See How Much This Roth Conversion Strategy Saved Them
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- Опубликовано: 2 июн 2024
- Understanding the tangible impact and the critical factors of Roth conversions is essential. James walks us through a client case study to demonstrate how Roth conversions can significantly impact your retirement savings. But is Roth conversion right for you? James considers five critical factors, looking at the case study of David (58) and Lisa (57), who have a substantial net worth, primarily in pre-tax accounts.
Understand Your Current Tax Rate:
The first critical factor is to recognize that the less you have in pre-tax accounts, the less impactful a Roth conversion will typically be. Understanding your asset composition is crucial in assessing the potential benefits of a Roth conversion.
Goals and Retirement Timeline:
David and Lisa plan to retire at 62, a pivotal factor in Roth conversion analysis. The period between retirement and the start of required distributions creates a tax planning window, allowing for strategic conversions. The couple aims to spend $10,000 per month in retirement, adjusting for inflation.
Income Sources and Savings:
Examining their income sources reveals David's $195,000 salary and Lisa's $50,000 income. Social security benefits and their saving strategies, including 401(k) contributions and IRA max-outs, contribute to their financial landscape. The assumption of an 8.7% pre-retirement and 6.5% post-retirement rate of return guides their investment strategy.
Understanding Cash Flows:
James illustrates the couple's income sources, emphasizing a transition from high pre-retirement income to reliance on social security during retirement. This highlights the importance of strategic planning during the tax planning window to minimize tax burdens in retirement.
Tax Planning Window and Roth Conversions:
The tax planning window is a crucial concept where strategic Roth conversions can be executed. James introduces a scenario where David and Lisa live off their taxable account, maintaining a 0% effective tax rate during the initial years of retirement.
Analyzing Tax Brackets and Required Minimum Distributions (RMDs):
A deep dive into tax brackets illustrates the potential tax savings during the tax planning window. By strategically converting to fill lower tax brackets, the couple can significantly reduce their future tax liabilities, especially considering the impact of RMDs.
Optimizing Conversion Strategies:
James outlines the iterative process of finding the optimal conversion amount. Demonstrating different scenarios, he emphasizes the importance of balance, as over-converting may lead to unintended consequences. A well-thought-out conversion strategy can result in substantial tax savings.
Roth conversions present a powerful tool to maximize your retirement savings, but a thorough understanding of your unique financial situation is crucial. By following the five critical factors outlined above, you can make informed decisions to secure a financially sound retirement. Before diving into Roth conversions, consider consulting with a financial advisor to tailor the strategy to your specific needs and goals.
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⏱Timestamps:⏱
0:00 - Save with Roth conversion?
0:42 - David and Lisa
3:59 - Initial analysis
6:13 - Tax and withdrawal strategy
10:14 - Considering tax brackets
14:33 - Conversion game plan
15:23 - Conversion principles 1-3
19:28 - Conversion principles 4-5
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Great video! Don't forget the increased IRMAA (income related monthly adjustment amounts). They will be significant and may make you want to start converting earlier. If I were the couple, I would quit funding anything pre tax above his 3%match. Save that money in brokerage account for later Roth conversion related taxes.
IRMAA cuts both ways. For me to do any meaningful converting will put me into IRMAA surcharges for 10 years so I can avoid them for 10 years to break even. That is age 85. If I am still alive I won’t be thinking about IRMAA surcharges.
I’m trying hard absorb as much useful information as possible since I’m getting close to retirement. I love your approach. As single woman, my portfolio and income don’t come close to the examples in most of your videos! I think I’ll be O.K. But I think a lot of people might benefit from some content that has scenarios with people who don’t have millions of dollars. Like I said, these scenerios look great for multi millionaires but seem pretty unattainable for people like myself…
Your analysis on conversions to a Roth IRA did not include the effect of IRMAA taxes for people on Medicare between ages 65 to 72- 2:36 75 depending on when RMD’s affect
I love the actual case study videos!
I don’t know where all these case studies come from but who spends 10-15k per month in retirement. Your expenses should be pretty low
What about the widow tax (or divorce tax)?
When talking about future tax rates, I'm amazed that so few people mentioned the tax rate increase a married person could experience when their spouse dies, or if they divorce. Why would you not mention that? A married couple will almost certainly deal with one or the other eventually.
Nicely done. While the wealth in this example is far above what most folks have, the explanation stays out of the swamp while illustrating just the conversion impact alone.
And kudos on considering the tax impact on your heirs. Most folks do want to maximize wealth (and preserve $ from taxes) across their entire family.
Excellent! Hit every point I can think of. Just one question please. This couple can pay their conversion tax bill from their non-retirement (taxable) accounts. If they could not, what is your opinion on paying taxes from pre-tax retirement accounts? Your videos are amazing!
Thanks James, this was a helpful video.
I do wish that these scenarios were run with more spending at the start of retirement instead of the end. Most of the videos I see say that retirement spending decreases as you get older. If I'm reading the taxable income curves correctly, these retirees are spending even more. I suspect this is a RMD effect, so I would rather see a video of how to cause my RMDs match my decreased spending in my later retirement years.
One of the biggest variables in this planning is death of a spouse, it is unlikely they both die at the same time, the effective tax rate will likely double when the surviving spouse files taxes as a single.
Great video!
Thank you very much!
Thanks for this. This video. The best one yet for me.
Should you look at the Net Present Value of the savings and taxes vs. the future numbers? (Paying taxes later with cheaper dollars.)
I appreciate this video but what about the fact that the conversion increases your AGI and if you are under 65 your health insurance will now be much more expensive.? I have yet to see a computer program that addresses this.
I have done some Roth conversions while still employed--trying to decide whether I should do a little more or not, but I definitely plan to NOT do any while on Obamacare between the time I retire (assuming before 65) and the year after I turn 65 and am eligible for Medicare. My current plan is that I don't have enough Roth savings to safely pay our living expenses for two years without endangering our long-term retirement, but would be able to coast through one year (and given my autumn birthday, an additional two months.) I'm pretty certain we can live on my Roth IRA funds that aren't on a 5 year conversion clock for that approx. 14 months so that our AGI (my understanding is that we self-report what we think our annual income will be for ACA) makes it appear that we are extremely poor and thus we will get great ACA health insurance subsidies. After that year, I might do additional Roth conversions in the period between Medicare and the start-up of our SS. That will depend upon where we are at that point. I do wish he would use examples of people who were less wealthy--like $100K combined income and at or under $1M in retirement savings.
Can I consult with you just on this Traditional IRA to Roth conversion issue? I like the software, easy to understand. I am right at this window and need good advice.
Do you recommend a tool to use to analyze the Roth conversions? Thanks.
Outstanding. Thanks for this.
Excellent analysis especially with the terminal tax rate impact. I’m assuming that anything I convert to Roth is for the benefit of my heirs. I plan to delay social security to age 70 and be more aggressive with early conversions and then stop once I start to collect. Deferring Social Security allows me to convert more without driving me into higher IRMAA brackets as well.
Also, for your case study I would suggest saving more pre retirement in taxable accounts rather than all tax deferred. I wish when I retired I had a greater allocation towards my taxable accounts.
What are you using for retirement planning software. It's pretty cool. I'm just getting into the business and need a good planning software. I'd appreciate a heads up if you're willing. Thanks for your anticipated cooperation. God bless you and the education you provide.
Good stuff. What is the software package being utilized in this video? Available to an individual?
I believe it is RIGHT CAPITAL but haven’t found out about availability to individuals yet.
@James Conole great info! Can you do one for the Thrift Savings Plan (TSP) conversion as well?
Unfortunately, TSP doesn't directly support Roth conversions. You have to transfer from TSP to traditional IRA and then convert that into Roth IRA. Otherwise the same concepts apply
What planning software do you use?
What if they pull 150k for living expenses plus another 70k for Roth conversion from the pretax retirement funds from 62-67, then less once SS kicks in. Save the taxable $$ until much later? That pretty quickly draws down the $$ which would be subject to RMD. Thanks
Thanks for the very informative video. I wonder what the effect would be of drawing from the IRA accounts from 62 to 67 rather than the regular savings account.
Exactly what I was wondering about as I watched this video. Wouldn’t it make more sense to withdraw from a traditional IRA first, then spend down a taxable account later, if needed, since the taxable account would be taxed at capital gains rates?
My take - by drawing down the taxable accounts during this window you are decreasing the taxable income these accounts throw off. While at that time using the tax bracket to do the conversions which protects the income they will throw off there "forever" or until cashed out into a taxable account - for the heirs in the example demonstrated?
But, then you'd miss out on some years of the primary benefit of an IRA (taxes being deferred). Plus, that would greatly limit your ability to do Roth conversions in those years. Terrible idea. Roth conversions are very valuable and should be your top priority (in those years). In my humble opinion.
I was thinking the exact same thing, especially since they’ll have those assets which won’t have to be taxed by heirs like IRAs would be.
This is the exact tool I have been looking for!! Please share a link!
Proprietary
One other thing about Roth conversions to consider is once you convert, all the subsequent growth is tax free. In a taxable account the growth is taxed. It's not clear if the analysis takes that into consideration.
So, one question I have is if you should be assuming a normal rate of return, or a low rate of return? A lot of strategies look much better with a mid-range or higher rate of return, but make less sense if you retire in a period of market doldrums. Using leverage to retire looks great on average, but has catastrophic downside risks for example.
If the goal is to assure you never go broke in retirement it is those bad sequence of return risk scenarios that will bite you more than having to pay too much tax on RMD's (i.e. first world problem). If you've already locked in a 22+% tax on conversions, but the market tanks you may lose out on converting a higher proportion at 12% in the RMD years, and that extra money probably is much more meaningful in that difficult scenario than having a little more in an average or better scenario.
Something about conversion that never gets said is that a dollar of taxes paid today is far different than a dollar of taxes paid 20 or 30 years from now. This is due to inflation and the fact that you can’t enjoy that same dollar as much when you are 85 years old. This might diminish the perceived value of a conversion.
Fair, but the dollar converted today grows beyond inflation tomorrow such that having to convert the same amount plus the growth ends up being a wash.
Yep, also keep in mind that over 25-30 years - tax brackets change every year and taxes change every year. Looking at the last 30 years they almost always go wait for it wait for it....Down. Meaning you might pay less taxes in the same amount of money than you think... It is impossible to tell, they use current brackets and current taxes projected forward.
The growth on the accounts does not move the needle much. If you have $1m in pretax and convert to a Roth in the 25% bracket and it doubles to $2m, the $250k of tax you paid would also double to $500k so you would have $2m tax free or $2.5m of which $2.225m is taxable. If you are still in the 25% bracket that is $562 in taxes so you would come out $62k ahead. However you paid the $250k in tax all up front, whereas the $562k is spread out over many years. With proper planning, using the standard deduction and lower tax brackets, you can pay much less than 25%. Year 1 RMD on $1m is about $40k. If your RMD is 10+ years out, the standard deduction with inflation adjustments will be about $40k, thus zero tax, pending your other income of course. H
👍 We enjoyed your case studies. We have pensions with similar portfolio. How should we plan our retirement?
He has a good one on how to plan for pensions…gotta look at the overall picture and see what portfolio withdrawals are needed before and after the pension kicks in.🎉
What stood out to me at first was that David had such a high IRA account, and in comparison a small 401k account. After thinking through it, I'm assuming that the IRA also includes rollovers from past 401ks, and his current 401k is from the current company.
I may have missed it, but wouldn't conversions also increase Medicare part b premiums? Thanks for your videos, I enjoy them!
Correct. The increased medicare premium amount needs to be converted & included in the effective tax rate. Lots of variables.
Nice case study I can relate too. Curious what converting to 32 percent bracket did. My analysis actually is converting 100% to Roth over about 5 years but starts at 32% bracket and ends at %25. It’s not a max out the same bracket each year to optimize. My approach also considers heirs tax, total net worth and Medicare premiums. Also need to look at widow trap when a spouse dies. Lastly I’ll mention asset location can be important. I keep the bond portion of my portfolio mostly in traditional rollover 401k. Helps avoid conversion creep and still maintains overall asset balance. Plus I think conversions at beginning of year is better than waiting until December since I assume my accounts grow throughout the year. Get that money into the Roth ASAP each year. Atleast most of it. Thanks again. I
And potentially NIIT, along with some people (me) wanting to drive their savings to $0, near the end of life.
I'm not a fan of converting everything out of the traditional IRA, particularly if it means going into the 32% bracket. Consider that there's only about $100k between the top of the of the 24% bracket to the top of the 32% bracket. I don't know your circumstances, but having less than $1M in a trad IRA shouldn't drive effective taxes, including IRMAA and SS tax, that much higher.
Is it possible or allowed by the IRS to double dip and max out on both Mega backdoor ROTH in a 401k and Backdoor ROTH in the same tax year? For 2024 it would be $69000 for 401k and $7000 for traditional aftertax IRA. IRS tax reference would be appreciated.
James Conole gives me a headache...I will just go live in a cave up on the Musshleshell like Hatchet Jack in the movie. No female panther needed!❤️😂
Love this type of content. But one thing I will add, at least in my situation which is almost identical except for two things - I don't have nearly as much money, and almost no money in non-taxable (it is all in 401k). What about ACA premium subsidies...which I want to take advantage of for myself and my wife? If I convrt over to fill up the 22% tax bracket, I will get NO subsidy, and the ACA subsidies can be substantial. I am thinking of converting up to the 22% tax bracket BEFORE hitting age 62. Thoughts?
You have to choose (ACA subsidy or Roth conversion), or some combination thereof. A very frustrating decision, because both are lucrative.
Isnt 401k taxable?
@larryjones9773 Agreed...tough choice. Like I said, I will probably do Roth conversions BEFORE I retire...filling up the 22% bracket. Which does kinda suck. I think the ACA subsidy will make it worth it. But I need to crunch the numbers.
@@darrelgrove5304You are correct...I meant Non-taxable. Thanks for finding my mistake. I have correct it in my original post.
James can you do a video on the situation. If someone takes social security before full retirement and lets say social security starts Nov 1, 2024 and they are paid out for vacation leave in January 2025. Will social security look at that as work income even though it is for leave paid out. They want to work in 2025, but this is not earn income, but vacation paid out. Is there anyway social security will know or can be told? Thank you
Question: If I am over 60 years of age and my Roth IRA has met the 5 year rule, do I need to wait another 5 years after I convert pre tax to my Roth to avoid a penalty?
Great video! I lost you at the zero percent tax bracket. Can you explain where they are getting money to live in those years right when they retire? Are they living off of cash or Roth IRA money? Thanks!
Taxable brokerage account…see the account summary in the beginning.
Can you only convert a portion of an IRA to Roth & pay taxes for what you convert during any given year? I vaguely remember that even if you converted only a portion to a Roth, you owe taxes for the total amount in IRA.
Another variable not mentioned is early termination. What if they do not live to age 90. By paying the taxes early for the conversions, what is the breakeven point of not paying the taxes. Could be as much as 19 years for each year converted. So all those tax savings may be from age 81-90. Die early and you pay taxes you did not need to.
If one spouse dies early, the surviving spouse's tax rate will rise. Thus, this couple should do Roth conversions.
James You said that Lisa would get $1,000 a month SS income at 67. Wouldn't she get $1,800 a month as a spouse benefit since it is higher the she gets on her own SS record?
RMD age is increasing to 75 for people born in 1960 or later. That's good news.
You may want to adjust the high conversions at age 63 to avoid IRMAA
It would be great to see an example that is probably more common, where there is no taxable account at all. Something like this scenario....
A single 65 yr old with income of $100k wants to retire now. They have a 401k worth $1.5m, a Roth IRA worth $400k, a HSA worth $200k and $50k in savings/checking, and they are an aggressive investor, averaging 9% annually. They have no debt and own a home worth $250k. They plan to delay SS until somewhere between 67 and 70, and they need $8000 per month in retirement income after taxes and they are interested in a dynamic guardrails type of withdrawal strategy to help maximize income. How might this person approach Roth conversions?
Your $50k in savings/checking sounds like a taxable account.
A $200k HSA? Very nice but that surely isn't common. You'd have to have been contributing to one since day 1 HSAs became law, and most of us didn't have that opportunity
I would think they start taking SS at 62, and put all those monies into a taxable SP500 ETF, and draw down their pre tax 401k as soon as you retire for all your expenses, and then fill up the 22% tax bracket. I think they will end up with more money when they die with a huge pile of money. Better advice would tell them to retire today and enjoy life. Husband is over 55 so he can immediately tap his pre tax 401k.
?? 59 1/2 to get at retirement funds isn’t it? How can you access 401k pretax at 55?
There is no question conversion will benefit me if:
1. I live to 90
2. Amount converted to Roth grows (or at least does not decline).
3. I don’t move to a tax free state in retirement
4. Tax rates rise in the future
These all could happen but are not guaranteed and even if everything aligns, yes I save some tax but the increase at end of life is not meaningful enough for me to pay tax up front.
How about people stop spamming prospects so they will read their email as it’s gotten ridiculous
Good info. However, I don't think majority of Americans cannot relate to ever having this much money. Just saying. Thanks
Good luck with 3% assumed inflation. I'd model at least 5%.
Lost me on assumptions! Why only $1000 spousal benefit? How is the wife able to contribute to a traditional IRA? At $4million, 4% is $160k.
Yes, obviously huge tax issues, but not a typical case.
This is so discouraging. They make the whole system so complex that only wealthy people who can afford advisors can understand it and take advantage of it.
David and Lisa could have retired long ago......
This all presumes you can trust the government to honor their promises. The reason I for all the last years have not done back door Roth conversions is because I absolutely anticipate that those of us who lived within our means and saved will be vilified and expected to "pay our fair share" and that those with assets above a certain amount or income above a certain amount WILL pay taxes at the time of Roth withdrawals. I paid my student loans and now pay others. The government exists at this point to siphon money from productive citizens towards the "gimmiedats". Follow this plan at your own risk.
While I agree with you that the government likes to change the rules to suit its needs, exactly how they’ll do that is tough to predict. I think there would be an uproar if they started taxing Roths, to the point where politicians would be afraid to do so. However, getting rid of back door Roth conversions would be easy politically since only “rich” people do that. If that’s true, convert now, while you still can!
Top notch dog whistling.
This is definitely not the dumbest thing I have ever read on the internet. But it is the dumbest thing I have read today.
Yes gov can change their rules, but we have no way of finding if, when and how they going to do it, we can only plan around the information we know now. Besides we can always change our plans a bit if things changes.
@@AK_AF_LBI concur😂
Once again, you are illustrating clients with vast wealth. Too bad