Fixing 10 Common Roth Conversion Misconceptions (Costly Errors)
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- Опубликовано: 13 июн 2024
- Is your Roth Conversion strategy designed to optimize the goal that is more important to you? Are you making one of the mistakes in this video? You can schedule an appointment with one of our Retirement Experts to look at your situation and help you plan for your future. Call us at (920) 544-0576 or go to www.safeguardinvest.com/contact.
Timestamps:
0:00 Fixing 10 Roth Conversion Misconceptions
0:10 #1 - There An Inherent Benefit to Roth Assets
1:48 #2 - Anything I Convert Will Be Satisfactory
4:37 #3 - Next Generation Misconceptions
7:01 #4 - You Need to Wait 5 Years to Touch Your Conversion
7:47 #5 - Roth Conversions Prevent Roth Contributions
8:29 #6 - Conversions Only Make Sense if You Pay Taxes Outside of Your IRA
9:44 #7 - I Can Pay Conversion Taxes Next April
11:09 #8 - There is Just One Conversion Goal
12:18 #9 - Tax-Free Retirements are Great!
13:46 #10 - I Need to Be Done With Conversions Before RMDs
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I'm 62 and just retired last fall. I just did my first conversion last month. I'm leaving my entire portfolio to my children to help them with their retirement, or to be passed on to my grandchildren, because I don't need it. I'm paying the taxes out of savings. Thanks for the informative video.
There won't be anyone left on the planet in 37 years.
You are one of the few that understands the rules and uses MATH to determine the best course of action. Thank you for sharing.
Creative math at that!
Did you happen to notice in the first myth how he took the 15% tax straight out of the Roth conversion itself to make it look equal? In reality, many people do Roth conversions when they are still working because they want to pay tax in advance so that it doesn’t have to come out of the Roth now or later. Of course that math would not have dovetailed with his “myth”
@@touchofgrace3217 his math is correct. If you are in the 15% tax bracket and invest $100,000 in a traditional account at the beginning, you pay no taxes so you invest a net of $100,000 because you don't have to pay tax on that money. However if you invest $100,000 in a Roth instead, you have to pay the tax on that $100,000 of income, which means you have a net of $85,000 to put in the Roth at the beginning.
When you take out the earnings, if you are in the same tax bracket, you will have to pay the 15% tax on the traditional, but not the Roth. Because of the commutative property of multiplication, you end up with exactly the same amount at the end. Hence, what matters is whether the tax rate is higher when you take it out versus when you put it in.
This is one of the best Roth conversion discussions I have seen and demolishes the notion set forth by others that there is only one optimal way to do this and for a fee we can tell you. Well done!
#5 is fascinating to me, because backdoor Roth contributions makes it almost completely moot. This is the kind of obscure knowledge I come here for.
Learn the most from your videos. Great topics. Keep em coming
One thing that makes Roth conversions so appetizing right now is the low tax rates. Because of the Tax Cuts and Jobs Act, it’s very unlikely that we will be paying taxes at a lower rate years from now. And if you did conversions when the market was down late last year, congratulations. You converted a smaller amount, paid less taxes, and watched your portfolio grow over the past 6 months tax free.
The Commutative Property of multiplication: Changing the order of factors does not change the product.
This is great info! Dense and full of actual actionable steps. So much of finance RUclips is fluff, and general info is amazing.
Great content! Thank you
Excellent video!
Every time I watch your videos, I am blown away by the analysis. Also, the blue background is fantastic! What color is that paint?!?!
Wow, this somewhat “geeky” presentation is loaded with excellent wisdom and smarts! I only wish you had a flat/hourly fee model since even at your lower than typical % of AUM model fee structure, we really have no interest in handing over full management of our assets. We prefer simple and maintaining full control. We’re looking for expertise to review what we believe is already a solid, but not fully optimized plan, not take over management.
Search for hourly rate Fiduciaries in your area. Prepare a clear presentation and snapshot of your finances, goals and strategy for them to revue and give you feedback. They're becoming far and fewer between but they are out there. You just gotta poke around.
@@bryanharrell4059 not worth the time invested - tried that. And we’re in a medium large metro area with plenty of wealthy individuals. Too many local planners stuck in the “buy us a steak dinner”, “investment advisor” past. Therefore went national in the search since it matters not where an advisor is located as long as they serve multi-states and use tools that cover all states. But certainly if we came across a qualified local referral from a trusted friend or colleague, we’d entertain local.
There are too many Rules of Dumb baked into the current advisor handbook to broadly trust their advice. A person could maybe work up a short questionnaire to evaluate prospective advisors, weed out the pretenders long before they "wow" you with their Monte Carlo simulation chock full of faulty assumptions.
This is EXCELLENT
I love all of your videos - they are incredible. However, on point #9, if you are taking Social Security while withdrawing from your IRA, there is no 10 or 12% bracket. Filling the 0% bracket with withdrawals is optimal - as you mentioned in the video.
Great video, Eric. Can you speak to Roth conversation misconceptions in regards to Back Door Roth operations?
I have a sizeable pension and I have taxes withheld from that pension to cover taxes associated with converting from my rather large traditional IRA. This allows me to pay the taxes from the taxable "bucket" while avoiding quarterly tax payments from savings or paying from the conversion itself. This is especially useful for me because I participate in some real estate limited partnerships that don't generate K-1 information in time for the first and second quarter of the year.
You can also have 0 withheld from your pension throughout the whole year then towards the end of the year figure out how much taxes you will owe and take a 401k withdraw with 100% withheld for taxes.
Item 9 was eye-opening to me. I now understand how continuing to receive some taxable income throughout retirement can make perfect sense.
@@AbeFroman-zx5hs The point is that it won't be at a higher rate as long as you plan correctly.
@@AbeFroman-zx5hs
I think the point is somewhat theoretical. If you created a situation where your ONLY income is from Roth withdrawals because you converted everything, then you have given up on getting even the standard deduction worth of 0% income tax rate. But most people will have SS, pension income, dividend/interest income, etc.
@@AbeFroman-zx5hs
Always best to watch the video before commenting. ;)
I agree that pensions are almost dead, but many Boomers have them, plus military, teachers, police, etc.
My point was really about whether it is even feasible for people to go “Roth only” or whether there will almost always be other sources of income.
Quibbling a bit on 2026+, but it will be interesting to see how the next admin works with Congress on the new tax rules. I’m betting on something between the old rules and Trump’s.
@@AbeFroman-zx5hsThe 10 and 12% tax brackets would like to disagree with you that taxes "through out retirement translate to high tax rates." Most people pay into their Roth accounts in the 22% tax bracket. If you're only going to have social security and retirement savings and income through retirement, as the majority of the population will, then having some taxable income will be optimal
@@AbeFroman-zx5hs
I don’t know what bracket your conversions would be in, but I think it is unlikely that our tax rates or the tables will go down in 2026. And no matter who is in the White House, there is a high probability that disfunction in Congress will mean nothing changes until the last second - or even part way through 2026.
So, if you are considering converting I’d at least do some in 2024. My $0.02.
Trying to think about this and wondering about timing of conversions during a big drawdown like during 2020? Does that change some of the math in the sense that valuations are lower?
For #4, something seems off. There are essentially two 5 year rules. You covered one of them but the other is that you also have to have done at least a single ROTH contribution/conversion at least five years ago. If I am wrong, please let me know. Thank you.
Question? The MAGI number I found for a single filer was $153k in 2023 & $161k in 2024 yet you show $146k?
Which is correct?
I agree with what you said a huge indicator is the future tax rates. Another indicator for me is when the market downs a lot, like in March 2020, we ready that’s another perfect time to convert to Roth.
It’s the IRMAA cliff that has me most focused on the Roth conversion amount. Whoops… $1 over the bracket and I owe like an extra $174 a month. Since the tax brackets use a percentage over the bracket, I’m a bit less concerned about jumping into a higher tax bracket. But, I’m no financial advisor, so thoughts from others to straighten me out are welcome!
Try to avoid IRMAA, if possible. But, if you need to go over, go over up to $1 below the next higher IRMAA amount.
@@larryjones9773Yep! But hard to get to $1 below bracket. It’s hard to predict my dividends for this year and IRMAA has that 2 year look back. Took Medicare at 65 and if I was smart I’d try to defer some of that pay when I was 63, but didn’t really understand at the time and thought I like this paycheck at 63… now I know could have been smarter when I was 63, but not planning / thinking.
The IRMAA “cliff” is real, but it is really a bump, not a cliff. The IRMAA penalty is about $2000, not exactly a back breaker. You would not want to pay more than $2000 in extra taxes to avoid $2000. I understand the penalties can exceed $4000 for very high earners. If you are converting at the 22% bracket, that is $22k per $100k.
The point is that you are paying taxes at some point, you have to look at the whole equation to see if it is a good move.
What happens to the comparison of taxes on traditional vs Roth if your investment return is much higher? ; for example some years the market might return 20%
Great video!. For No. 6, although you mentioned that you can pay the conversion taxes from the funds you are converting (rather than other outside funds), you neglected to mention that if you do that before being 59.5yo you would have to pay a 10% penalty on the amount withheld to pay those taxes.
Yes, that is correct. Good add on.
Can anyone really see tax rates lowering in the future? The countries debt, deficit, and SS situation will have to be addressed at some point. It will most likely begin sooner rather than later and depending on how fast it's corrected it will take generations.
Could have said the same thing in 2017, right?
@@SafeguardWealthManagement Well, you do have a point. I guess it's the usual question of how long we can kick the can down the road, and individual time horizons for retirement do need to be considered. I'm thinking I'll defer to you as I'm an Armchair Economist. How long before the debt and deficits must be addressed? Can the same economic behavior continue with zero correction and consequences? I mean consequences other than the current wealth gap widening and middle class disappearing. Is it possible to print money forever, lower revenue, and never pay the piper?
@@bryanharrell4059 This is the main reason why I believe we have to plan based on the rules we know today. Beyond that, I tend to leave prediction out of the equation. There is too broad a spectrum of options and timelines to try to predict with any meaningful accuracy. I 100% agree things need to change, but the combination of changes is effectively infinite. Take income taxes rising. The change may raise income taxes across the board (this is the default most seem to assume). They could also keep the same tax tables and simply change the levels you are taxed at. They could also keep the tax tables at lower income levels the same and raise rates on higher income levels, which may not change the conversion math at all for some retirees.
The current economic policy is based on Modern Monetary Policy, which effectively bets on growth outpacing inflation. It works, theoretically, but is a very fragile system. So, another variable to work into the grand economic model is economic growth.
My point is that we can all agree that we have problems here in the U.S., but we are dealing with an incredibly complex system that makes it impossible to make any reasonably accurate predictions. So, it's not a game I play, nor do I think you should play.
Good info…Does Turbo Tax automatically calculate the amount in step 5? The MAGI calculation subtraction? Do I get sent a form that showed the amount of conversion or do I just have to remember the amount I did? I did some Roth converting but stopped because I didn’t want to disqualify doing a Roth IRA. Thanks
If #5 is correct, then my TurboTax did not do it correctly for me. My regular income in 2023 was way below the $230,000 limit, but a Roth Conversion pushed my AGI to around $260,000. I made a Roth contribution, TurboTax indicated that my MAGI was above the limit and I would have to pay a penalty unless I remove my contribution. I removed my contribution.
My experience suggests that TurboTax does not know this rule for MAGI for Roth Conversion. My regular income in 2023 was way below the $230,000 limit, but a Roth Conversion pushed my AGI to around $260,000. I made a Roth contribution. TurboTax indicated that my MAGI was above the limit and I would have to pay a penalty unless I remove my contribution. I had to remove my contribution to make TT happy. I plan to contact TurboTax. Do I point to Worksheet 2-1 in Publication 590A? @@_-Karl-_
#6 - Paying tax on conversions. If under 59.5 and paid w/ IRA funds, assume that counts as distribution and subject to early draw penalty?
Nope
I believe early withdrawal penalty 0:12 would be owed on withholdings for those under 59.5, unless one of the exceptions apply such as the rule of 55
No, but withholding taxes from the conversion would count as a distribution.
I had originally planned on converting all of the funds in my rollover IRA. At this point, I intend to leave some of the funds in the IRA. This way, I can withdraw funds to fill up the 12 then 15% bracket (2026 forward). My wife is older then me, and I realize that when one of us passes, the survivor will get hit with that darned tax torpedo. Better to take out more when we are both alive. At this point, we have a lot of ROTH funds due to contributions and conversions. (No children, BTW).
I have $5 million in pretax. Just talked to Schwab fp to get confirmation. I’m doing all at once. Makes sense especially when my three kids will get tax free.
Not a good idea to convert 5m all at once. Find another fee only FP
@@mlee1308 I'm no expert, but you might want to get some advice from an advisor not related to Schwab. (You would be in a really high tax bracket if you do it all at once).
@@mlee1308 Horrible advice you received!!! Unless it's you, Warren, or Mr. Gates...
Talk about the widow and widowers tax trap, why would to leave a tax bomb to the survivor plus they would have to pay more for Medicare.
If all your money was in a Roth 401K, then your social security wouldn't be extra taxed and medicare premiums would be lower. But if all my money is is a just a 401K then all my social security gets penalized and I get hit with bigger taxes and medicare premiums.
Good rundown.
Still hate the chart you use for #2 though - just very unintuitive.
I believe I have watched all of your Roth Conversion videos and have learned a lot. You are really good at this. However, the type of chart used in #2 comes up frequently and I have never really understood how these works. I guess what confuses me is how the chart has these torpedoes in them. How does a tax implication reduce as the income increases? The dips and valleys in the chart make me think the tax rate drops as the income increases. Would you consider doing a ‘deep dive’ video into how to create a chart like this based on a persons income profiles as an example,mor examples?
@@apeel2008 That's because that chart is incorrect and meant to scare you. He is adding tax rates on disparate amounts of money. You can't do that, it is mathematically incorrect. Its the equivalent of having a nickel and adding 5 pennies, and declaring you have a 500% increase in money. It is correct you have a 500% increase in the number of coins, but only a 100% increase in money.
@@jerrylabat550, why do you assume the chart is incorrect and meant to scare you just because you don't understand it? I'm not sure the relevance of your penny/nickel example. The chart shown is a marginal tax chart that a number of tax softwares can create. Widely used by advisors and CPAs alike. At various times, a dollar of ordinary income in retirement can force taxation on other income, such as capital gains and Social Security. If a dollar of income forces you to own $.22 of taxes, that's a marginal rate of 22%. If that dollar of income forces $.40 of tax because of S.S. also becoming taxable from that extra dollar of income, then your marginal rate is 40%. It is not fear-mongering, just math.
@shawnbrennan7526 and @apeel2008, I'd be happy to run through the math behind the chart in a future video.
@@SafeguardWealthManagement I do understand that when you cross various income thresholds you see significant marginal tax rate increases. If the purpose of that chart wasn't to scare someone, you would have layered the effective tax rate over the top of it, which would have basically remained flat. That would have made the chart look much less dramatic(not nearly as scary).
@@jerrylabat550, we don't use the effective tax rate in tax planning because it has very little decision-making power. The effective tax rate only matters if everything is the same cost. Here's an example. Let's say you need to buy 10 bananas at the store, and there are three stores (three accounts) you can choose to purchase from. If the price of bananas is the same across the board, great, use total cost (effective tax rate) for the analysis.
But if there is a marginal difference in cost for each banana at each store, the total cost is meaningless for decision-making. Or rather, it's only helpful in calculating out marginal cost. For instance, if at one store, the first 2 bananas are free. Then the next 3 cost $1 each. Then the next 5 cost $10 each. You probably wouldn't want to buy all of the bananas from that store. You might want to buy 2 or 5 bananas from that store and then compare the marginal cost from other stores.
I don't know what you mean by scary. My goal is to show reality. In most videos where I dive into detail about these graphs, I provide context. If you are being charged 50% for only $1,000 worth of income, it's not a big deal if it's just a spike and tax rates drop after. If you're paying 50% taxes for $20,000 worth of income, it's probably a bigger deal worth managing.
If I am regularly contributing to a Roth, and I do a conversion from my IRA, how does the government know the conversion money is from the IRA, not my regular contribution?
You will get a 1099-R with the proper code in Box 7. I think for Roth conversion it is a 2. Your tax software will handle it from there.
If you are a super saver, it’s best to be in Roth 401k especially if you already have a million in pretax before age 50. The taxes are huge when a spouse dies then the kids inheritance have to be drained within ten years because of the secure act. I’m doing Roth 401k max until age 55 when I will retire with irs rule of 55. Plus I want the ACA subsidies from age 55 to age 65
“The kids inheritance” should be re-titled as the grandkids inheritance. We are retired in our mid 60’s, and still “waiting” for our moms to die so we can get the inheritance. Obviously I’m joking about mom, but most people don’t realize that their kids will enter retirement in their 60’s when many parents are in their early 80’s.
We will get a house, but we don’t need it, we had to plan for retirement well before counting on that property.
Either give your kids the money much earlier, when it will actually help, or plan on the grandkids being the heirs.
@@_-Karl-_ - Ah, super returns will do it too.
Give to your kids along the way is the better option.
What if I do Roth conversion towards the end of the year, how to avoid under tax penalty for the first few quarters that missed the estimated tax payments? My brokerage does not take tax withholding for Roth conversion.
Just pay the tax on your Roth conversion a few weeks later (by January 15), and you'll be fine.
Thanks
You will be fine if you pay the tax in the quarter of the Roth conversion, however, you will likely need to fill out the annualized income section for Form 2210 to show that your income was unequal throughout the year, and thus your tax payments were unequal. Without doing that you will likely get hit with the penalty. Filling out the Form 2210 is a pain but worth it to avoid the penalty issues.
Please tell us which brokerage house doesn't offer to withhold the tax...
Big investment firm start with F😅
there's an expression "better the devil you know" which in this application would mean it's better to knowingly convert at today's tax rates because future tax rates are speculative, one look at the national debt and to me it seems probable they are going to have to go up, up, and away.
Eric, Thank you! ❤ I must disagree with this misconception spread out perhaps who don't know the complexity of Tax and Retirement Planning "it all comes down to the Tax Rates" for Rollover to ROTH Conversion. Your channel videos thank God explain to me the STEEP UNFAIR IRMAA SURCHARGES (aka "IRMAA TAX PENALTIES"). These IRMAA SURCHARGES should be VIEWED as TAX PENALTIES in TAX PENALTIES COLUMN which people should not forget to build in their own thinking even if they can't do complicated analysis of Taxes in Excel like you do. 😂. Also, if people don't vote Republican in 2024, in 2025 Trump's Tax Cuts and Jobs Act of 2017 is set to Sunset, and due to lowering Standard Deduction in 2025 and STEEPER TAX BRACKETS hitting even lower income brackets it would be only "MORE TAXES" in the Future. So any modeling or thinking about Rollover to ROTH Conversion should keep KEY IRMAA SURCHARGES (aka "IRMAA TAX PENALTIES" or some call them "RETIREMENT TAX B0MB$" and together with Social Security Benefits Tax Torpedo they are DEFINITELY DESIGNED TO HIT YOU HARD SPECIFICALLY IN RETIREMENT). After all, they never updated these Social Security Benefits Tax Torpedo Brackets to be prorated and raised with giant Inflation, and that's DESIGNED TO HIT YOU HARDER WITH HIGHER AND HIGHER TAXES even at lowest incomes than if it would be if you were working. Besides, it's going to cost significantly more for Retirees to afford Healthcare Insurance as Advantage MEDICARE Plans are going to change for the worse, especially after recently MEDICARE changed how they are compensating Advantage MEDICARE insurers hitting their profit margins (recent news for Earnings for Humana and their planning to exit some markets, CVS (parent of Aetna), UnitedHealth news). So TAXES are DEFINITELY DESIGNED TO HIT YOU HARDER specifically at Retirement or Older age, and it's better to anticipate all Retirement Hurdles (and not just be overly focused on "the same tax" assumptions). Also, most of people would agree that Social Security Benefits Tax should be completely removed as it's Money already Taxed and set aside specifically for retirement, but the punishment is designed with SS Tax Torpedo to punish those who saved and invested instead of spending, and those with better financial awareness who planned for their own supplemental to Social Security Benefits Income.
Your statement that every conversion starts a timer for the 5 year rule will cause more confusion not less. It is true that being over 59.5 doesn't necessarily mean the 5 year rule doesn't apply. But if you're over 59.5 AND have contributed to any Roth at least 5 years ago at the time of conversion ALL withdrawals are qualified. If the distribution is qualified, for those over 59.5 the 5-year clock for conversion distributions is not relevant. This has been done in great detail on Bogleheads.
Since everyone’s situation is different, I disagree with the blanket advice to avoid a tax free retirement. We simply don’t know the future. Tax laws will change. One spouse may die prematurely much earlier than the surviving spouse. There clearly is a risk that you will convert too much. There is also clearly a risk that you will convert too little. In my opinion, no one will convert precisely the correct amount each year. Be prudent with your Roth conversions and reassess them annually. In my case, we should owe zero income tax after 2026 if tax laws remain as expected. We will file federal tax returns in 2027-2030 to obtain ACA tax credits. Our smaller Roth conversions should be completed by 2038. Still, I expect changes to our plan before then. But, we will sleep really well with little to no income taxes in our future.
I had an expert run the numbers and showed that we were better off biting the bullet and converting over 2 years instead of 3. I can’t even imagine making the assumptions for spreading it all the way through 2038, especially since you don’t know how much growth you’ll really have between now and then.
I’m also not a fan of assuming the ACÁ subsidies will stay as you predict.
@@shawnbrennan7526 I made a large conversion in 2021 at age 62 (24% bracket) before IRMAA age. My 2022-2025 conversions went into 22% bracket while capturing the AOTC tax credit for son in college. My 2026 conversion goes into the 15% bracket. That will leave me with a relatively small amount to convert along with wife’s 401k. The remaining conversions will be small enough to avoid taxation if we live that long. They will be reevaluated annually as tax laws, including ACA, may change. I am quite confident in the investment returns for those tax deferred assets as they are mostly invested in a short term government MM fund. I am no longer in a position where I need to risk those assets in pursuit of higher investment returns. As I said, every situation is different. Hindsight is needed to evaluate how each person’s plan worked out.
Can I convert my Traditional IRA into a Decepticon?
The Autocrats would have something to say about that ;D
It's great to hear that you are considering investing in the stock market after being inspired by the success of Munger and Buffett with Berkshire Hathaway. Here are some key points to consider when investing a significant amount like the proceeds from selling your apartment:
What if you just want more tax free money to spend without a big tax hit? Right now I have $700,000 in a rollover IRA. If I want to buy a Porsche for $125,000 I'll get hit with a huge tax bill in tax season. If I roll it over into a roth over a few years, taxes are spread out, and I won't get hit with one large tax bill. Same for buying a house or other major purchase. I'm a disabled vet so I can't contribute my disability to a roth because it's not considered income and is non taxable. Fidelity advisors won't go anywhere near taxes, so I'm looking for a real advisor.