In today’s episode, David McKnight focuses on whether you should do a Roth conversion, how much you should convert per year, and whether it’s possible to over-convert to Roth.
David explains that an effective tax rate is the actual percentage of your income that you pay in taxes after accounting for deductions, exemptions, and credits.
For David, the only reason you should do a Roth conversion is if you believe that your effective tax rate in retirement will be higher than your marginal tax rate today.
David touches upon a couple of reasons why your effective tax rate in retirement could be higher than your marginal tax rate today.
Remember: the national debt is projected to be $57 trillion by 2035. If Trump extends his tax cuts, you can layer another $5 trillion right on top of that…
According to a recent Penn Wharton study, if the U.S. doesn't right its fiscal ship of state by 2040, no combination of raising taxes or reducing spending will arrest the nation’s financial collapse.
Before undertaking your Roth conversion strategy, you have to remember that in retirement, absent any other deduction, the IRS will give you a deduction called standard deduction.
The standard deduction is $30,000 if you retired today as a married couple and $15,000 as a single filer.
David illustrates a scenario that can lead you to fall into the Roth IRA over-conversion trap.
Your goal should be to keep your balance in your IRA or 401(k) low enough that required minimum distributions in retirement are equal to or less than your standard deduction, but also low enough that they don’t cause Social Security taxation.
David has done the math: if you don’t have a pension or other residual taxable income, you want to keep between $300,00 and $400,000 in your 401(k) or IRA in retirement.
Got a sizable pension or another significant source of taxable income? Then, your ideal balance would be much closer to zero.
It’s crucial that, when converting your money, you do it slowly enough that you don’t rise into a tax bracket that gives you heartburn, but quickly enough that you get all the heavy lifting done before tax rates go up for good.
If Trump ends up extending his tax cuts, they’ll expire at the end of 2033. That means that somewhere between 2034 and 2040 tax rates will likely rise in dramatic fashion.
By including the 2025 tax year, that gives you nine full years during which you can execute your Roth conversion strategy.
Mentioned in this episode:
David’s national bestselling book: The Guru Gap: How America’s Financial Gurus Are Leading You Astray, and How to Get Back on Track
PowerOfZero.com (free video series)
@mcknightandco on Twitter
@davidcmcknight on Instagram
David McKnight on YouTube
Get David's Tax-free Tool Kit at taxfreetoolkit.com
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