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Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, healthcare, and more. This show is an extension of the book How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com.
This show is intended for those within 10 years of their target retirement date or for those are are currently retired and are concerned about their ability to stay retired.
Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, health care, and more. This show is an extension of the book, How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com. My name is Mike Decker. I'm the author of the book, How to Retire on Time, but I'm also a licensed financial advisor, insurance agent, and tax professional, which means when it comes to financial topics, we can pretty much talk about it all. Now that said, please remember this is just to show.
Mike:Everything you hear should be considered informational, as in not financial advice. If you want personalized financial advice, then request your wealth analysis from my team today by going to www.yourwealthanalysis.com. With me in the studio today is my colleague, mister David Fransen. David, thanks for being here today.
David:Pleasure to be here.
Mike:David's gonna be reading your questions, and I'm gonna do my best to answer them. You can always send your questions in by either texting them to (913) 363-1234. That's (913) 363-1234, or you can email them to, hey, Mike, at how to retire on time dot com. Let's begin.
David:Hey Mike
David:With Social Security taxes potentially going away, how does that affect Social Security optimization?
Mike:Social Security optimization is really an IRA to Roth conversion conversation. And the reason why is most people in America aren't gonna live off the pension. They're gonna live off of their four zero one k. Now their four zero one k, the argument is, okay, taxes should be lower when you retire, which was a complete guess, and it completely got that wrong.
Mike:Uh-huh. Taxes should be lower when you retire, so you should just put money into a pretax account, like an IRA or four zero one k, so that when you pull taxes out, you can just pay taxes then and it should be better off for you. Well, it's not true. So now we have this tax issue. All your money or a lot of your money is in a pretax account.
Mike:How do we get it out? As you pull the money out, that creates income taxes. Income taxes are what's going to determine or what used to determine your Social Security tax. So if your total taxable income is less than a certain amount, then 0% of your Social Security is taxed. If a certain threshold is taxed, so your modified adjusted gross income Right.
Mike:Then 50% of your Social Security would be subject to your income tax bracket. If it's greater than a certain threshold, then it's 85% of it would be subject to taxes. So if someone wanted to become tax efficient, they would slowly minimize their IRA assets, either spend it down or convert it to Roth so that at some point, they would have a low enough amount of income, usually from RMDs, required minimum distributions at around 73 years old, that you're drawing from. And it's underneath the threshold so that you're getting basically social security tax free. Okay.
Mike:It's a journey that you take an IRA to Roth conversions or spending down your pretax accounts. So that at some point, your overall total taxation is low enough that your social security is also tax free. You can't have one without the other. If you're paying taxes from income from your pension or your four zero one k, you're gonna pay taxes on social security. If you can get to a tax free retirement or a lower tax environment, then your social security would also be tax free.
Mike:Okay. And the idea was those who have less should have more tax advantages. Well, if Social Security in fact does become tax free, then IRA to Roth conversions become less essential. So an average person might save around maybe 5 to 6, maybe $7,000 depending on if you have state tax or not in social security taxation. Well, if you're just gonna get that benefit, then how much less do you need to convert from your IRA assets to your Roth assets?
Mike:And the best way I can explain this is the zero tax bracket is not in your best interest. It's not your friend. And the reason is the standard deduction. Oh. K?
Mike:Yeah. So would you rather pay 20% or 25%, whatever your effective tax rate is, until you get to a zero tax bracket, or would you rather pay 20 to 25%, whatever your effective tax rate is, until a point to where you can stop doing the irate or Roth conversions? And let's say the standard deduction in the future is $30,000. K? And now you take out $30,000 each year tax free for the rest of your life.
Mike:Mhmm. Because you get the standard deduction. Yeah. So why would you convert money to something when you could just take it out tax free? Yeah.
Mike:Alright. The conversion requires you to pay taxes on that conversion. Yeah. Or you can just get it low enough that then you can just slowly siphon it out tax free. That sounds good to me.
Mike:So because we don't need to get to the zero tax bracket or a lower tax bracket as fast because everyone's getting the tax benefit. If social security becomes tax free, then it means we can be a little bit less aggressive on IRA to Roth conversions. And that preserves more of your portfolio. If it preserves more of your portfolio, then it's able to grow better. If it's it's able to grow better, then you've got more flexibility in the future.
Mike:So is that an idea being floated around by lawmakers right now? The house passed it. At the time of the recording, the house has passed. The social security will become tax free. The senate is at the time of this recording, it's under review in the senate.
Mike:They may come back, and they may wanna change parts of it, send it back to the house Yeah. Or they've just made send it to a straight vote. It's uncertain at this point. That would be a significant change. And the reason why people wanna go to tax free, they wanna go tax free with their overall retirement because it's just simpler.
Mike:Yeah. But what many people miss is when you do too many or too aggressive of Roth conversions, the taxes coming out is a hit to your principal, and it's much easier to grow a higher dollar amount in your portfolio Yeah. Than it is a lower dollar amount because the percentage. The dollar is how much the compounding interest works in your favor. And so a larger number would compound more.
Mike:Right? 10% on a million dollars gives you more money than 10 of 800,000. Yeah. So we want to be cognizant of not accentuating losses of the principal Mhmm. Of our assets because we're nervous about taxes.
Mike:The way I like to think about it is zero body fat is actually unhealthy for you. Right. There's a healthy amount of body fat that you actually want. Yeah. The ideal situation is that in your tax minimization, you're minimizing taxes for a long term period of time, a healthy tax diet, and then you maintain a certain taxable amount.
Mike:But it's healthy, it's efficient, and it you enjoy the lower tax brackets and the standard deduction, so you get more out of your money for income purposes and for legacy purposes. And because it's nuanced and because it's balanced, many people miss this. But it can lead to hundreds of thousands of extra dollars to either spend in retirement or pass on to your kids. Let me say that again. Finding the right balance can lead to hundreds of thousands of extra dollars.
Mike:That's incredible. And out of fear, people are unintentionally giving up that money because either they don't understand it or they're making an unintentionally emotional decision. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time.
Mike:Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date. Go to www.yourwealthanalysis.com today to learn more and get started.