "effective tax rate" people. The critical number is how much tax on the next dollar of income. The government depends on people foolishly looking at effective tax rate so they stay motivated. Knowing that I was going to be paying the gov't 50% on the next dollar I earned meant I was not being compensated for the additional stress and aggravation that came with the promotion. Why put up with it? Instead I took a pay cut and reduced my hours to 32/week the last few years for the best return on my time.
Considering anything other than marginal rates is simply combining disparate data - the 0% dollars, the 12% dollars, the 22% dollars, etc. are not equal, yet "effectively" would be thought of as the same. It's just bad thinking.
Thank you🎉
I watched this video a couple more times and it seems to be missing important points. It wants to compare effective tax rates and marginal tax rates but doesn't take into account the effects of not doing a Roth conversion and having all the effects of RMDs, higher social security taxes and IRMAA penalties. I learn a lot from this channel but it seems to me that this current video is just simply wrong.
Can you please do a video that includes the complications of RMDs, SS taxes and IRMAA penalties when weighing roth conversions? You're the best !
People are facing a tough retirement. and it's even harder for workers to save due to low-paying jobs, inflation, and high rents. Now, middle-class Americans find it tough to own a home too, leaving them without a place to retire in.
This video is about planning before you retire correct and not during retirement right?
@_-Karl-_ so are you saying during retirement to calculate Roth conversions that the marginal tax rate is more important than the effective tax rate?
It is for both. Part of the point is to have Roth assets in retirement to give you flexibility to manage your taxes. You achieve in part by doing Roth contributions pre-retirement, but you can also make conversions pre-retirement depending on your tax bracket. Once retired, depending on your age of retirement and IRA balance, you may still have a window for conversions before Medicare/IRMAA and SS kicks in, assuming that conversions make sense for you based on future tax brackets, additional taxes, RMD amounts, and goals such as future spending or inheritances.
IMMRA is nasty surprise after a lifetime of saving. Especially if you are healthy and don’t use any Medicare benefits.
Sorry, but still I think effective tax rates is more crucial in retirement. For example, in your example where a retiree withdraws $3,000 more and ends up with a 58% marginal tax rate. But that %58 applies only to the $3,000. With everything considered (IRMAA, windows tax trap, etc.), still the retiree pays only about 16% of his total income. That’s much better than 24% marginal rate he would have had to pay during Roth conversion.
Sure, it would be the best if the retiree plans in advance and plan not to withdraw $3,000 more
You are comparing the 16% effective rate of his overall income to the marginal 24% tax rate of a conversion of a much smaller amount of money done several years ago, that grew to $3000 over those years. That would not be an apples to apples comparison. Yes, from an effective tax rate view, the additional tax seems to be not that much more ($1700 additional over the original $15,000, or about 11% more tax) but it is significant especially when you consider that this bump was due to just $3000 more of income, or just a 2.5% increase in income. The main point is that, if you definitely need that additional $3000 in income, it is better to have the flexibility of having it available in Roth assets, to avoid the tax impact. Otherwise, say that this extra income is to make an urgent home repair, if you take it from pre-tax it’s like paying $4,745 for the repair rather than $3000.
I usually enjoy learning from this channel, but unfortunately I don't see any real proof provided in this video about why using marginal tax brackets in my retirement tax decision-making process is so much better than using my effective tax rate. It's kinda like the professor already knows the answer (and keeps repeating it), but it is left to the students in his class to derive the actual proof.
And I think the IRMMA example provided is a poor one given that IRMMA are tax cliffs that are piled on top of our progressively-taxed income. I can make tax-related income decisions like a Roth Conversion knowing where those IRMMA cliffs are, regardless of whether I track effective tax rates or marginal tax brackets. And since I tend to concern myself with the total taxes paid, I see more value in understanding the impact to the effective tax rate (both federal & state combined) to give me insight to help make the best decision possible, versus whether knowing that something like an extra $5 of income is being taxed at some incredibly high marginal rate.
Full transparency: I have always been an effective tax rate kind of guy - that is how I currently figure out my current withholdings - but I am new to the retirement scene so I would be willing to convert, if provided enough data to make a decision that is best for my particular situation.
If you change 1 variable while holding the rest constant, the marginal rate is the slope or proportional response to that change. They're not talking about $5. They're talking about $10's or $100's of thousands. Someone who perhaps over saved in non-Roth 401k/IRA, got lucky on their stick picks, and has a sizable qualified account such that they're worried about RMDs. They worry that after one spouse passes, the remaining spouse will change to the single filing status, significantly increasing their taxes (marginal and effective). A strategy is to perform several years of large Roth conversions at the right time to minimize overall taxation, do it before the spouse passes. Project what marginal bracket the remaining spouse would be in. You might fill up a bracket today at 22% or 24% so that they don't pay 32% later. The $10s of thousands of dollars saved overall on taxes can benefit the grandchild or charity of your choice.
You can pay 20% tax today or 10% tax next year, on the same amount of money. Which do you choose? Why would the average rate you paid on all previous money impact that decision? What average rate on past money would make paying 20% better than 10%? It’s a sunk cost.
Also conveniently, paying a higher marginal rate will result in a higher effective rate, all else being equal.
I think he didn't spend enough time on the last example, which was the key point of the video. In that case, if you had money available in both Roth and Traditional accounts, taking out the last 3000 from the Roth would have saved a huge marginal tax hit. Way beyond a 22% or 24% tax rate. Planning for that specific scenario is really hard 20 years out, but planning for it during that year is quite doable with tax planning.
Keep on watching and studying. With perseverance, you will catch on.
Face it, we have no idea what tax rates will be in two years, let alone 20 years.
True, but some of the information are useful today for income tax.
The irony of your video saying retirees should only worry about marginal tax brackets, and then your graphic at 3:50 proves that Roth conversions are beneficial by using effective tax rates.. :-) That graphic was based upon an effective tax rate of 15%, not the marginal 22/24% (depending on the tax year you used).
No, the graphic assumes the conversions were done at a marginal rate of 15%
@ *jerry* Chart at 3:50 is not a "proof" about effective vs marginal taxes; it merely demonstrates that if identical tax rate is applied for Roth at contribution/conversion and traditional at distribution, then end result is identical. While Roth contribution/conversion is paid at marginal rate, this hypothetical scenario uses only a single tax rate of 15% for both Roth and traditional so there is no meaningful argument regarding marginal vs effective tax rates. There is no irony here.
eh just check the tax bracket there is only 2% difference between 102K and 197K for a single taxpayer. I think you should focus on effective. You don't actually show which strategy is better. Marginal rates don't demonstrate what you are arguing for.
You are only focusing on federal income tax rates. You have to look beyond that which is the point. Did you check your Medicare premiums? What about Capital Gains? Or even more impactful if prior to 65, your Obamacare subsidy. The jump may be much higher than 2% if you do total tax planning.
That’s the point. You are paying 58% tax on just a 2% of additional income taken. So, you just needed $3000 more money, but you paid a extra $1750 in taxes just to get those $3000 out of your Trad IRA!