November 7, 2023 • 21 mins
What are the benefits of Roth conversions in retirement planning? James addresses questions about when Roth conversions become worthwhile.
This episode explores key factors:
Changes in tax bracket
Spousal scenarios
Impact of portfolio size on tax savings
Potential tax savings tend to increase with a higher portfolio balance but be careful not to take unnecessary Roth conversions. James explains different strategies to optimize tax planning.
Questions answered:
Is there a specific portfolio value at which Roth conversions should be considered?
Why might one choose not to do a Roth conversion, and what are the alternatives?
Timestamps:
0:00 Intro
3:14 Scenario
6:47 Tax bracket
11:15 Provisional income
14:27 Spousal scenario
16:45 Bottom line
20:29 Outro
Create Your Custom Strategy ⬇️
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
One of the most talked about retirement planning
points is Roth conversions, andfor good reasons, because in
some case, a good Rothconversion strategy can save you
hundreds of thousands ofdollars or even more.
But at what point do theybecome worthwhile?
Is there a portfolio value oneneeds to have before
implementing this type ofstrategy?
And, alternatively, is there aportfolio value at which you
(00:20):
don't need to worry about this?
That, and more, is what we'regoing to discuss on today's
episode of Ready for Retirement.
This is another episode ofReady for Retirement.
I'm your host, james Kanol, andI'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode is based upon alistener question, and this
(00:42):
question comes from Danny.
Danny asks the following.
He says I really appreciate allthe great information in your
podcast and especially that youtake feelings into account when
giving options.
One thing that I have noticed isthat you most often give advice
to portfolios of between $1 and$2 million.
That makes sense becausethere's a greater tax impact for
those people.
I am retiring in March and Iwill receive $65,000 per year
(01:02):
from Social Security andAppention.
I have two 401ks with acombined value of $400,000, and
our mortgage is paid off, so Ishouldn't need to tap into them
for a few years.
I am wondering how some of theusual advice regarding Roth
conversions versus the impact ofRMDs, required minimum
distributions and survivingspouse issues apply with a
smaller portfolio.
Thanks again for all theinformation you provide, danny.
(01:24):
Well, danny, thank you for thatquestion.
I appreciate it and you areright, I think.
Typically, at least, when we'retalking about tax planning
points, I am talking aboutportfolios that are maybe $1, $2
, $3 million or more, notbecause tax planning is unique
to that, but because there ismore tax planning opportunity
the larger your portfolio is.
But, danny, you bring up areally good point.
(01:47):
Is there a point, or is there athreshold, at which I need to
start being concerned about someof these issues?
Here's my portfolio today, myother income sources.
So what I'm going to do ontoday's episode is use Danny's
situation, I'm going to makesome assumptions about it, and
I'm going to use this to show isthere any potential benefit to
tax planning at the currentportfolio value and how might
(02:08):
that change at differentportfolio values in the future
or in other cases.
Before I do so, though, I wantto highlight the review of the
week as saying thank you to allof you who are leaving reviews.
This review comes from usernamejauntijoe from Jersey.
I like that jauntijoe fromJersey leaves a five star review
and says I have tried literallydozens of retirement podcasts
and this was by far the best.
(02:29):
The information is succinct,relevant and financially sound,
and he makes it so everyone canunderstand.
You don't need to be a CPA tofollow the podcast.
Thank you so much, james.
Well, thank you, jauntijoe, forthat review.
Really appreciate that, and ifyou have enjoyed this podcast or
received any value from it,would really appreciate you
taking a few moments and leavinga review so more people can
find the show and get theinformation they are looking for
(02:51):
.
So with that, let's jump rightinto the episode.
So, danny, a couple things.
One again.
Thank you for the question.
I'm going to start with what Idon't know about your situation
and, by the way and this goesfor every episode none of this
should ever be construed asadvice or recommendation.
This is really just foreducational purposes only, but
providing some context within aspecific person's situation.
(03:14):
So here's what I don't knowabout Danny's situation, before
we start diving into what we doknow.
I don't know what Danny'sdesired living expenses are.
That's going to be a big partof tax planning.
I don't know what amount he'sreceiving from pension and what
amount he's receiving fromSocial Security.
I know that he's receiving$65,000 combined but I don't
(03:34):
know what's pension and whatSocial Security.
That's important becausethey're taxed differently,
social Security versus pension.
It's also important becauseSocial Security has a cost of
living adjustment.
The pension may or may not.
If it's a government pension,it most likely does have a cost
of living adjustment.
If it's a private sectorpension, it most likely doesn't.
Also, social Security hassurvivorship options.
(03:57):
So if Danny predestines hisspouse or vice versa, the
surviving spouse can collect thehigher of the two current
benefits With the pension,though I don't know what the
survivorship options are, if any.
The pension could go awaycompletely if Danny passes away,
or it could be a joint lifepension.
So again, we know $65,000 iscoming in, but I don't know what
(04:19):
should.
That is Social Security andwhich of that is pension.
And these may seem likeunimportant differences when
we're looking at tax strategy.
It might be tempting to look atthen say, yeah, that's all
important information for maybea comprehensive plan or an
income plan, but we just want toknow about the tax stuff.
Well, all of these things feedinto one another.
So these details, yes, haveincome implications, investment
(04:40):
implications, long termretirement implications, but
they also have tax implications.
So those would be importantthings to know.
I'm assuming that Danny ismarried.
He didn't come out and say it,but he referred to our mortgage
and he referenced what are theissues for survival, driving
spouse with this.
So I'm going to make theassumption that Danny is married
.
I don't know his age.
So I know he's eligible forSocial Security, but I don't
(05:02):
know his exact age.
I don't know if charitablegiving is something that he does
.
Again, may seem irrelevant, butwhen we're looking at things
like Roth conversions, it verymuch is relevant, and I'll show
you why in just a bit.
And I don't know what statehe's in.
So, again, when we're lookingat Roth conversions, it's a tax
plan, but there's the federaltax issues and then there's a
state tax issues and every stateis different.
(05:24):
So these are just some piecesof information.
I don't know, and I justhighlight this because, as we go
through this, I do not want togive the impression that this is
advice or that this is going tobe universal information,
because any number of thosethings I just listed could
potentially change this.
So with that context, here'sthe assumptions I'm going to
make, just so we can kind ofhave clean, tidy numbers to work
(05:46):
with.
Of the $65,000 per year that'scoming in, I'm going to assume
that $48,000 per year of that iscombined social security.
So I'm going to say $2,000 forDanny and $2,000 for a spouse I
don't know if maybe a spouse'ssocial security was on top of
the $65,000, but I'm just goingto make the assumption that it's
included.
So I'm assuming $2,000 permonth for each of them for
(06:09):
social security, which is$48,000 per year, and I'm going
to assume that Danny's pensionis $17,000 per year.
So combined that comes out to$65,000, and then he has
$400,000 combined in 401K plans.
The question should he do Rothconversions?
He said, james, I know you talkabout this, you talk about this
(06:29):
quite a bit, but typically theportfolios are maybe a million
dollars or $2 million.
I see the case for Rothconversions.
There there's more taximplications.
But with my situation here's mypension, here's social security
, here's 401K would that beworthwhile for me?
So let's explore that.
The first thing that we want toknow if we're going to do a
Roth conversion, we want toideally know that the tax
(06:51):
bracket we're going to pay todayfor any potential conversion is
lower than the tax bracket we'dbe in in the future.
So pretty self-explanatory Ifyou're going to be in a higher
tax bracket today, let's not doa Roth conversion and add to our
tax bill.
Let's only do it if we can doso and pay less in taxes today
than we otherwise would in thefuture.
Now I'm going to make anotherassumption that there's no other
(07:14):
income, no interest income, nodividend income.
No, any other income outside ofDanny's pension and social
security.
Yes, he has a 401K and if youwere to pull money out of the
401K, that would be taxableincome.
But he referenced in hisquestion that he's not going to
need to tap into that for sometime.
So here's why that matters.
If there is zero other incomeand if we assume a $17,000 per
(07:37):
year pension, it's fully taxable$48,000 of combined social
security and I'm assuming astandard deduction of $30,700.
If Danny and his spouse wereboth 65 or older, they would
actually get an extra standarddeduction above and beyond that.
But even with just these numbersand this is important Danny is
(07:57):
in the 0% tax bracket once heretires.
Again, this is just looking atfederal taxes, because I don't
know what state he's in, but youmight be asking how on earth
could he be in the 0% taxbracket?
He's got $65,000 of income.
Even once you back out thestandard deduction, there's
still some taxable income left.
Well, here's why that's thecase.
I'm assuming the $17,000 ofpension income is fully taxable,
(08:19):
which it almost certainly is,unless it's some type of a
military or VA pension andthere's a VA disability of some
sort probably fully taxablepension.
But here's the thing with socialsecurity.
With social security, there'ssomething called provisional
income.
When you want to know how muchof your social security is
included in your taxable income,you need to understand your
provisional income.
I've talked about this on otherpodcasts.
(08:41):
I'm not going to go too into ittoday, other than to say that
his provisional income is suchthat only 4,500 per year of
their combined social securitybenefit would actually be
included in their total income.
Yes, they have $48,000 ofsocial security benefits, but
the taxable part is only 4,500.
(09:03):
You add that 4,500, the $17,000of pension income, their
adjusted gross income is 21,500.
Now, as a married couple, theirstandard deduction is $30,700.
It's even higher if they're 65or older.
What do you get there?
Well, if you have an adjustedgross income of 21,500 but
(09:25):
deductions of 30,700, yourtaxable income is zero.
In Danny's case and again I wantto be very clear I'm assuming
zero interest income, zerooutside income.
I'm making the assumption thatthe $65,000 that Danny gave me
is including a spouse's socialsecurity and that that's not
additional.
I'm taking some liberties herebecause they're not explicitly
(09:45):
provided in the question, butwhat we can see here is look,
danny, you're in the 0% taxbracket.
You could convert for free acertain part of your 401k into a
Roth IRA, at least at thefederal level, before we even
look at state taxes.
Now, I don't care what taxbracket you're going to be in
the future.
If you can convert funds at a0% rate today.
(10:06):
It makes sense to convert fundsat a 0% rate today.
One thing you have to be mindfulof, though, when we go back to
this tax analysis that we did,where we said look, of the
$48,000 in social securitybenefits, a very small amount
$4,500 of it, to be precise isactually included as taxable
income.
Well, as you're looking atconversions, you have to look at
(10:27):
a couple things.
Number one.
Every dollar that you convertincreases your adjusted gross
income by $1, but it also bringsin another portion of your
social security benefit intoyour taxable income.
This is what's called the taxtorpedo.
The social security tax torpedois not only does the extra
conversion amount increase youradjusted gross income by itself,
but it's also pulling with itmore and more of your social
(10:50):
security benefit that nowbecomes taxable.
So still absolutely makes senseto do in a lot of cases, but
something that most people missand something that's important
to be mindful of.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment tax,
(11:10):
legal or other financial advice.
It is for informationalpurposes only.
Another thing that you want tomake sure that you're noting at
least for people who are insituations here like Danny,
where a big part of their socialsecurity benefit maybe isn't
taxed today is that when we'relooking at that that provisional
income, as I mentioned andprovisional income is what
determines how much of yoursocial security benefit is
(11:32):
included in your taxable incomethe income bans or the income
thresholds for provisionalincome are not indexed for
inflation.
Practically speaking, what thatmeans is every year, all else
being equal, more and more ofyour social security is now
included in your taxable income.
Why does that matter?
Well, if you're in a situationlike Danny at least under the
(11:54):
assumptions that I'm making hereyour tax bill is probably going
to be going up over timebecause more and more of your
social security benefit is goingto be added to your taxable
income, which is going to pushyou out of the 0% tax bracket at
some point.
Now you could still be in avery low tax bracket, at least
relatively speaking, but that'ssomething to be mindful of.
Of that benefit, of not havingyour full social security
(12:17):
benefit taxed, isn't going tolast forever.
And this goes back to what Iwas saying before.
Should you do a Roth conversion?
Well, it does have to do withhow much you have in your IRA
balance or 401k balance, whichI'll get to in a second.
But the biggest thing is what'syour tax bracket today, or at
least in the year that you'reconsidering a conversion, versus
what's your tax bracket in thefuture?
Well, what's Danny's taxbracket going to be in the
(12:39):
future?
Well, things could change inthe tax world.
But let's just look at what wedo know.
I'm going to assume that he's65 years old today and I'm going
to assume, with that being thecase, that his required
distribution starts at age 73.
Well, we know that right nowDanny has $400,000 in retirement
accounts and we know that rightnow he doesn't really need to
touch them to meet his livingexpenses.
Social security and pensionwill do that.
(13:01):
Well, if we assume that that$400,000 grows at, say, an
average return of 6% over thenext handful of years until
required distribution start,then his $400,000 will turn to
$640,000 by the time that he's73.
His required minimumdistribution on a portfolio of
$640,000 would start rightaround $25,000 per year.
(13:23):
What does that mean?
What means in the future, atage 73,?
Now his taxable income isn'tjust pension plus social
security, it's now pension plussocial security plus required
distribution of, call it,$25,000 per year.
Now, that's not going to bumphim into a huge tax bracket, but
what it will do is most likelyput him in a higher tax bracket
(13:44):
than he's in today.
So, danny, to go back to eventhe premise of your question of
hey, I know Roth conversionswork for the million dollar
portfolios plus.
What about for mine, well, it'sless a portfolio size, although
portfolio size absolutely playsa role in this.
But what I would look at is areyou in a higher tax bracket in
the future when you do havethose required distributions, or
(14:05):
today?
It's likely, with theassumptions I'm making I'm not
going to say these assumptionsare all accurate, because I'm
just making assumptions.
As I mentioned, I'm making someof these up it would make some
sense to at least consider doingRoth conversions.
To what extent depends upon awhole bunch of different things.
I'd want to have a lot moreinformation, but I would very
much still consider this insomeone's situation like Danny
(14:26):
is describing.
Let's now take this one stepfurther Danny alluded to in his
question.
He said well, what about theimpact of, say, one spouse
predestined the other?
How do Roth conversions playinto that type of a decision
making process?
Well, let's examine that.
Let's assume that of the 48,000that I'm assuming they have
coming in from Social Security,so 2000 per month each or 24,000
(14:48):
per year each.
Let's just assume that one ofthem passes away and after that
the Social Security benefitdrops to $24,000 per year.
So it goes from 48 to 24.
And let's assume that thepension has a survivorship
option so that pension stays atexactly $17,000 per year.
Well before, when they weremarried, because of a combined
(15:10):
standard deduction, they were inthe 0% federal tax bracket and
there's really not technically,a 0% federal tax bracket.
Being in the 0% bracket, theway I'm saying it, is just the
understanding that whateverincome they have is completely
offset by their deduction.
So technically they're in a 0%bracket even though that bracket
doesn't exist.
(15:30):
So when we're looking at this,daniel will go from a 0% tax
bracket today if married to, ifone of them passes away and
social security drops to $24,000per year and pension stays at
$17,000 per year.
Now the surviving spouse is atthe top of the 10% bracket and
very soon to cross over into the12% federal tax bracket.
All that because now there'sfewer deductions.
(15:53):
They can't take the samestandard deduction.
That gets cut in half.
Also, provisional income,slightly different brackets
around that.
So when you're looking at this,that is something that you very
much need to keep in mind Notjust what tax bracket am I in
today versus what tax bracket amI in in the future, but what
would be the tax hit and theimpact to the surviving spouse
(16:13):
if one of us pre-deceased theother.
What you can see is, right away, it would push the surviving
spouse and Danny situation intoa higher bracket.
So relatively low tax bracket,all things considered, still in
the 10% to 12% rate.
But if you're doing Rothconversions with the goal of
protecting a surviving spouseand you're in a 0% tax bracket
(16:34):
today, absolutely take advantageof the 0% rates.
But also consider how high dowe want to go under the 12%
bracket or 10% bracket orwhatever the case might be for
your specific situation.
So here's the bottom line forDanny Danny, in your situation,
you probably won't ever being asignificantly higher tax bracket
.
It's not as if you're going togo from the 0% bracket into the
(16:55):
35% bracket because of RMDs oranything like that.
This is barring anythingexceptional huge inheritance,
huge windfall, huge something orother.
So in your situation, there'snot going to be a huge impact to
tax brackets.
But, that being said, the righttax strategy could still save
thousands or even tens ofthousands of dollars in taxes
(17:17):
over the course of your lifetime.
Now, that is pretty significant, regardless of your portfolio
balance.
So the general principle that Iadd on top of this is yes, the
higher your IRA balance, themore impactful the right tax
strategy becomes and we can seethat real.
Simply, we talked about Danny'sRMD maybe being around $25,000
(17:37):
by the time he turned 73, underthe assumptions that I made.
Well, if, instead of having$400,000 in his portfolio, he
had $4 million in his retirementportfolio Now, specifically,
I'm seeing retirement portfolio,so IRA, 401k, things that are
subject to requireddistributions Well now, instead
of his RMD starting at $25,000per year, it would start at
(17:58):
$250,000 per year and increasing.
So you can see the dramaticimpact that would have on both
his income and his tax bracketin the future if we use a
significantly larger portfolio.
So in those cases, the largeryour portfolio balance is, the
likelihood is that you're goingto have a more of potential tax
savings through having a goodtax strategy in place.
(18:21):
But I wouldn't say there's apoint at which you should never
consider Roth conversions.
You should always consider it.
It doesn't hurt to run thenumbers.
It doesn't hurt to have ananalysis to see can it save you
money, but keep this in mind.
This is what I'm always lookingat when I'm looking at tax
returns and tax plan for clients.
Is there a good reason not to doit?
It's always the lens I'mlooking through, because Roth
(18:43):
conversions cost you money.
You're having to pay taxestoday that you otherwise
wouldn't have paid for severalyears.
In many cases that's notnecessarily pleasant, but it can
save you a lot of money in theright circumstances.
You know, for example, a reasonthat you might not do it.
I mentioned before some things Idon't know about Danny in his
situation is was charitablegiving part of something that he
(19:04):
does?
If it is well, then maybe youjust use a qualified charitable
distribution to minimize theimpact of Roth conversions.
Talked about that in recentepisodes of ways to lower your
required minimum distribution orcertain tax planning
opportunities.
So the qualified charitabledistribution you just give funds
directly to the charity fromyour IRA so you never have to
(19:24):
have that money touch your bankaccount and become taxable to
you.
So this is just one littleexample of that, that lens that
you want to look through.
Is there any good reason not todo a Roth conversion?
They're gonna cost you money.
So let's not do a Rothconversion unnecessarily.
If there are other things thatwe can look to do that will help
to minimize the impact of Anypotential required distribution
(19:46):
or the tax impact on thesurviving spouse if one
predecessors the other.
But, going back to this,everyone should consider it in
my opinion.
But the magnitude of potentialsavings from a good Roth
conversion and really just agood overall tax planning
strategy Really starts toincrease the more your portfolio
balance increases over time.
So, no, there's not an actualnumber of, is it 250,000 verse
(20:10):
500,000 versus a million dollarsin your portfolio.
It's not a specific number, butthat does tend to correlate.
That portfolio balance numberdoes tend to correlate the
higher it goes, the higher yourpotential tax savings goes.
So, danny, thank you for thatquestion.
I think this is a good thing toexplore for a lot of people,
regardless of the portfoliobalance.
I appreciate all of you tuningin.
(20:31):
Please, again is reminded,leave a review for the show if
you have not done so already.
Also be sure to check us out onYouTube.
The channel name is James Kanol.
You can find this episode andother videos all around
retirement planning there.
Thanks for listening and I'llsee you next time.
Thank you for listening toanother episode of the ready for
(20:51):
retirement podcast.
If you want to see how rootfinancial can help you implement
the techniques I discussed thispodcast, then go to root
financial partners calm clicks.
Start here, where you canschedule a call the one of our
advisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember nothing wediscuss in this podcast is
(21:12):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
One of the most talked about retirement planning
points is Roth conversions, andfor good reasons, because in
some case, a good Rothconversion strategy can save you
hundreds of thousands ofdollars or even more.
But at what point do theybecome worthwhile?
Is there a portfolio value oneneeds to have before
implementing this type ofstrategy?
And, alternatively, is there aportfolio value at which you
(00:20):
don't need to worry about this?
That, and more, is what we'regoing to discuss on today's
episode of Ready for Retirement.
This is another episode ofReady for Retirement.
I'm your host, james Kanol, andI'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode is based upon alistener question, and this
(00:42):
question comes from Danny.
Danny asks the following.
He says I really appreciate allthe great information in your
podcast and especially that youtake feelings into account when
giving options.
One thing that I have noticed isthat you most often give advice
to portfolios of between $1 and$2 million.
That makes sense becausethere's a greater tax impact for
those people.
I am retiring in March and Iwill receive $65,000 per year
(01:02):
from Social Security andAppention.
I have two 401ks with acombined value of $400,000, and
our mortgage is paid off, so Ishouldn't need to tap into them
for a few years.
I am wondering how some of theusual advice regarding Roth
conversions versus the impact ofRMDs, required minimum
distributions and survivingspouse issues apply with a
smaller portfolio.
Thanks again for all theinformation you provide, danny.
(01:24):
Well, danny, thank you for thatquestion.
I appreciate it and you areright, I think.
Typically, at least, when we'retalking about tax planning
points, I am talking aboutportfolios that are maybe $1, $2
, $3 million or more, notbecause tax planning is unique
to that, but because there ismore tax planning opportunity
the larger your portfolio is.
But, danny, you bring up areally good point.
(01:47):
Is there a point, or is there athreshold, at which I need to
start being concerned about someof these issues?
Here's my portfolio today, myother income sources.
So what I'm going to do ontoday's episode is use Danny's
situation, I'm going to makesome assumptions about it, and
I'm going to use this to show isthere any potential benefit to
tax planning at the currentportfolio value and how might
(02:08):
that change at differentportfolio values in the future
or in other cases.
Before I do so, though, I wantto highlight the review of the
week as saying thank you to allof you who are leaving reviews.
This review comes from usernamejauntijoe from Jersey.
I like that jauntijoe fromJersey leaves a five star review
and says I have tried literallydozens of retirement podcasts
and this was by far the best.
(02:29):
The information is succinct,relevant and financially sound,
and he makes it so everyone canunderstand.
You don't need to be a CPA tofollow the podcast.
Thank you so much, james.
Well, thank you, jauntijoe, forthat review.
Really appreciate that, and ifyou have enjoyed this podcast or
received any value from it,would really appreciate you
taking a few moments and leavinga review so more people can
find the show and get theinformation they are looking for
(02:51):
.
So with that, let's jump rightinto the episode.
So, danny, a couple things.
One again.
Thank you for the question.
I'm going to start with what Idon't know about your situation
and, by the way and this goesfor every episode none of this
should ever be construed asadvice or recommendation.
This is really just foreducational purposes only, but
providing some context within aspecific person's situation.
(03:14):
So here's what I don't knowabout Danny's situation, before
we start diving into what we doknow.
I don't know what Danny'sdesired living expenses are.
That's going to be a big partof tax planning.
I don't know what amount he'sreceiving from pension and what
amount he's receiving fromSocial Security.
I know that he's receiving$65,000 combined but I don't
(03:34):
know what's pension and whatSocial Security.
That's important becausethey're taxed differently,
social Security versus pension.
It's also important becauseSocial Security has a cost of
living adjustment.
The pension may or may not.
If it's a government pension,it most likely does have a cost
of living adjustment.
If it's a private sectorpension, it most likely doesn't.
Also, social Security hassurvivorship options.
(03:57):
So if Danny predestines hisspouse or vice versa, the
surviving spouse can collect thehigher of the two current
benefits With the pension,though I don't know what the
survivorship options are, if any.
The pension could go awaycompletely if Danny passes away,
or it could be a joint lifepension.
So again, we know $65,000 iscoming in, but I don't know what
(04:19):
should.
That is Social Security andwhich of that is pension.
And these may seem likeunimportant differences when
we're looking at tax strategy.
It might be tempting to look atthen say, yeah, that's all
important information for maybea comprehensive plan or an
income plan, but we just want toknow about the tax stuff.
Well, all of these things feedinto one another.
So these details, yes, haveincome implications, investment
(04:40):
implications, long termretirement implications, but
they also have tax implications.
So those would be importantthings to know.
I'm assuming that Danny ismarried.
He didn't come out and say it,but he referred to our mortgage
and he referenced what are theissues for survival, driving
spouse with this.
So I'm going to make theassumption that Danny is married
.
I don't know his age.
So I know he's eligible forSocial Security, but I don't
(05:02):
know his exact age.
I don't know if charitablegiving is something that he does
.
Again, may seem irrelevant, butwhen we're looking at things
like Roth conversions, it verymuch is relevant, and I'll show
you why in just a bit.
And I don't know what statehe's in.
So, again, when we're lookingat Roth conversions, it's a tax
plan, but there's the federaltax issues and then there's a
state tax issues and every stateis different.
(05:24):
So these are just some piecesof information.
I don't know, and I justhighlight this because, as we go
through this, I do not want togive the impression that this is
advice or that this is going tobe universal information,
because any number of thosethings I just listed could
potentially change this.
So with that context, here'sthe assumptions I'm going to
make, just so we can kind ofhave clean, tidy numbers to work
(05:46):
with.
Of the $65,000 per year that'scoming in, I'm going to assume
that $48,000 per year of that iscombined social security.
So I'm going to say $2,000 forDanny and $2,000 for a spouse I
don't know if maybe a spouse'ssocial security was on top of
the $65,000, but I'm just goingto make the assumption that it's
included.
So I'm assuming $2,000 permonth for each of them for
(06:09):
social security, which is$48,000 per year, and I'm going
to assume that Danny's pensionis $17,000 per year.
So combined that comes out to$65,000, and then he has
$400,000 combined in 401K plans.
The question should he do Rothconversions?
He said, james, I know you talkabout this, you talk about this
(06:29):
quite a bit, but typically theportfolios are maybe a million
dollars or $2 million.
I see the case for Rothconversions.
There there's more taximplications.
But with my situation here's mypension, here's social security
, here's 401K would that beworthwhile for me?
So let's explore that.
The first thing that we want toknow if we're going to do a
Roth conversion, we want toideally know that the tax
(06:51):
bracket we're going to pay todayfor any potential conversion is
lower than the tax bracket we'dbe in in the future.
So pretty self-explanatory Ifyou're going to be in a higher
tax bracket today, let's not doa Roth conversion and add to our
tax bill.
Let's only do it if we can doso and pay less in taxes today
than we otherwise would in thefuture.
Now I'm going to make anotherassumption that there's no other
(07:14):
income, no interest income, nodividend income.
No, any other income outside ofDanny's pension and social
security.
Yes, he has a 401K and if youwere to pull money out of the
401K, that would be taxableincome.
But he referenced in hisquestion that he's not going to
need to tap into that for sometime.
So here's why that matters.
If there is zero other incomeand if we assume a $17,000 per
(07:37):
year pension, it's fully taxable$48,000 of combined social
security and I'm assuming astandard deduction of $30,700.
If Danny and his spouse wereboth 65 or older, they would
actually get an extra standarddeduction above and beyond that.
But even with just these numbersand this is important Danny is
(07:57):
in the 0% tax bracket once heretires.
Again, this is just looking atfederal taxes, because I don't
know what state he's in, but youmight be asking how on earth
could he be in the 0% taxbracket?
He's got $65,000 of income.
Even once you back out thestandard deduction, there's
still some taxable income left.
Well, here's why that's thecase.
I'm assuming the $17,000 ofpension income is fully taxable,
(08:19):
which it almost certainly is,unless it's some type of a
military or VA pension andthere's a VA disability of some
sort probably fully taxablepension.
But here's the thing with socialsecurity.
With social security, there'ssomething called provisional
income.
When you want to know how muchof your social security is
included in your taxable income,you need to understand your
provisional income.
I've talked about this on otherpodcasts.
(08:41):
I'm not going to go too into ittoday, other than to say that
his provisional income is suchthat only 4,500 per year of
their combined social securitybenefit would actually be
included in their total income.
Yes, they have $48,000 ofsocial security benefits, but
the taxable part is only 4,500.
(09:03):
You add that 4,500, the $17,000of pension income, their
adjusted gross income is 21,500.
Now, as a married couple, theirstandard deduction is $30,700.
It's even higher if they're 65or older.
What do you get there?
Well, if you have an adjustedgross income of 21,500 but
(09:25):
deductions of 30,700, yourtaxable income is zero.
In Danny's case and again I wantto be very clear I'm assuming
zero interest income, zerooutside income.
I'm making the assumption thatthe $65,000 that Danny gave me
is including a spouse's socialsecurity and that that's not
additional.
I'm taking some liberties herebecause they're not explicitly
(09:45):
provided in the question, butwhat we can see here is look,
danny, you're in the 0% taxbracket.
You could convert for free acertain part of your 401k into a
Roth IRA, at least at thefederal level, before we even
look at state taxes.
Now, I don't care what taxbracket you're going to be in
the future.
If you can convert funds at a0% rate today.
(10:06):
It makes sense to convert fundsat a 0% rate today.
One thing you have to be mindfulof, though, when we go back to
this tax analysis that we did,where we said look, of the
$48,000 in social securitybenefits, a very small amount
$4,500 of it, to be precise isactually included as taxable
income.
Well, as you're looking atconversions, you have to look at
(10:27):
a couple things.
Number one.
Every dollar that you convertincreases your adjusted gross
income by $1, but it also bringsin another portion of your
social security benefit intoyour taxable income.
This is what's called the taxtorpedo.
The social security tax torpedois not only does the extra
conversion amount increase youradjusted gross income by itself,
but it's also pulling with itmore and more of your social
(10:50):
security benefit that nowbecomes taxable.
So still absolutely makes senseto do in a lot of cases, but
something that most people missand something that's important
to be mindful of.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment tax,
(11:10):
legal or other financial advice.
It is for informationalpurposes only.
Another thing that you want tomake sure that you're noting at
least for people who are insituations here like Danny,
where a big part of their socialsecurity benefit maybe isn't
taxed today is that when we'relooking at that that provisional
income, as I mentioned andprovisional income is what
determines how much of yoursocial security benefit is
(11:32):
included in your taxable incomethe income bans or the income
thresholds for provisionalincome are not indexed for
inflation.
Practically speaking, what thatmeans is every year, all else
being equal, more and more ofyour social security is now
included in your taxable income.
Why does that matter?
Well, if you're in a situationlike Danny at least under the
(11:54):
assumptions that I'm making hereyour tax bill is probably going
to be going up over timebecause more and more of your
social security benefit is goingto be added to your taxable
income, which is going to pushyou out of the 0% tax bracket at
some point.
Now you could still be in avery low tax bracket, at least
relatively speaking, but that'ssomething to be mindful of.
Of that benefit, of not havingyour full social security
(12:17):
benefit taxed, isn't going tolast forever.
And this goes back to what Iwas saying before.
Should you do a Roth conversion?
Well, it does have to do withhow much you have in your IRA
balance or 401k balance, whichI'll get to in a second.
But the biggest thing is what'syour tax bracket today, or at
least in the year that you'reconsidering a conversion, versus
what's your tax bracket in thefuture?
Well, what's Danny's taxbracket going to be in the
(12:39):
future?
Well, things could change inthe tax world.
But let's just look at what wedo know.
I'm going to assume that he's65 years old today and I'm going
to assume, with that being thecase, that his required
distribution starts at age 73.
Well, we know that right nowDanny has $400,000 in retirement
accounts and we know that rightnow he doesn't really need to
touch them to meet his livingexpenses.
Social security and pensionwill do that.
(13:01):
Well, if we assume that that$400,000 grows at, say, an
average return of 6% over thenext handful of years until
required distribution start,then his $400,000 will turn to
$640,000 by the time that he's73.
His required minimumdistribution on a portfolio of
$640,000 would start rightaround $25,000 per year.
(13:23):
What does that mean?
What means in the future, atage 73,?
Now his taxable income isn'tjust pension plus social
security, it's now pension plussocial security plus required
distribution of, call it,$25,000 per year.
Now, that's not going to bumphim into a huge tax bracket, but
what it will do is most likelyput him in a higher tax bracket
(13:44):
than he's in today.
So, danny, to go back to eventhe premise of your question of
hey, I know Roth conversionswork for the million dollar
portfolios plus.
What about for mine, well, it'sless a portfolio size, although
portfolio size absolutely playsa role in this.
But what I would look at is areyou in a higher tax bracket in
the future when you do havethose required distributions, or
(14:05):
today?
It's likely, with theassumptions I'm making I'm not
going to say these assumptionsare all accurate, because I'm
just making assumptions.
As I mentioned, I'm making someof these up it would make some
sense to at least consider doingRoth conversions.
To what extent depends upon awhole bunch of different things.
I'd want to have a lot moreinformation, but I would very
much still consider this insomeone's situation like Danny
(14:26):
is describing.
Let's now take this one stepfurther Danny alluded to in his
question.
He said well, what about theimpact of, say, one spouse
predestined the other?
How do Roth conversions playinto that type of a decision
making process?
Well, let's examine that.
Let's assume that of the 48,000that I'm assuming they have
coming in from Social Security,so 2000 per month each or 24,000
(14:48):
per year each.
Let's just assume that one ofthem passes away and after that
the Social Security benefitdrops to $24,000 per year.
So it goes from 48 to 24.
And let's assume that thepension has a survivorship
option so that pension stays atexactly $17,000 per year.
Well before, when they weremarried, because of a combined
(15:10):
standard deduction, they were inthe 0% federal tax bracket and
there's really not technically,a 0% federal tax bracket.
Being in the 0% bracket, theway I'm saying it, is just the
understanding that whateverincome they have is completely
offset by their deduction.
So technically they're in a 0%bracket even though that bracket
doesn't exist.
(15:30):
So when we're looking at this,daniel will go from a 0% tax
bracket today if married to, ifone of them passes away and
social security drops to $24,000per year and pension stays at
$17,000 per year.
Now the surviving spouse is atthe top of the 10% bracket and
very soon to cross over into the12% federal tax bracket.
All that because now there'sfewer deductions.
(15:53):
They can't take the samestandard deduction.
That gets cut in half.
Also, provisional income,slightly different brackets
around that.
So when you're looking at this,that is something that you very
much need to keep in mind Notjust what tax bracket am I in
today versus what tax bracket amI in in the future, but what
would be the tax hit and theimpact to the surviving spouse
(16:13):
if one of us pre-deceased theother.
What you can see is, right away, it would push the surviving
spouse and Danny situation intoa higher bracket.
So relatively low tax bracket,all things considered, still in
the 10% to 12% rate.
But if you're doing Rothconversions with the goal of
protecting a surviving spouseand you're in a 0% tax bracket
(16:34):
today, absolutely take advantageof the 0% rates.
But also consider how high dowe want to go under the 12%
bracket or 10% bracket orwhatever the case might be for
your specific situation.
So here's the bottom line forDanny Danny, in your situation,
you probably won't ever being asignificantly higher tax bracket
.
It's not as if you're going togo from the 0% bracket into the
(16:55):
35% bracket because of RMDs oranything like that.
This is barring anythingexceptional huge inheritance,
huge windfall, huge something orother.
So in your situation, there'snot going to be a huge impact to
tax brackets.
But, that being said, the righttax strategy could still save
thousands or even tens ofthousands of dollars in taxes
(17:17):
over the course of your lifetime.
Now, that is pretty significant, regardless of your portfolio
balance.
So the general principle that Iadd on top of this is yes, the
higher your IRA balance, themore impactful the right tax
strategy becomes and we can seethat real.
Simply, we talked about Danny'sRMD maybe being around $25,000
(17:37):
by the time he turned 73, underthe assumptions that I made.
Well, if, instead of having$400,000 in his portfolio, he
had $4 million in his retirementportfolio Now, specifically,
I'm seeing retirement portfolio,so IRA, 401k, things that are
subject to requireddistributions Well now, instead
of his RMD starting at $25,000per year, it would start at
(17:58):
$250,000 per year and increasing.
So you can see the dramaticimpact that would have on both
his income and his tax bracketin the future if we use a
significantly larger portfolio.
So in those cases, the largeryour portfolio balance is, the
likelihood is that you're goingto have a more of potential tax
savings through having a goodtax strategy in place.
(18:21):
But I wouldn't say there's apoint at which you should never
consider Roth conversions.
You should always consider it.
It doesn't hurt to run thenumbers.
It doesn't hurt to have ananalysis to see can it save you
money, but keep this in mind.
This is what I'm always lookingat when I'm looking at tax
returns and tax plan for clients.
Is there a good reason not to doit?
It's always the lens I'mlooking through, because Roth
(18:43):
conversions cost you money.
You're having to pay taxestoday that you otherwise
wouldn't have paid for severalyears.
In many cases that's notnecessarily pleasant, but it can
save you a lot of money in theright circumstances.
You know, for example, a reasonthat you might not do it.
I mentioned before some things Idon't know about Danny in his
situation is was charitablegiving part of something that he
(19:04):
does?
If it is well, then maybe youjust use a qualified charitable
distribution to minimize theimpact of Roth conversions.
Talked about that in recentepisodes of ways to lower your
required minimum distribution orcertain tax planning
opportunities.
So the qualified charitabledistribution you just give funds
directly to the charity fromyour IRA so you never have to
(19:24):
have that money touch your bankaccount and become taxable to
you.
So this is just one littleexample of that, that lens that
you want to look through.
Is there any good reason not todo a Roth conversion?
They're gonna cost you money.
So let's not do a Rothconversion unnecessarily.
If there are other things thatwe can look to do that will help
to minimize the impact of Anypotential required distribution
(19:46):
or the tax impact on thesurviving spouse if one
predecessors the other.
But, going back to this,everyone should consider it in
my opinion.
But the magnitude of potentialsavings from a good Roth
conversion and really just agood overall tax planning
strategy Really starts toincrease the more your portfolio
balance increases over time.
So, no, there's not an actualnumber of, is it 250,000 verse
(20:10):
500,000 versus a million dollarsin your portfolio.
It's not a specific number, butthat does tend to correlate.
That portfolio balance numberdoes tend to correlate the
higher it goes, the higher yourpotential tax savings goes.
So, danny, thank you for thatquestion.
I think this is a good thing toexplore for a lot of people,
regardless of the portfoliobalance.
I appreciate all of you tuningin.
(20:31):
Please, again is reminded,leave a review for the show if
you have not done so already.
Also be sure to check us out onYouTube.
The channel name is James Kanol.
You can find this episode andother videos all around
retirement planning there.
Thanks for listening and I'llsee you next time.
Thank you for listening toanother episode of the ready for
(20:51):
retirement podcast.
If you want to see how rootfinancial can help you implement
the techniques I discussed thispodcast, then go to root
financial partners calm clicks.
Start here, where you canschedule a call the one of our
advisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember nothing wediscuss in this podcast is
(21:12):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
Popular Podcasts
Dateline NBC
Current and classic episodes, featuring compelling true-crime mysteries, powerful documentaries and in-depth investigations. Follow now to get the latest episodes of Dateline NBC completely free, or subscribe to Dateline Premium for ad-free listening and exclusive bonus content: DatelinePremium.com
24/7 News: The Latest
The latest news in 4 minutes updated every hour, every day.
Therapy Gecko
An unlicensed lizard psychologist travels the universe talking to strangers about absolutely nothing. TO CALL THE GECKO: follow me on https://www.twitch.tv/lyleforever to get a notification for when I am taking calls. I am usually live Mondays, Wednesdays, and Fridays but lately a lot of other times too. I am a gecko.