Episode 54: Tax Planning Strategies, Part 1: Roth Conversions

Here are just a handful of the things that you’ll learn:

Have you ever heard of the tax torpedo? Or how about the ticking tax time bomb? Maybe you’ve heard it called the tax freight train?! All these terms sound pretty scary. So, what can you do about them?


In this multi-part series, we discuss some popular, and not so popular, tax planning strategies that may help you mitigate potential tax increases that most experts agree are heading our way!


Disclaimer: Please do not take advice from me on this show. As a licensed Fiduciary I am only allowed to give advice to clients. So, unless you’re a client I can’t give you advice because I don’t know you. So, think of these as helpful hints and education only. And please before implementing any information or ideas you hear on this show always consult your legal adviser, your tax adviser, and your financial adviser………….right? that’s just common sense.


(1:30) Practical planning segment: Rather than get into all the reasons why we think taxes are going to go up in the future let’s just assume that they will be right? It’s hard to see them actually going any lower. And we already know the tax cuts from the 2017 Tax Cuts & Jobs Act expire in 2026.


Even if the current administration does nothing to raise taxes. They will be going up in 2026 as part of the TCJA of 2017. I want to focus this show on some popular and not-so-popular tax planning strategies. And I think the first one we should tackle is the ever so popular, for good reason, Roth conversions.


In later shows we’ll talk about some other less popular techniques like QCD’s & DAF’s and get into some bunching strategies. However, today let’s talk about Roth conversions.


(4:15) What is a Roth conversion? in its simplest form a Roth conversion is moving money from a traditional pretax IRA account into a Roth (potentially tax-free) IRA account. I’ll get to why I said potentially tax-free in a minute!


Sounds simple, doesn’t it?  And for all practical purposes, it is very easy. Many custodians (that hold your accounts) can simply do this with a stroke of a key.


But why? Why would you want to do a Roth conversion? There are many reasons that you may consider completing a Roth conversion, but the number one reason is you think tax rates are going to be higher in the future. You would rather pay taxes now at a lower rate now than in the future ……….at a potentially higher rate.


This of course, not only has tax implications for you but also potentially for your heirs that will be inheriting your IRA or Roth IRA accounts! And by the way that’s another reason folks consider doing Roth conversions while they are alive!


Rather than having their non-spouse heirs, such as their children, inherit their IRA (and as of 2020 under the new Secure Act (non-spouse and non-eligible designated beneficiaries) they can no longer stretch out those distributions on their life expectancy) they now have to empty the account within 10 years…………accelerating the distributions and paying more taxes!


When do the 10 years start?  The 10-year clock starts the year after the year of death.


If most or all of it was already in the Roth account, it would still have to be taken out over 10 years by the non-spouse (non-eligible) beneficiary……………. however, it would all be tax-free! And the smart ones would leave it there for 10 years and continue to get tax-free growth compounded over that time! WOW!!!


(16:02) how do you go about completing a Roth conversion?  We will get into the pros and cons of should you complete a Roth conversion in a second.  But if this is a strategy that you want to employ then the first step is to make sure you have a traditional IRA with $$$ in it to convert and you have already opened a Roth IRA account READY to receive those funds.


(As a side note, there are traditional IRAs that have both pre-tax and post-tax monies in them. That is for an entirely different discussion and tax planning opportunity)


If you already have both accounts open it would also probably help if they are at the same custodian for example a TD Ameritrade or a Charles Schwab or a Fidelity that is holding both accounts. It can be done if they are both not at the same custodian however, it adds complexity and time to the process.


I like to keep things simple! As I mentioned earlier it’s often as simple as hitting a keystroke and moving money from one account to the other.


You can also transfer the securities “in-kind” into the Roth account. This may save some transaction costs in placing trades and liquidating the securities to cash and then moving the cash directly to the Roth IRA.  But both essentially do the same thing!


(22:00) There are many proponents and many articles written about all the benefits of Roth conversions and many pundits that think everybody should consider Roth conversions!


The pros are simple: If you think your tax rates in retirement are going to be even 1% higher than your current tax rate now, then a Roth may make sense.

Many folks say but wait a second Jeff, I’m in a much higher tax bracket while I’m working and when I stop working, I’m going to be in a much lower tax bracket!


Well, how do you know you are going to be in a lower tax bracket in retirement? If you have 10 or 15 years before you are ready to retire, we have no idea what tax brackets could be and what they could look like.


Also, keep in mind if your traditional IRA is rather large and this includes 401(k)s and other pre-tax accounts and you have 10 or 15 years prior to retirement, you are most likely still adding to those accounts through pre-tax contributions and getting market growth within your investments in those accounts. At age 72 under current law, you must start withdrawing money out of those accounts.


Some of these accounts could be extremely large, and right at the time when you are forced to take the money out through required minimum distributions.


Think about potential tax rates and all the other income you may be receiving such as Social Security, pension, possible rental income at age 72 … at the same time you must take large distributions that will be all taxable and added on top of your existing income at potentially exorbitant future tax rates!


Those withdrawals are considered INCOME! They go right to your AGI!


(24:35) Other Stealth taxes are linked to your AGI and many opportunities for tax deductions are also linked to your AGI:


  • IRMAA is a surcharge on your Medicare Part B and part D payments. If those RMD’s are large enough your Medicare payments will increase substantially. In the top bracket, the surcharge is over 300% per person.


  • Of course, whether or not your Social Security is taxed is based on MAGI.


  • Deductions tied to your AGI may be limited if your AGI is higher because of all those RMDs; Medical Exp have a floor of 7.5% of AGI……if Your AGI was lower in retirement you have more availability for deductions


  • The Widows penalty- When one spouse dies the following year, the widow moves to the Single Filer tax bracket. Guess what? Those brackets are much lower and Large RMD’s in those later years leads to way more taxes! A Roth solves all those issues.


(28:00) A lot of time we talk about the good, the bad, and the ugly when it comes to Roth conversions. We already covered the good,  so let’s cover the bad…


The Bad: Well, any money converted and transferred from your traditional pretax IRA into your Roth IRA will be taxed in the year of conversion.  Most people don’t like that! They don’t like paying any more taxes than they have to pay. And that’s a really hard decision to do a conversion and decide to pay more taxes! We are so trained in our society to think “Micro” in terms of taxes, rather than “Macro”.  Even most accountants try to focus on how you can save taxes this year, thinking small and micro. Versus how you can save taxes over a lifetime and potentially for your heirs as well!


The Ugly: Well, you cannot undo them any longer. Once it’s done! It’s done.  This used to be called -recharacterization. Kind of like a re-do.  But no longer allowed


Could trigger taxes on other sources of income such as Social Security. The simple act of converting creates taxable income. It increases your AGI!  That taxable income added to other income +1/2 of your Social Security will determine whether your Social Security is taxable.


Another one to look out for is your IRMAA! If you were already on Medicare or even a couple of years prior to Medicare age and you do a large Roth conversion, it could increase your part B Medicare premium and part D prescription drug plan. This is called IRMAA which is Income Related Monthly Adjustment Amount (IRMAA). IRMAA is an extra charge added to your premium and the IRS looks back two years to determine whether you are subject to this extra charge.


(30:00) Coachable Segment: 6 Other Benefits of Roth Conversions


  1. No lifetime required minimum distributions.
  2. Spousal rollovers can add tax-free accumulation, they continue to be exempt from lifetime requirement distributions.
    1. Surviving spouses are exempt from the 10-year rule
  3. Surviving spouse received tax-free retirement income! This is HUGE- Widows Penalty does not apply to a Roth. Why? IT’S ALL TAX-FREE
  4. The elimination of the trust tax problem
    1. Applies to discretionary trust under the 10-year rule
    2. Inherited funds are protected in the trust even after 10 years, even though inherited Roth funds still must be paid out to the trust after 10 years
  5. Elimination of accelerated income tax to beneficiaries after 10 years
    1. If funds were left in a traditional IRA, they must all be withdrawn in 10 years which accelerate income tax and causes other income to be taxed at higher rates
  6. For larger US states that are subject to federal and state estate tax, it can lower the taxable estate.
    1. The reason for this is the taxes paid on the conversion reduces estate and eventually income tax paid by the beneficiary


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