I'm 63 And Retired With $2,000,000 In My 401(k) Should I Convert To A Roth IRA

you're 63 years old and you're retired with two million dollars in your 401k and you're asking yourself the question should I put money into a Roth account from this 401K that I've accumulated that's what we're going to look at today thanks for joining us my name is John Vandergriff I'm one of the owners and wealth planning team lead here at Blue Ridge wealth planners where we help people make the transition from their working years to retirement with planning or if they're already in retirement making sure that planning reflects the things they want to do so that they can enjoy that retirement better and one of those conversations that we have on a daily basis is in the realm of taxes with tax planning and so we're going to go into that today with this particular situation but as always we point out a couple things when we get started first we're going to cover some specific details here before you make any decisions off of the information here make sure you consult a tax professional or a tax planner or both in some cases you know we work hand in hand with our clients tax professionals to make sure that we have all the information available before we make some decisions here the other is if you enjoy this content make sure that you like share and subscribe and comment with any questions or or observations that you have we'd love to get that feedback from you and uh with that being said let's go ahead and jump into today's situation so we've got a 63 year old who is retired they have accumulated pretty large sum in their 401ks two million dollars and so we're going to look at the details of this situation to see if now is a good time for them to start converting this money from the 401K or tax deferred position into a Roth position where it can now from this point forward grow tax-free and so as we look at this obviously there are a lot of things that need to be considered when we go into a retirement planning conversation and so as we look income Investments taxes Health Care Family Legacy make up what we call a plan for everything for retirement we're going to be focusing primarily on the income needs uh today and in the future of this couple but also the tax ramifications and what you're going to see is there's a lot of overlap in these areas which is why it's important to make sure that you're getting the right level of planning and so again as we start to add a little bit more meat onto the bone here for this situation we've got a married couple age 63 and 64. 72 000 or 6 000 a month is their income need and lucky for them between the pension income and their combined Social Securities they have more than their income need provided on an annual basis and these are sources that are not going away anytime soon so as we look at this this makes it to where they really don't need any of the money that's inside of this 401k or even the banks other than maybe emergency pools but if you're going to pick one of these two it would be much better to take from this guy than this one so as we look at our situation here we've got a 401k that has um a substantial amount of money in it but not a lot of need today and what we do know about these tax diverted accounts even if you don't need them by the time you reach the age of 72 or for this couple in eight and nine years they're going to be forced to take money out of these 401ks whether they want to or not even though their income needs are supplied they may have to pull larger than needed withdrawals and we're going to look at that in a particular situation so as we look at Roth conversions we need to you know obviously evaluate for this situation if that's a good decision or not but Roth conversions we need to know moving money out of a an IRA or a 401k is a taxable event so whatever dollars come out are going to be taxable in that tax year and they're going to go on top of any other income so in this situation it's going to go on top of their social security and their pension income and they'll be taxed at the top tax rate for this conversion now Roth IRAs need to be in place for five years before the contributions and the growth are tax-free but in this case since we are over the age of 59 and a half when you make this conversion your principal will be available to you during the five-year period but the growth on that money would be taxable so if you give you an example if you converted a hundred thousand dollars after taxes have been taken out and it grows to 105 during that five-year period you could take up to 100 with no taxes if you got into that extra 5 1000 anything over your original amount would be taxable to you and then after the five years obviously it would be tax-free all right so as we look at this situation and start to fill in our chart here we've got the annual income need of six thousand dollars a month or seventy two thousand dollars more than that provided between pension and social security so seventy six thousand eight hundred dollars their current income which would put their top tax rate today at 12 percent so as we look at this two million dollars of pre-tax money five hundred thousand dollars of after tax money and then zero dollars in tax-free accounts like a Roth IRA or properly structured life insurance so what we're trying to do is take this very top heavy picture and start to migrate those monies down to where they're in a much more tax favorable position as these uh people move forward so as we talk about this it's important to point out um what we have to look at when it comes to a Roth conversion example so so what we're going to do is we're going to look at uh what's involved if the money stays in the 401K versus if it gets moved into a Roth IRA position so for this case we want to use an example of a hundred thousand dollars just for good easy math looking at if it stays versus if it gets converted over and so as we look at this scenario obviously if the money stays in the 401K there are no taxes owed today because this is a tax deferred option so a hundred thousand dollars continues to be the balance of the account if we move these monies into a Roth position uh that money is going to be taxable and for this example to not be unfair we've got to consider that the taxes on this money are paid by the money itself and so if 20 was the tax spot on these dollars then that means the net amount going into the Roth account would be 80 000. so as we look at this some financial advisors will stop here and they'll say doing a Roth conversion is a bad idea because you have less money you know 100 000 if you do nothing eighty thousand dollars and if the market grows this account will grow slower than this one and on the short term that is true because both of these accounts make ten percent this account makes eight this account makes ten but we're not looking at the same types of buckets this one is fully taxable this one from this point forward is growing tax-free so as we look at these positions here uh let's assume that they're invested the same way over the same period of time that way we take care of Time Value money uh inflation all these things so that this is truly an example that looks at the taxes uh so what we will find is the Roth conversion is now worth 160. the IRA 401k account is 200. and then we're assuming at this point that we pull money out well the Roth we know what we have because there are no taxes owed so you've got 160 000 at your disposal the 401K it depends it depends on what the tax brackets or the tax environment looks like when you take your distribution now the interesting thing about this example is if those tax brackets are the same at the end as they are at the beginning what you will notice here is that your bottom line is exactly the same in both scenarios so it actually does not matter of which decision you make if your tax brackets stay the same now when we look at the way that most people give advice in retirement in regards to the way taxes work they'll say oh well your income will go down in your retirement years from where that was when you were working and if that's the case then you will actually have a lower tax bill and so if you have lower tax bill lower percentage in this case it makes more sense for you to leave this in the 401K even if you're growing money tax free in the Roth account because it all matters when can you pay the lowest percentage tax I do think this is unlikely because of our current situation both with the overspending that's happening in Washington as well as the large amount of debt that we have in our Ledger over 30 trillion dollars both of those factors I believe are going to cause taxes to go up we don't know exactly when but we do know that that's a very high likelihood scenario so if that is the case and even though your income goes down in retirement or stays the same you could see a higher percentage tax that gets assessed on these monies because this is income taxable money and this will go on top of any other income that you have and so if that were the case you would actually have less money by leaving it alone waiting until retirement instead of taking action and paying taxes on these accounts today so this is why this is important because we don't know when the taxes are going to change we also don't know what those brackets are going to look like but we do know that the longer we leave these monies in these tax deferred accounts they're going to continue to grow and so will the tax obligation that we have on those dollars and so again we've got to look at where the tax brackets are first to see if the tax brackets are what we need to assess but also we need to look at the impacts of leading tax deferred dollars alone and what that could do later when forced to withdraw them so so in 2023 this shows for a married couple with the tax brackets look like and so for them their top dollar events and so for them their top dollar would be at 12 percent uh with seventy six thousand dollars of taxable income uh so 117 000 if we look at a very similar situation uh 2017 the reason we point this out is if the rules stay in effect um that are in place now our current tax code is set to expire after the tax year 2025 so 2017's brackets would basically become 2026 brackets uh and this is assessed for inflationary increases but the brackets for this couple would put their top dollar at 15 instead of 12 Which is higher now the next one I look at is looking at a period of time where really we had a much higher uh tax obligation especially the higher your income went if you notice today uh your top tax bracket no matter how much income you have is 37 percent whether you're single or married here top tax bracket was 70 so noticeably higher almost double but for this particular couple with the income that they show today they would actually reach the 28 percent for any dollars taken out of their 401K um which is pretty noticeable now if we look at this scenario which is very common if people have their income needs taken care of typically they will leave the tax deferred money alone because they don't need it they don't need to generate taxes for their lifestyle and so if that were to happen we've got to look at the impact of what rmds will do to you later because when we look at this particular situation as we said this couple has two million dollars in 401ks and not a need from it because not only do they have after tax money to be able to get to in case of emergencies but this is not necessary for their lifestyle because their pension and social security income makes up everything they need on a monthly basis so if we just look at this two million dollar account and we say very simply if this were able to have a five percent return average per year for the next nine years this 2 million would turn into 3.1 million dollars and the reason we say nine years is you have to start pulling out money from this account at the age of 72 and if you did taking the rmd at that age would result in an additional 113 000 of income which would go on top of the seventy six thousand dollars of income they have today putting them in an income total of a hundred and ninety thousand dollars which is noticeably different than uh the seventy six thousand they have today and much higher income which you would conclude would bring about much higher taxes so what we want to look at uh here is obviously where is their uh income today in those brackets and so we're going to look at this kind of uh pre rmds because if we're making decisions today obviously we don't have 3.1 million dollars we've got two million dollars in those accounts anything that we would pull out would start at a 12 distribution percentage today a 15 versus a 28 so obviously if this plays out in the scenario today is the lowest tax environment we have well even if we factor in the rmd money in today's bracket saying okay well we know we're gonna have to take out let's say conservical a an extra hundred thousand dollars what would that do to us from a tax bracket perspective as far as our top tax dollar that we look at so that would jump this particular couple from the 12 bracket in today's tax code to the 22 percent so an increase almost double it would bring them from the 15 bracket to the 28 if we look at 2017 or what would be things in 2026 and then based on the way things were in 1981 which was a much higher tax environment you would have almost 50 percent of the distributions at your top dollar uh paid out in taxes which is not what you want so the signs here point to an opportunity to pay less taxes today especially since we know there is no way to avoid the rmds other than giving that money away and again unless they're wanting to give two million dollars to charity it could make sense to start moving these monies now so the question becomes how much would be wise to convert well again based on this situation I look at this and say anything that we can get converted underneath the 25 tax bracket I think is a good opportunity as we looked at obviously they have a situation where they could get into the 28 or higher tax bracket depending on uh what things look like when they have their rmds but if we're trying to stay under 25 percent obviously that gives us the ability to get the rest of the 12 bracket taken care of max out the 22 bracket and the 24 bracket and that would put them at almost 320 000 of the two million dollars being able to be converted at an effective tax rate of 21.7 percent which is exceptionally low and for this particular couple I don't know that they'll ever get to see that low and effective tax rate on the money that is forced to come out of their IRAs or 401ks in the future so so we know that that's a good opportunity but there's one more thing that we have to consider because when we are in the position now of this youngest person being at age 63 Medicare does a two-year look back on your income to determine what your medicare premiums are and so as we look at this the Baseline cost for that in 2023 is for a couple a little less than four thousand dollars a year but as your income goes above 194 000 you start to pay additional Medicare Part B premiums depending on how high that income gets well what we're looking at for a total income would exceed 366 000 which means if we're doing a true cost analysis of this conversion we would need to add eighty seven hundred dollars of cost to this conversion that means that's a real cost of conversion in this particular situation so so whatever taxes get generated based on the conversions that we did we would need to factor this in to the decision making process and if we did what that does is it brings your in this case total cost of conversion to a 20 24.3 percent which again is lower than that goal of 25 so still even though this is adding additional cost to Medicare two years from now I still think this could be a very good move for this couple based on where they are but also where R DS will put them as they progress through their retirement so as we look at this obviously we went into some detail here in this conversation if no one has gone into at least this much of a conversation with you about tax planning I think you're missing an opportunity to hopefully make some good decisions based on your situation and so you're going to see a link pop up below here what I would ask you to do is click that link schedule a time with us here at Blue Ridge wall planners and see how we can walk you through this discussion because again when we look at the risks today obviously there's Market risk but one of the unknown and often unplanned for risk is what happens when taxes go up in the future because of this large amount of overspending and debt and what impact will that have on the savings that you have today we want to know that before time so that we can make some good decisions just like this just hopefully get money moved from a tax deferred position to a tax-free position and then that way you've got tax diversification just like investment diversification so thank you for joining us in this conversation today we hope you learned a lot like we said comment with any questions or observations that you have and make sure that you share this with someone else but thank you for this conversation and joining us and we look forward to sharing more information with you in the future

Channel: Blue Ridge Wealth Planners

Views: 144,497

Keywords: retirement planning, retirement, income planning, investment planning, financial advisor, retirement income, Roth IRA, IRA, Tax Planning, Tax, 401k, wealth planner, wealth planning

Id: BkxYuQ0Vb88

Length: 18min 20sec (1100 seconds)

Published: Wed Feb 15 2023