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 on Amazon or by going to www.how to retire on time.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 adviser, 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 a show.

Everything you hear should be considered informational. That's it. It's not financial advice. If you want personalized financial advice, then you can request your wealth analysis from my team today by going to www.yourwealthanalysis.com. With me in the studio today is my esteemed colleague, mister David Fransen.

Thanks for being here.

Yes. I'm glad to be here.

And David's gonna be reading your questions as they're submitted, and I'm gonna do my best to answer them. Now you can send your questions in by either texting them to 913-363-1234. Text them anytime during the week. 913-363-1234. Or you can email them to hey mike@howtoretireontime.com.

Let's begin.

Hey, Mike. Friends keep telling me I need to do IRA to Roth conversions, but my current income is more than the income I want when I retire. Something's not right. What do you think?

Yes. Something is not right. Yeah. Anytime you hear an absolute, run. I don't care what they're saying.

The only absolute is that absolutes are bad in finance.

I tell my kids that all the time too. Like, don't use absolutes.

Superlatives lose credibility in my mind, except for that superlative. That superlative.

Okay. Yeah.

I see. I feel like there's a contradiction in saying that, but you get the point. Yeah. So anytime someone says you should always do this, pump the brakes and start asking questions. So generally speaking, when you look at irate to Roth conversions, let's ask a few questions.

First off, are you before the age of 59a half? If so, then you're gonna need to pay out of pocket for that irate or Roth conversion as in pay it with cash. Okay. Because you can't pay your taxes from the conversion internally. That would create a 10% penalty.

Oh, right.

Yeah. But if you can afford it, it, it can be a great way to kind of move more money to a Roth earlier on than trying to cram it all in a couple of years when you retire. Now that said, if you are retired or you're 59 and a half or older and you're considering IRA to Roth conversions and you're still working. Let's talk to these people for a second. If your current salary or overall household income is higher than the income that you want in retirement, it probably doesn't make sense to do IRA to Roth conversions.

Why? Because you're already at a higher effective tax rate currently in that. Specifically, I'm talking to my doctors, to my airline pilots, the attorneys, the engineers that have really excelled in their careers. Software engineers, there are senior developers, people that really have high growth trajectory in their careers. And the last couple of years, they're really raking it in.

Uh-huh. These are the people that typically don't do IRA to Roth conversions. In fact, many of them will will actually contribute to their pretax account because at the end of the day, what you're looking for is the target effective tax rate while you're working and while you're retired. What is the effective tax rate? That's that's not a normal thing to talk about.

Is it?

Do I have to answer that right now?

No. I'll answer it for you. May I

ask chat GPT first?

That that'd be a great resource.

Thank you.

Chat GPT is a great resource if you're looking for definitions, but not strategies. Okay. Okay. Alright. Doesn't understand everything when it comes to strategies.

But okay. What is the effective tax rate? The effective tax rate is, at the end of the day, what's the dollar amount that you paid in taxes and how much did you make?

Okay.

So taxable income and taxes actually paid. And the reason why this is important is our progressive tax situation is complicated. I don't know anyone that's walking around in January February saying I'm only paying 10¢ on the dollar taxes. But in February, oh, it's 12¢ now. I gotta tighten the budget.

Uh-huh. And then towards the end of the year, well, you know, 24% taxes. I I guess no. You average it all out and you're looking at an effective tax rate. That's really what we're trying to accomplish here.

Okay.

So when you look at the effective tax rate and if you can keep that lower, then you're in a good position. I say lower. It's kind of a subjective comment because if you if you don't wanna pay any taxes, then don't live a life. Just just don't do anything. Right?

You wanna live your life while being efficient with a target effective tax rate. So this is where the flexibility in a plan really comes into play. Let's say you're retired and you've got an effective tax rate you're targeting. Let's say, for easy math, let's just say 20% is your target effective tax rate. Nice round number.

Okay? And tax brackets were to increase. So let's say the 12% goes to 15%. Let's say the 24% goes to 28%. Right?

They all increase and then the dollar amounts of each threshold decrease. So overall, taxes just went up. Okay. Well, maybe in that time, because you prepared, you take a little bit less from your IRA assets, a little bit more from your Roth, but you still generated the income that you wanted and you paid still 20% from your taxable experiences.

Okay.

This is not taught at any of the financial conferences I I go to, except for the ones I speak at. I don't remember any of this in my original training when I got into the industry. I don't remember them talking about this in the licensing that you have to pass. They'll just, you know, taxes are taxes. Right?

This is a strategy. If you can focus on your effective tax rate and give yourself wiggle room on where to draw income from, you could be more effective on your overall tax strategies, tax planning, minimizing your taxes. And you might say, well well, Mike, if taxes are going up, why wouldn't I just pay more in the lower tax bracket overall? Let me give you an analogy. What I'm about to say is an oversimplification to teach a principle.

Okay.

This is not actually the case. Okay? But let's say the IRS waves their magic wand, hypothetically, and you could convert your entire IRA assets. You can convert your entire IRA account to Roth and pay a flat 20%. That's it.

Or you could pay 15% in taxes for life. Remember, this is a hypothetical oversimplified strategy to teach a principle. Here's what would happen. Let's say you have $1,000,000 for easy math. $1,000,000 you convert it all over.

You pay $200,000 in taxes, but you have 800,000 now that now can grow tax free and pay you income tax free. You are done with taxes.

Nice.

And you only paid $200,000. Done. The person that took the 15% for life, all things being equal, so the same growth, the same net income would pay. Let's assume that they retired at 60 and they live to 95. They would pay around 412,000 if I remember right.

412,000 in taxes, double. Oh. So you think, well, paying you know, just getting it done, the higher percentage makes more sense. Not true. The person that paid 15% for life ended up with 690,000 more dollars in their accounts at the end of life for legacy purposes.

Why? Because the person that paid 20% at the beginning converted it all over, took such a large chunk out of their assets, the assets were not able to recover. Does that make sense?

Yeah. So there was less money in the market to grow. Right?

Let's say what what you know, 10% growth of 800,000 is less growth than 10% of $1,000,000. Right? Yeah. And so the person that took the 15% for life and slowly worked away at it had more money to grow. And because it was growing at the same percentage, because the market is the market, they had more money overall.

They targeted a lower effective tax rate and slowly worked out it over the time.

Yeah. That makes sense.

That makes sense. Yep. So tell your friends, good luck. All is well. Yeah.

But for you specifically, target an effective tax rate. Be mindful of RMDs. Be mindful of IRMAA. So if you're doing high IRA to Roth conversions after 65 years old, those things can sting. But overall, target your salary or what you're making during your working years and the effective tax rate there.

The target effective tax rate when you're minimizing your IRA to Roth conversions and your effective tax rate when you're maintaining your accounts. That's when you're done doing the IRA to Roth conversions. You're just managing things at a specific lower effective tax rate. The zero tax bracket is usually not in your best interest. It's usually expensive to get there.

I personally believe that the 10 to 12% tax bracket is better, especially when you consider that we all get a standard deduction.

Yeah.

So why pay more when you could just be more efficient overall and get more out of your hard earned money? 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. 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.

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