WEBVTT 00:00:01.760 --> 00:00:38.280 If I were to bet, I would say that tax rates overall over the next twenty, thirty, forty, fifty years, I would assume that they're gonna be higher than they currently are today. It might make more sense to do those conversions now at perhaps the lowest we're going to see for a while. 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. 00:00:38.280 --> 00:00:58.365 So let's go ahead and get started with today's show. Hey everybody, welcome back to another episode of Retirement Answers. As always, my name is Jacob Duke, and I'm excited that you're here. I hope that you have found this podcast helpful. If you've recently found it, I'm seeing that a lot of folks are are kind of tuning into it lately. 00:00:58.870 --> 00:01:23.085 If you are and you're not a subscriber, I encourage you to go ahead and subscribe. That way you don't miss any future podcasts or episodes. And if you're also liking it, I would also encourage you and ask you to give us a rating or review on whatever platform you listen to podcasts. So if that's Apple Podcast or Spotify, go ahead and give us a rating and also a written review if you would like to do that. So thank you so much for your help and support along the way. 00:01:23.325 --> 00:01:51.135 Alright. So today I wanted to talk about Roth Conversions, but I didn't necessarily wanna talk about them in such a way that explains them in terms of what they are. I'll do a quick recap of that, but today I wanted to talk more about when you should maybe think about doing Roth conversions or perhaps when the best time to do them would be. So just a quick refresher on Roth conversions, what are they? Well, essentially you are moving money from a tax deferred account, like a traditional IRA or a four zero one k, and you're moving that over into a Roth account, like a Roth IRA. 00:01:51.295 --> 00:02:12.555 So to do that though, that word convert means to pay the tax on. So let's say you do a $50,000 conversion. You're moving $50,000 out of your IRA, and then you're going to pay the tax on that amount whenever it goes into the Roth, and you're paying the tax as normal income, it's not a capital gain. So that's what a Roth conversion is. Now, why would you do them in the first place? 00:02:12.555 --> 00:03:01.560 The the primary reason to do them at all is because you have a large tax deferred account balance. So if you've got $750,000 a million or more in tax deferred account sources such as four zero one k's, four zero three b's, TSP's, IRA's, anything that's tax deferred, you should probably evaluate and just to see if a Roth conversion would benefit you. And the reason for even doing them is you have these large tax deferred balances and if they continue to grow and build over time, whenever you get to RMD age one day, whether that be 73 or 75, you're gonna have to begin distributing money out of your accounts due to those RMDs, which if they've grown over the last ten to fifteen years when you otherwise could have had that money in Roth, you basically built up a larger tax bill for yourself. So it's really a question of should I pay the tax now or should I pay that tax later? It's one of those two questions. 00:03:01.560 --> 00:03:27.200 And if it's beneficial to pay the tax now, that's whenever you would do that Roth conversion. Now, I wanted to encourage you, like I said, if you've not subscribed to the podcast, go ahead and do that because next week I'm gonna be talking about how to actually pay the taxes on the conversion. So a lot of us, we find ways to do the conversions and it's actually helpful for us, but whenever we get to actually executing and doing it, the logistical side of it is sometimes where questions come into play. How do I actually pay the taxes? Do I have them withheld? 00:03:27.200 --> 00:03:39.285 Where do I send my money? Do I send to the IRS? Do I just pay at the end of the year whenever, you know, I'm actually doing my taxes? So next week, I'm gonna talk about how to pay taxes on your raw conversion. So be sure to subscribe that way you don't miss that one. 00:03:39.685 --> 00:03:56.470 Okay. So we know that doing Roth conversions is essentially the decision between paying tax now versus paying tax later. Now, when do we need to do the conversions? That's really the question that we wanna talk through today. So if you're out there, you might either be working still or you might be retired or kinda somewhere in between. 00:03:56.630 --> 00:04:18.930 Everybody's in a different situation in terms of their life, their income, and the stage of life that they're in. So, when do we actually want to do conversions? Well, in general, it's gonna be whenever your tax rate is the lowest. So that might mean you have a low income year, while you're still working for whatever reason, or it's after you have retired. So one of those two things has to be in play. 00:04:18.930 --> 00:05:01.435 Your income has to be at a lower point than otherwise has been or otherwise will be in the future in order for this to make sense. Because really what you're trying to do is you're trying to fill up a certain tax bracket, whether that's the 12% or 22% or 24% tax bracket, you're trying to utilize that tax rate where it's at currently, to pay your taxes now as opposed to perhaps a higher tax rate in the future. And that higher tax rate in the future could be from either increased tax brackets overall, or if your income is gonna be higher in the future. So when do I think is the best time to do Roth conversions or what is the Roth conversion sweet spot? Personally, I think the best time to do them is whenever you are retired in the early stages of your retirement. 00:05:01.435 --> 00:05:32.405 And a few things kinda have to come together for this to work out and actually be really, really beneficial for you. Now it can be beneficial if some of these things are not checked off, but to be the most beneficial, here's kind of the list of things that I would evaluate and say, hey, you can actually do Roth conversions and they're gonna be super helpful is number one, if you're retired. Number two, you have not started social security yet. Number three, if you don't really have any other income sources like pensions or rental income. If you don't have any other taxable income sources, that's really helpful here. 00:05:32.645 --> 00:06:17.360 And if you have cash or after tax savings that you can live on, but also if you can have that money to pay the taxes with. And then finally, if your RMDs have not started yet. So if you're in the early stages of retirement, you've delayed social security and you really don't have much other taxable income, it will perhaps be the best time to do those Roth conversions during that time period, because your income will likely be at its lowest point throughout the rest of your life. So those five or six things are primarily what I'm looking for in terms of evaluating, hey, is this period of time the best time to do a Roth conversion? So, in order to kinda look at this together, I wanted to walk through a scenario of sample couple, but this is a lot of people that I talk to and actually meet with, because this is a very common scenario that I hear. 00:06:17.440 --> 00:06:35.565 And the questions are, can we do this? Should we do this? And what I'm gonna do along the way is kinda tweak a few different levers and say, hey, here's why they either can, should, or should not, because of these different levers being pulled. Maybe they have started social security. Maybe they do not have any after tax savings like cash or brokerage account money. 00:06:35.565 --> 00:06:50.190 Maybe they don't have very large tax deferred accounts like IRAs. So all these different things kind of change the scenario a little bit, but let's go ahead and kind of walk through this together. That way we can really get a good understanding and glimpse of what we're looking at. Okay. So Doug and Judy, we're just gonna call them Doug and Judy Sample. 00:06:50.910 --> 00:07:02.805 They're both 62. They've got a combined $1,500,000 in IRAs. That's tax deferred money. They have $250,000 in cash and after tax investments. Most of that $2.50 is actually in cash. 00:07:02.805 --> 00:07:21.275 There is some in a brokerage account. And then also they have around $50,000 of annual living expenses because they have no debt. So $50,000 a year, it's around $6,000 a month that they need to live on to meet their normal income and living expense needs. They're also currently delaying social security. So remember, they're 62. 00:07:21.435 --> 00:07:46.755 They could have taken social security at this point, but they're delaying that for now. So why would they need to do Roth conversions in the first place? Well, number one is because they have over 1,000,000 in IRAs. So they got $1,500,000 in IRAs. If you think about that, if they're currently 62, whenever they turn 73 or 75 in the future, they are gonna have to pay taxes on an even larger amount because that's ten, twelve years away. 00:07:46.915 --> 00:08:21.175 They're gonna actually have a larger account balance. So by that point, they're gonna have most likely at least $2,000,000 in their IRAs because even invested conservatively, they're gonna that money's gonna grow. And so their account balances are gonna grow more and more over the next ten plus years, and they're ultimately building up a larger tax bill for themselves. So checkbox number one, they've got large tax deferred accounts. So number two, whenever we look at their social security, they are 62, but they're not yet taking social They're delaying that into the future, whether that be all the way to full retirement age or just at least another year, they're currently not receiving it. 00:08:21.175 --> 00:08:39.060 Now, why is that important? Well, the first reason is is social security is taxable at least in part. So if their only income that they receive throughout the whole year is social security, they will not pay any taxes on that money. Now, I'm not gonna get into social security taxation today. That's a different podcast for a different day. 00:08:39.060 --> 00:08:54.905 I'll do that again. I've done that in the past. So go back and listen to the episodes I have on that. But just know that whenever you receive social security and that is your only income, you will not pay any taxes. Now, as soon as you start adding income to that, it could become taxable because of how the calculation works. 00:08:55.145 --> 00:09:22.125 So it's kind of like a double edged sword. As soon as you start taking money out of your IRAs, which is what a Roth conversion technically looks like on paper, whenever you start taking that money out, number one, you're gonna pay income tax on the dollar amounts that you take out. But if you're also taking social security, you will then also cause your social security to become taxable, at least in part. So it's kind of like a double edged sword. Number one, you're paying tax on the income from your IRAs, but then also now you're creating a tax for your social security because you've got income from your IRAs. 00:09:22.285 --> 00:09:54.335 So in general, whenever you can delay your social security and do raw conversions at the same time, that's when it's most beneficial because you're not creating additional tax on your social security income, but then also you're not increasing the level of income you have because that keeps you in lower tax brackets in order for you to pay less tax on the actual conversion amount. So right now they're delaying social security, which is gonna be a benefit to them. Number three, they really don't have any other income at this point. Now they can create different incomes out of their IRAs, which is taxable, right? But they don't have like a pension. 00:09:54.335 --> 00:10:30.600 They don't have different rental properties that are spitting off rental income to them each month. So at the end the year, they're gonna pay minimal taxes because they really don't have income to report. They also, number four, they've got a decent amount of cash savings on hand. So that was one of the biggest points and kind of things that I like to look at in terms of check boxes to evaluate is, do you have after tax savings or cash to use whenever you are trying to do these conversions? Because I'll get into this next week, but whenever you're trying to pay taxes on a conversion, it is typically best to try and do that with cash rather than do it withholding from your IRA. 00:10:30.600 --> 00:10:51.505 So in Doug and Judy's situation here, they actually have $250,000 in cash slash after tax investments. So that amount of money is gonna be useful in two different ways. Number one, they can choose to use that money to pay the taxes on their conversions. But also number two, they can live off of that income. Remember, they need $50,000 a year of living expenses. 00:10:51.745 --> 00:11:23.445 So technically that's about five years worth of living expenses. They they can use that $250,000 of cash to live off of and do so tax free. So whenever they pull money out of their bank account, they're not paying income tax on that because it's already been taxed. So what that does is, is that allows them to not have to pull out of their IRAs while they're doing the conversions, which means they're not having to double dip and pay taxes on all of it, which ultimately decreases the amount they can convert at certain tax rates. So by having that cash, it gives them the flexibility to do those two things. 00:11:23.445 --> 00:11:48.685 Number one, they can live on that money as opposed to living on other taxable income sources. And they're able to, if they would like, and it's beneficial, they're able to use that money to pay taxes on their Roth conversions. So, also finally, they're 62, so their RMDs have not started yet. Those are gonna be another ten plus years away, so no worries for them there. So number one, they're able to do Roth conversions because they have this large tax deferred account balances in their IRAs. 00:11:48.685 --> 00:12:47.065 They've got a sufficient amount of cash and after tax savings built up. They have minimal expenses because they have no debt, and they're delaying their social security. All of those things are a recipe for success whenever doing Roth conversions. So what that does is that affords them the opportunity to do conversions now at a 10% or 12% or even perhaps 22% tax rate, as opposed to in the future whenever they have their social security income turned on at full retirement age, let's say 67, then they would have that income plus their other IRA or Roth conversion income coming in, but their tax brackets are a lot more compressed, meaning they're not gonna be able to convert as much money in that 10 or 12 or 22% bracket, depending on how much income they have in total. So utilizing situation with no income, they can use that ten and twelve percent bracket, they're married filing jointly, which means they can convert upwards of a $100,000 from their IRAs to their Roth IRAs at no more than an effective rate of around 10 or 11% taxes at the federal level. 00:12:47.560 --> 00:13:21.700 And on top of that, if you're in a state that does not have income taxes, that means that your overall effective tax rate is around ten, eleven or 12%. So they can convert around a $100,000 a year with no other income sources because they're living off cash and they don't have social security. They can actually do that $100,000 conversion a year at a maximum tax rate of 12% on any dollar they convert. Now it is important to remember that in 2026, federal tax rates will increase from where they are today back to what they were previously. So the 10% bracket will remain the 10% bracket, but the 12% bracket will go up by 3%. 00:13:21.700 --> 00:13:53.060 It'll go up to 15%. The 22% will go to 25% and the 24% will go to 28%. So in 2026, which is only three years away, that will go all of our federal tax rates will be increasing. So if you're in a position currently to think about, hey, should I do Roth conversions if maybe if you're on the fence and you have these larger tax deferred account balances, just know that whenever you take money out in 2026 and beyond out of those accounts, you will be taxed at a higher rate than you otherwise will be taxed at now. So that's even your first incentive to think about doing a conversion. 00:13:53.060 --> 00:14:19.530 If you're kind of in this early retirement timeframe, you know that your tax rates will be increasing in the future. And I'm not a betting man, but if I were to bet, I would say that tax rates overall over the next twenty, thirty, forty, fifty years, I would assume that they're gonna be higher than they currently are today. That's just with everything going on in the world around us. We know that the US government has more debt than they otherwise have had ever. And it seems like that's the trajectory we're gonna be on for a while. 00:14:19.690 --> 00:14:39.435 They're gonna have to make up that money somewhere. And I'm assuming that that will be on your income tax rates. It might make more sense to do those conversions now at perhaps the lowest rates we're gonna see for a while. Now let's say that Doug and Judy had already began taking social security and everything else is the same. They've got $1,500,000 in their IRAs, $2.50 in cash, and they still need $50,000 to live on. 00:14:39.930 --> 00:15:29.185 Would it still be beneficial to do Roth conversions? Well, it might be because no matter what, even if they're taking that social security, what happens there is because that is likely gonna meet most of their $50,000 a year of annual living expenses, that means they're not gonna have to take any money out of their IRAs, and they're not gonna have to take very much money out of their cash that they have built up. So what that does is it allows them to pay the taxes on their conversions with the cash they have, as opposed to having to live on all of it every single year. Now, that might mean you pay a little bit higher tax rate because some of your social security will be taxable in this situation whenever you're doing a conversion and taking social security at the same time. But it still will likely be beneficial for them because like I said, in ten plus years, that $1,500,000 is likely gonna be at least 2,000,000, if not 2,500,000. 00:15:29.185 --> 00:16:08.255 So paying taxes now, getting more money into the Roth today is still probably gonna be very beneficial for them because they're gonna avoid even larger RMDs at 73 and beyond. So if you have the large IRA account balances and you're still early in your retirement, so they're still 62, and you've already began taking Social Security, I would not necessarily rule out Roth conversions entirely. Just know that the benefit is gonna be slightly reduced because you're gonna be paying a little bit higher tax rate or you won't be able to convert as much in those 1012% brackets. Now let's say that they did not have any cash and they're delaying social security. So let's say, let's call it just $30,000 of cash in the bank. 00:16:08.255 --> 00:16:32.605 They have $1,500,000 in their IRA still. They're both 62 still, and they're still not taking social security because they're trying to build that benefit up. They're gonna plan on taking it at full retirement age, but they still need $50,000 a year of living expenses and they don't have any debt. Well, that $50,000 a year, where's it gonna come from? Well, it has to come from their IRAs because they're going to delay their social security and they don't have enough cash to even fulfill their income needs. 00:16:32.605 --> 00:17:00.255 So that means that every dollar they take out is gonna have to come from IRAs. And every time they do that, they're gonna pay income tax on that. So let's think about it that way. Let's say they're taking $50,000 out of their IRAs for living expenses, but they're also trying to evaluate, should I do conversions or not? Well, in this situation, they still might be able to do conversions, but just know that their conversions are gonna be a lot smaller in those ten, twelve and twenty two percent brackets because they've already got $50,000 of income that's going to happen. 00:17:00.575 --> 00:17:46.640 So if they're wanting to a $100,000 conversion and now they're also having $50,000 come out of their IRAs, that's $150,000 of taxable income that they're gonna pay tax on. So that means that they're paying a higher tax rate on their conversion amount than they otherwise would have to compared to if they had the cash available. So in this situation, it's worth evaluating to say over the next five to seven years, whenever we're not taking our social security, how much will we be able to draw down our IRA amounts in order to ultimately lower those RMDs in the future? So if they take 50,000 out for five years, that's 250,000, that would leave them based on their current balance with 1,250,000 in their IRAs, which those RMDs are still gonna be perhaps more than they need or more than they would like. So it still might make sense to do some conversions, but it's worth looking at. 00:17:46.925 --> 00:18:26.955 It's worth evaluating and understanding, is it even beneficial still to do the conversions at all? And finally, maybe they're in a different situation and their annual living expenses because they do have debt, whether it's a mortgage or car payments or anything else, their annual living expenses are a $100,000 per year and they still have the same amounts. $1,500,000 in IRAs, they're both 62, 250,000 in cash, and they're still delaying social security. Is it worth doing conversions at that point whenever they have to have a $100,000 a year of of living expense needs. Well, at that point, you're gonna have to kinda pull money from cash and you're gonna have to pull money from IRAs, which obviously means that your income tax brackets will be compressed in terms of how much you can actually convert. 00:18:27.435 --> 00:19:02.250 But it might be helpful early on in retirement to delay that social security, build up that benefit. Also, the meantime, you could be drawing down and and kinda decreasing the amount of money in your tax deferred accounts by living on that money early on. Keep your cash where it's at in terms of keep that two fifty where it is, make a little bit of interest on it. And then in five years, you're gonna have around a million dollars in IRAs, which your RMDs are gonna be lower and lower at that point. So there's so many different ways to kinda evaluate or look at this and all the different levers that you can pull, whether it's do the conversions now or delay them in the future. 00:19:02.410 --> 00:19:12.730 What income am I gonna live on early on in retirement? Do I delay social security? Do I live off the cash? Do I live off IRAs? How does all of this affect how much I can convert and at what tax rate? 00:19:13.075 --> 00:20:00.020 So these are the things that you should be thinking of as you're evaluating your Roth conversion strategy. But number one, remember this, if you are retired and you're early in your retirement and you have delayed social security and you're not taking that currently, you don't really have any other income sources like a pension or rental income, and you have a decent amount of cash savings, you can probably benefit really well from doing Roth conversions because you've got all the different ingredients going for you in that situation. If you can't check the box on one of these things, you can probably still do conversions. Just know that that benefit is gonna be slightly reduced. Like for example, mentioned earlier, if you are taking social security already, then you can probably still do conversions at this point, but just know that your tax brackets in terms of how much you can convert at certain tax rate, that's gonna be lowered, and you might end up paying a little bit more tax on a portion of your conversion amount. 00:20:00.020 --> 00:20:21.555 So, all these different levers, think about all these things whenever you're evaluating conversion, but that's the Roth conversion sweet spot. Just remember that. If you're early in retirement, no social security yet, you really don't have other income that's taxable and you have a decent amount of cash savings. That's whenever you're primed to do Roth conversions and really benefit from them for the rest of your life. So I really appreciate you tuning into this week's episode of Retirement Answers. 00:20:21.630 --> 00:20:40.735 But remember subscribe that way you don't miss next week's episode, where I talk about how to actually pay the taxes on these conversions. I appreciate you tuning in. Go ahead and give us a rating and review there on the app that you're listening through. And I look forward to talking with you again next week. Hey, it's Jacob again, and I wanted to extend a quick offer to you. 00:20:40.735 --> 00:21:03.858 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.