Jacob: Whenever it comes to doing Roth conversions, you've gotta analyze your situation. You've gotta understand, hey, what is the point of doing this in the first place? Am I gonna benefit from them? And if so, when should I be doing them? The reason I wanted to talk through this is because we're coming up on that fourth quarter of the year.
Welcome to Retirement Answers, a podcast built to answer your most pressing retirement questions. If you're someone who's either thinking about retirement or already in retirement, well, you're in the right place. Hey there, my name is Jacob Duke, and each week I'll be walking through different tips and strategies to help you succeed in retirement. So let's go ahead and get started with today's show. Hey, friends, and welcome back to another episode of Retirement Answers.
My name is Jacob Duke. I'm your host as always. I appreciate you tuning into this week's episode. We're gonna be talking about when the best time to do a Roth conversion might be. And the reason for this is because we are coming up on a wonderful time of year to be doing Roth conversions and I get a lot of questions around this.
Hey Jacob, is there an optimal time to do my Roth conversions? Should you even be doing Roth conversions in the first place? And if so, when is the best time to do that? Or what are some opportunities to do those most effectively? So that's what we're gonna talk through today.
But, first, if you're enjoying the show, I appreciate you being here. Thanks for being a listener of the podcast. I hope it's been helpful and valuable to you. If you are enjoying it, I would appreciate it if you give a rating and review there on the podcast platform that you listen through, whether that's Apple Podcast or Spotify. It helps other people find the show and learn from these same tips and strategies that you're able to benefit from.
So if you do that, that'd be greatly appreciated. It helps more than you know. All right, so let's talk about Roth Conversions. And before we jump into maybe some really good times or optimal times to actually do a conversion, let's quickly do a refresh on what a Roth Conversion is in the first place. Well, in general, a Roth Conversion is simply saying I want to pay taxes on my tax deferred assets now by moving that money from a tax deferred IRA or a four zero one ks to a tax deferred Roth IRA or Roth four zero one ks.
And so essentially you're choosing to pay taxes before you otherwise have to. You're not making a distribution out of your IRA and taking that and spending it. You're moving it from one IRA, being a traditional IRA, over to a Roth IRA. And the reason that this is significant is because a traditional IRA is a tax deferred account type, meaning you've not paid income taxes on it, and a Roth IRA is an after tax account type and you have paid taxes on the money that's in there. So that's what Roth conversions are.
But one of the big questions that I would emphasize you might need to be asking yourself is, well, should you be doing them at all? Maybe you don't need to be doing conversions in the first place. And the reason I see this come up as an issue is because I, like many other retirement planners and people you might be listening to on podcasts or YouTube or wherever it may be, we talk about Roth conversions a lot and we talk about their benefits. But the key here is that they only benefit a certain type of person or a certain type of asset makeup for these retirees or people that have a certain amount of tax deferred assets and their situation lends itself to being able to benefit from these Roth conversions and electing to pay taxes before they otherwise have to. So there's something you've got to know here is that Roth conversions are not for everyone and they're not beneficial for everyone.
And so the first thing you've got to do is evaluate are Roth conversions right for me? And that's where you got to start. But today, let's say that you can benefit from a Roth conversion. It's something that would be helpful for you long term in terms of lowering your overall taxes paid throughout the rest of your life, if that's what one of your primary goals. So that's where we're gonna kind of sit today is assuming that these Roth conversions are helpful, but to get started, you've got to establish and identify are they even helpful for you and then go from there.
Let's say today that Roth conversions are beneficial for you. So the question then is gonna be, well, when are the best times to do a Roth conversion? The first one is gonna be whenever you are in your low income years. So a couple of things that I like to think about here is if you're early in a career, likely you're going to be at the lowest income point of your life. And so that's a really good time if you've got some sort of tax deferred assets.
Let's say you work for five years at a company, you've a four zero one ks with $50,000 in it and you move on to another company, so you roll that over into an IRA and you're trying to figure out what should I do with this money, you're now like, let's say 35 and you've got $50,000 in a tax deferred account, your income is a $100,000 and you're trying to say, hey, what do I do with this money? Should I convert it? Should I leave it in the tax deferred account? Well, converting it might be optimal. We gotta evaluate it, but converting it might be optimal because if your income is expected to go up over the next twenty, thirty years of your career, you're gonna pay higher taxes in the future if you're saving to the Roth.
So if you convert the money you currently have tax deferred over to a Roth now at potentially lower tax brackets, that's beneficial, but the key here is that you can, being this young, you can benefit from the long term growth of a tax free account. So if you get that money into the Roth by paying the taxes, you get to benefit from long term growth that is gonna be tax free and that's where the compounding of this tax free account is really powerful. So that's one time that you could be in your low income years, early on in a career. The second time might be if you are between jobs or maybe you got laid off or maybe you have an opportunity to do something where you take some time off work and you've got a year or so, it's like, hey, my income is only a partial year, I don't have as much income for whatever reason, that might be a good time if you got really large tax deferred account balances or wanna take advantage of these lower years, you can do some Roth conversions during those particular years. And for other folks who are listening to this podcast, you're probably thinking about this in terms of retirement or in retirement, when should you do Roth conversions?
And the most optimal time is gonna be whenever you are in your what's called gap years, and that's gonna be the time from whenever you retire until your social security or your pensions get turned on. So by delaying your Social Security, you're creating a greater number of years or a larger gap there that you can do Roth conversions at a lower tax rate. So that's the first element of a when to do a Roth conversion in terms of like your lifespan. So early on in a career, maybe mid career, if you've got some year or so where your income is lower for whatever reason, that's a really good time to do some conversions. Maybe you leave, here's a good example of that mid career type thing, maybe you're a W-two employee working for a company for twenty years and you decide to stop that and then go start a business, and the business takes a couple years to get off the ground in terms of actually making a profit.
Well, those two years are wonderful time period to do a conversion from a tax deferred four zero one ks that you've had over the last twenty years you've built up and move that to the Roth, at least in part. So, that's a good example of a mid career Roth conversion and why you might think about doing that during low income years. And then finally, the most important, maybe today that we're talking about, is gonna be during those gap years, whenever your income is at its lowest point. You just stopped working, you're making a really good income, now your income goes to zero, and maybe your social security is not yet turned on. So, that's the first thing to look at in terms of your, like your lifespan, in terms of the best time to do a Roth conversion.
Another great opportunity to do a Roth conversion is whenever markets have declined or you've got a good correction that's happening. So if you think back to 2008, you know, obviously that's a big market event, a lot happened and it was prolonged. And so it's hard to say, you know, in the moment, it's really hard to say, yeah, I'm gonna convert money and pay taxes on this IRA that I've got that's now down 40%, I'm gonna move that over my Roth. Well, that's probably not the first thing on your mind in that moment, but it's a really good opportunity to convert money from a tax deferred account over to a Roth account for a lot less tax than you would have done it had you done it before the correction happened. Another time this might be helpful is if we look back to 2018, there was about a 20% dip there in Q4 of that year.
We can look at COVID in 2020, if we've got a 33% drop in about a month, that's a great time to do a Roth conversion there, that happened earlier in the year. So whenever you're thinking about why this is beneficial to do this during a market correction, what happens here is, let's say you have room in your tax brackets to do $50,000 worth of conversions. Well, if you convert that $50,000 before a market correction happens, there's only, there's a certain number of shares that make up that $50,000 So depending on the price of those shares or how many you have, that's gonna make up $50,000 that you have in your income tax brackets that you can convert at a certain tax rate. Now, if we wait till after a market correction happens and the market goes down 20 or 30%, now you can convert $50,000 because remember that's your tax bracket, that hasn't changed, but the price of the shares has changed, those have gone down. And so you can actually convert more shares of the holdings at the same price and get that over to the Roth.
So what happens here is you get a 20% discount to move money over to your Roth. So you pay the same amount of tax. But on the other side, once the money's in the Roth IRA and the recovery starts to happen, now you have more shares growing at a faster rate in a tax free account. So that's why a Roth conversion whenever markets are down is a great time to do it. You get to move more shares over for that same tax payment.
And then you get to benefit from more shares being in that Roth IRA for whenever the market recovery does happen or the asset values do start going back up. Now you're growing in a tax free capacity. So that's the second reason that you should think about doing Roth conversions or maybe the really good time to do it. And then finally, the best thing I would say here is try to do them at the end of the calendar year. So a Roth conversion is hard to kind of plan out early in the year, especially if you've got income that would be fluctuating.
And so what I would say is once you get towards the last quarter of the year, so October, November, December, that's when you will actually want to execute on your Roth conversions and actually complete the task of doing it. Don't do it January 1 because you don't know what your income might be for the year. And so the reason that you might wanna not wanna do that is because if you do a $50,000 conversion and expected to have another $50,000 of income, and then your income ends up being a $100,000, but you already converted the 50 in your Roth, now your gross income is gonna be a $150,000 and you thought it was only gonna be a 100. So somewhere along the way, you're gonna be paying more taxes than you otherwise thought on that conversion amount. So that's why it's important to, if you can, wait till the end of the calendar year to assess, hey, how much money have I earned so far this year?
And is that gonna continue to be the case in these last few weeks or this last month of the year? Is there anything that's gonna change? And that would be a lot easier to project for one month rather than a whole twelve months. And so doing your conversions at the end of the year is optimal. Now, does it always line up that way?
No, because if we have a big market correction in March or April 2020, going back to that moment, thirty three percent down due to COVID pandemic that happened then, well, that's not the end of the year. So does that mean we shouldn't do a Roth conversion at that point? I would say that it might be more beneficial to take advantage of the opportunity in that moment rather than worry about doing it at the end of the year. So, in general, if all things are considered normal or nothing's really abnormal throughout the year, the best time to do it is the end of the year. But there are moments that are off schedule and you have big market corrections and that presents a great opportunity to do a Roth conversion.
So in a perfect scenario, you would have a big market correction at the end of the calendar year or towards the end of the calendar year, and then you can do a conversion at that moment very precisely to know exactly how much tax you're gonna pay on it based on your income so far that year and the month or so that you have left to project forward, and then you're getting that market correction on top of that, and then you would be able to do that most efficiently. So whenever it comes to doing Roth conversions, you've got to analyze your situation. You've got to understand, hey, what is the point of doing this in the first place? Am I gonna benefit from them? And if so, when should I be doing them?
Going back to, you know, if you're retired, it's gonna be whenever you're in your low income years in the early stages of retirement before social security or a pension or RMDs, any of those things have turned on, if you can do that before those things happen, you're gonna benefit that much more because you can use those lower tax brackets, and then also too, these things don't necessarily apply to retirees versus non retirees, but a big market correction is a great time to do that, and then also the end of the calendar year is a smart time to do Roth conversions because you can more precisely predict your income for the whole calendar year. So hopefully this is helpful for you. The reason I wanted to talk through this is because we're coming up on that fourth quarter of the year here in 2024, and wanted to share these ideas with you as you think about Roth Conversions here in the calendar year of twenty twenty four. So hopefully this was helpful for you, and if it was, I'd love again, a rating and review there on Apple Podcasts or Spotify, helps other people find the show and it helps me out a lot.
So other than that, I hope you have a great rest of your week and we will talk to you again next week. Hey, it's Jacob again, and I wanted to extend a quick offer to you. If you have a question and you would like to have it answered here on the show, please email me at jacobretirementanswers dot net. And I'd love to answer that question for you right here on the show. Also, wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice.
Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. I look forward to talking with you again next week.