How Much Should You Convert To A Roth IRA?

hey everyone bill lethemon here for money evolution in today's video i'm going to be discussing how much you should convert from a traditional ira to a roth ira or quite honestly whether or not you should actually be doing a roth conversion at all so if you've been on the channel and you've heard me talk about this topic before you may have heard me talk about the number one thing that matters when trying to figure out whether you should do a roth conversion or how much you should convert and that is what is your tax bracket today versus what is your tax rate going to be in the future and maybe contrary to what a lot of people have been brought up to believe here with regard to their traditional retirement accounts is that they put this money away they took a nice tax deduction as the money went into those accounts and then they thought hey i'll be in a lower tax rate in retirement than i was while i was working and the reality that we're seeing for many of our clients is that as we start looking at these forecasted required minimum distributions and the large balances that are starting to build up for many people inside these ira accounts we find that it's very common to see somebody in a higher tax rate in retirement than they were even while they were working so this is what we're going to talk about today and a couple of the key considerations that you need to keep in mind to try to figure this out now with that said one of the things that we do here with our clients is we do comprehensive financial planning so where we're going to get into a lot of detail here today really the best way to do this is through a comprehensive financial plan that includes a complete cash flow and also a tax analysis so we can see based on a number of different inputs that we're going to be talking about in this video how that all kind of lays out over the next 5 10 15 even 20 or 30 years so you can see uh what those future tax rates may actually be based on a number of these assumptions so if anyway if you want to learn a little bit more about the financial planning that we do you can head over to wealthvisionplan.com there's some information about our financial plan that we do for clients and if you like what you see there i think there's a get started now button answer a few questions and you can set up a free consultation with me see if it's something that might be right for you so let's dive into the video here today okay so let's jump in and let's talk about a couple of these key considerations that you need to think about and remember what we're talking about here is trying to figure out whether or not you might be in a higher tax bracket in retirement or a lower tax bracket and again what we're going to get to at the very end of this video is trying to determine a little bit about how much money you should be thinking about converting on an annual basis and remember too and you don't have to necessarily wait until retirement because i think that's something that a lot of people mistakenly think is that they're still working maybe they're still thinking they're in a relatively high tax bracket and maybe they're pushing it off saying hey i'm going to do some roth conversions but i'm going to wait until i retire to do that so hopefully some of the information that i give you in the video here today well maybe help to debunk that a little bit or at least have you thinking about whether or not a roth conversion makes sense even if you're still working and still making what you think is a relatively high level of income so the first thing you want to think about is how much do you actually have in those traditional retirement accounts right now today and just to make this relatively simple here let's say you're 62 years old and let's say you have a million dollars in traditional retirement accounts and again one of the things to think about is whether or not you're still working so if you're still working are you still contributing to that account is it still continuing to build up just from your own contributions in there and that may be a factor that we definitely need to consider but uh the first thing we want to do is we want to start thinking about what's likely going to happen down the road and so if we're not touching this 401k plan or ira whatever it may be traditional and we get to the age of 72 what happens at 72 are the required minimum distributions um that's something that's recently changed used to be at age 70 and a half you had to start taking those mandatory distributions but now it's age 72 and so if you're earning uh let's say a seven percent rate of return just to make our math super easy we use that rule of 72 all the time so if we divide seven percent into the number 72 it tells us we're going to double our money in about 10 years and so by the time we get to age 72 we could have about 2 million dollars in that account and rough numbers again there's going to be a table that you're going to use to determine what that required minimum distribution is going to be first year distribution it's a little bit less than this number but we said you know usually like to use about four percent so that means that you might have about eighty thousand dollars of income that you're going to have to take out of that traditional retirement account and again these numbers you know they might be much larger for you they might be a little bit smaller but these are the things that uh you want to be thinking about so what we really want to think about is not only just what that account is going to grow to and that's why having some software that's specialized in this really helps to make this flow a lot easier because one of the things that goes into this is your cash flow and what what i mean by that is you may not necessarily leave that ira account in there you may have to take some money out for just the everyday living expenses if you're planning to retire sometime between 62 and 72. so you want to understand what that uh what that anticipated cash flow need might be the other thing you want to think about is is the ira account your only source of money so you may have as we talk about it money in each of the three tax buckets and so one of those buckets that we see a lot of people that have some money in is the non-retirement bucket so that's outside of roth ira or traditional ira and what happens a lot of times is generally people don't like to pay taxes and they know if they take money from their ira account that they're going to have to pay taxes on that so if somebody's built up a big chunk of money let's say they have uh going with our example here let's say they have 500 000 in this non-retirement account they know that they can maybe access that especially if it's in cash or even if it's invested in something that they may have to sell they may be in a lower tax bracket because they may be paying zero taxes if they're just taking it simply out of a money market account or they might be having long-term capital gains uh or dividend income that they can use to supplement that uh that income so you want to understand what the cash flow is and what your anticipated needs are with this and and again what that's going to do is it's going to give you some idea of what that ira account is going to build up on now along with that you're going to also want to make sure that you're including other forms of income like like pensions of course social security would be another one and remember 85 percent or up to 85 percent of your social security benefit could be subject to tax you may have other sources of income you may have income coming from an annuity if that's something that's paying out on a regular basis so annuity income you may have you know real estate if you're renting property out or maybe even some deferred compensation let's say that you had from your employer and maybe for at least a few first few years or maybe up to 10 years of your retirement you're getting some of that deferred compensation so you want to understand uh as you're going through this uh what your year to year tax rate is and you're going to do that by trying to figure out what your taxable income is in each of these years going forward and what we're going to do is then we're going to start looking at you know where that income falls within the different tax bracket and again that's what we're going to be using to make this determination you know what is your tax rate today versus what is that tax rate in the future so once you've run through a couple of those calculations you kind of get an idea of where your taxable income may be this year and kind of out into the future what we want to do is we're going to take a look at where that income falls within the irs federal tax brackets and again kind of to refresh here what we have going on right now for 2021 is we have still the tax cuts and jobs act they went into effect in 2018 they're set to expire at the end of 2025 so in 2026 we're going to revert back to the old tax rolls prior to the tax cuts and jobs act so we'll have to see what happens and there's always the possibility that tax rates may even change before that they may be left low and made more permanent or they may change and they may go up and of course that's one of the fears that a lot of people have is that tax rates are going to just continue to go up in fact that's one of the things we talk about a lot is we feel that tax rates are more likely to go up than they are to go down so these are some of the things we want to think about as we're looking at this and so if we're looking at the tax table here and make that a little bit bigger you know we can kind of see you know let's say our income is 250 000 so what we need to do is we need to find for married couples filing a joint tax return uh where that is and so if our income is um you know over 172 000 and we say we have 250 000 of taxable income we know that we're in the 24 tax bracket and as of 2021 the tax rates we can go as high as 329 850 and still be in that same 24 tax bracket so again as we're starting to map this out and we see okay 24 tax rate what is that rate likely going to be in the future is my income going to be pretty consistent do i expect that i'm going to continue to have 250 000 of taxable income uh is my future required minimum distributions going to possibly push me up into a higher tax bracket if i'm not being a little bit more aggressive with some of those distributions and one of the things we can do and we continue to come back to kind of these old tax rates this is the 2017 federal tax table and i put this up here because this is the way the tax worked before the tax cuts and jobs act went into effect so if nothing else happens and congress does nothing we're going to revert back to this tax table now of course it will be adjusted a little bit for inflation so the numbers we see here will be a little bit higher uh if they do in fact come into effect in 2026 but we can see right here that 250 000 of income actually for a married filing a joint tax return actually put us in the 33 tax bracket so again uh what is our number one thing that we're trying to figure out as we're looking at roth conversions is our tax bracket going to be higher in the future if it is then we may want to pay some taxes right now so in this case right here to kind of answer the question how much money should we convert well a simple thing would be to convert i guess about 88 000 or so which is the difference between the 250 000 of taxable income that we have right now and the upper end of the uh tax bracket there uh 329 850 which is the top end of the 24 tax bracket okay so probably one of the easiest answers to this initial question that i brought up at the very beginning of the video how much money should you convert to a roth ira is to simply look at where you are in your current income tax bracket and then think about doing a roth conversion that brings you up to the top of that bracket so in this example that we've been using here if you've got 250 000 of taxable income uh you can contribute or convert i should say about 80 000 from a traditional ira to a roth ira and it's still going to keep you pretty much in that 24 tax bracket and again what we need to be thinking about make sure we've uh properly calculated is is that 24 tax bracket a lower bracket than what we feel it's going to be in the future so another consideration that you need to think about before doing a roth conversion are your state income taxes so what we've been talking about so far is federal income taxes but especially if you're thinking about moving you need to think about what are your state income taxes today in the state that you currently live in and what are those state income taxes where you might be moving to most of our clients i would say probably move from a higher tax state to a lower tax state or even to a zero tax state i think is another very popular move it's something i personally plan to do when i retire but anyway if you're even in michigan here where we have a four and a quarter percent state tax or even if you live in california where it's 12 plus uh moving to a zero percent tax is something you need to think about because again when we're talking about doing a roth conversion we're trying to answer the question are you going to be in a higher tax or a lower tax rate in retirement than you were while you're working or when you made the conversion and so if you're going to a low tax state that's something that is going to obviously help to bring that overall taxation down so it's something you need to kind of think about as you're looking at making this type of decision now the last thing i want to talk about here is something that has come up here recently where i've talked to several clients that want to get super aggressive with their roth conversions and i've talked to one client in particular that wanted to be really aggressive this individual had an ira account that was totaling up in the multi-millions of dollars and was very concerned about taxes going up and so this individual felt that income taxes were you know going up much sooner than later and that they were going to start going up by a lot and it wouldn't be surprising if they did go up if they started hitting the kind of income tax brackets that this individual was in or the ira account balances that this individual had because if the irs is going to start taking on uh trying to figure out how they can get more taxation maybe multi-million dollar ira accounts is a pretty good spot to start you know as for as far as maybe gaining some additional tax revenue let's take a look at an example let's say that you have five million dollars in a traditional retirement account or it could be your 401k or a combination of all those accounts and let's say it totals five million dollars as we talked about in the first part of the video uh one of the things we want to think about is what is that account maybe going to potentially grow to uh over your lifetime and in particular what's it gonna grow to to that magic age of 72. so if we kind of use the similar example that we started with and we say if you're 62 right now if you don't take any money out of that account that account could be 10 million dollars if it in fact earned a seven percent rate of return that's the way the math works out and instead of having to take out eighty thousand dollars per year that you add to your ordinary income uh in this case four percent of that would be that you'd have to take a four hundred thousand dollar required minimum distribution and that's going to be on top of everything else that you may have going on you may have other income from other investments you may have pension you may have social security income and so that 400 000 right there if we look at where that falls within the tax bracket that's already getting you up into a much higher bracket especially when we look back at the 2017 tax rates once the tax cuts and jobs act rates expire at the end of 2025. so one of the things you may be thinking about doing and it's not completely an uncommon thought is to say okay if i know that's the path and that's where this is going i need to get this out of the traditional ira account i need to get it over to a roth ira and i need to do it as quickly as possible and so it wouldn't be uncommon for somebody to think hey i'm just going to convert that entire five million dollars over today from a traditional account to a roth account and in fact i'm sure many people have probably done this and they say okay i'm gonna take five million dollars i'm going to move it over to the rothside and then i never have to worry about paying taxes on that money ever again and in doing that of course you're going to have a very large tax bill as the tax rates are right now it's going to be that most of that 5 million is going to put you in a 37 tax bracket you may say okay well 37 percent is a better tax rate than the 2017 top tier tax rate uh which is 39.6 percent so you say okay bill what you've been saying is in fact that if i'm gonna be in a higher tax bracket uh when i go to pull this money out that i am today that i should convert the money and i should maybe convert that all very quickly so what we actually want to look at here is we want to talk about your effective tax rate and that's going to be something different than your marginal tax rate so we're absolutely true and correct to say that if we're looking at just the top line that our future tax rate on that money may be 39.6 versus 37 percent uh but in reality uh not all of our tax is going to be taxed at that highest marginal tax rate so if we're looking at for example for for 2021 we see that the top tax bracket is above 628 300 and anything above that number is going to be taxed at 37 percent which means that we have a whole bunch of income up to that 628 300 level that is actually taxed at a whole bunch of different rates some of that money is actually even taxed at you know the 10 and 12 tax rate uh but again anything over that so in this case right here if we're converting a million dollars and again this isn't taking into consideration uh necessarily what maybe your other sources of income are but just looking at the conversion um you know a little less than 400 000 of that would be taxed at that 37 tax rate whereas when we do a conversion that's larger even if we were to do a 2 million conversion or if we did like we talked about maybe to convert all 5 million of it then the majority of that money is going to be taxed at 37 so that's kind of what we need to think about and if we look at this and say okay we've got five more years of these lower tax rates we can then spread that out now hopefully there's going to be some growth on the accounts along the way and so those accounts don't necessarily have to be drawn down to zero by the end of the five years but even beyond that so even when we look at 2026 if in fact that's the year that we go back to those old tax rates you know where is your taxable income going to be so a lot of times people think okay we only have a limited window to do these roth conversions but in reality when we look at even maybe where somebody would fall in their income tax bracket in 2026 and beyond especially if 2026 is before they turn 72 when those required minimum distributions kick in so that is one of the the big kind of i don't want to say there's a deadline to that but that is one of the key ages that we get to so you know if you turn 20 26 and you're you're 68 years old you have four more years in those middle years where even though you may be back to those old tax table rates you still can do some more conversions in those years before you get to 72 and even 72 don't be afraid of that just because you hit 72 and you have some required minimum distributions you know look at what those required minimum distributions are going to do to your income over time and again you know this gets a lot you know very complicated uh as we're looking at this on you know pen and paper and doing hand calculations or even doing some spreadsheets and again that's why we use the software that we use so we have the ability you know to kind of map this out so we can see okay let's let's throw in an alternate scenario and let's see what a hundred thousand dollar per year roth conversion does and what is that doing to bring down those required minimum distributions or in some cases where we have much larger ira balances we're looking at doing you know three four five hundred thousand dollar roth conversions every year sometimes it is a million dollars per year depending on how much you have in there and so these are all the factors that we want to look at and what i'm an advocate of is trying to smooth out or balance your tax rates over time and i think there's some people out there that you know kind of talk about the same subject that i talk about that do advocate for you know kind of really front loading you know those uh those conversions you know in those first few years you know 2020 uh 2021 uh you know through 2025 and say okay that's our window but in reality you know taking some of those big conversions to get your ira or 401k balance down to zero within those you know five or six years uh maybe pushing you up into too high of a tax bracket you may be paying you know 32 or maybe you might even pay 37 tax and as we kind of map it out once all of your money is in roth ira and you can take penalty free or you know tax-free withdrawals from that roth ira we may find that you might be back to a 25 or 28 tax bracket you know even if we do go back to those old tax tables so again it takes a lot to kind of figure some of this stuff out but hopefully the video today gave you at least some of the big things that you want to think about and don't feel like some people do that you have to you know get all of these roth conversions done in a very short window of time for some people that is what we need to do but for a lot of us we're looking at you know kind of creating a balance over time so anyway i hope you enjoyed the video i hope you got some great information out of what we discussed here today remember if you want to learn a little bit more about the financial planning that we do head over to wealthvisionplan.com there's some really great information about the financial plan that we do and all of this stuff that we're talking about here is covered 100 within the financial plan that we do and we'll provide to you this roadmap for uh what your cash flow looks like how you're first of all going to be able to meet all of your retirement uh planning goals be able to have the cash flow needs to just do all the things you want to do in retirement but also see you know how that fits in with all of the other big decisions that you have for retirement like when to take social security and how to best optimize that and whether or not you should be doing roth conversions as we're talking about here so anyway that's wealthvisionplan.com if you like what you see there click on the little get started button uh answer a few questions you can set up a call to talk with me and see if it's something that may be right for you so with that uh enjoy the rest of your day and i'll see you back here soon in one of my next videos thanks you

Channel: Money Evolution

Views: 328,161

Keywords: yt:cc=on

Id: yAj1D2z4mLA

Length: 22min 1sec (1321 seconds)

Published: Sat Jan 09 2021