Woodstock Financial Advisor – Third Act Retirement Planning —

Should you do a Roth conversion during retirement?

Should you do a Roth conversion during retirement?

This is a question that many retirees face. It is quite relevant today for two primary reasons. Number one, people are living longer, so whereas the expected life of a woman 20 years ago was roughly 74, now it’s around 80. Life expectancy for a man 20 years ago was around 70, now it’s 76. And life expectancy continues to creep up. The reason that this is relevant to Roth IRA conversions is because now it gives your money more time to grow tax deferred and then be withdrawn tax free. 

US Government Changes To Tax System

The second reason this is a good question is because there’s no question that our government is changing. The government has always changed. However, with the passing away of the greatest generation and now even the Baby Boomers starting to pass away, we begin to see the generations that follow them be more geared toward socialism. And when you think about socialism, you begin to think about higher taxes so that the wealth can be distributed. So, again, a Roth conversion becomes very important to someone based on your belief system. Are we going to stay in the tax system that we’ve had or are we going to continue to progress toward higher taxes to create the ideal that some of the younger generations have about how to run government and how to help people in need? 

If you don’t think that taxes will go up in the future in general, then that may deter you from doing a Roth conversion. However, if you feel that they might go up, this would encourage you to do a conversion.

As I sit down with my clients, one of the things that I look at in determining whether or not they should do a Roth conversion is to first look at the taxes. I wait until they retire, and then I look and see what their taxes are going to be. Usually, their taxes are going to be lower. I  then determine if they will come down a full bracket or did their income just come down but they didn’t come down a bracket? 

2 Big Jumps in the Current Tax Brackets

If you remember the way that our tax bracket system is set up, there’s two big jumps. There’s a jump from 12% to 22% right now in 2022. That 12% jump is for single people with an income all the way up to 41,000 and for married people an income all the way up to 83,500. As it jumps to 22%, the income goes all the way up to 89,000 for single people and 178,000 for married couples filing jointly.

The next big jump is from 24% to 32%. The income for the 24% bracket goes all the way up to 170,000 for singles and for married couples it goes all the way up to 340,000. And then it jumps to 32%. So that’s the first thing that we do, we ask what do we think your income’s going to be this first year in retirement? Sometimes we’ll wait and then do their tax return after they’ve already been retired for a full year so we know what their income was and can make an accurate assessment of what we want to convert, if we want to convert at all.

What I help my clients do is convert up to the next highest jump.

So, if they’re at the 22% bracket, we will convert their Roth all the way up to the tip of the 24% bracket. If they’re in the 10% bracket, we’ll convert them all the way up to the tip of the 12% bracket. 

I have concerns about converting them to the next big jump because even though taxes will likely increase, in my opinion. That is my worldview, if you will, of where our country is going with its tax structure and overall politics. But even though I think that, I don’t think we’re going to see the 12% bracket go up to 22%. 

I try not to let people take the big jumps up. You’d see that 24% bracket go up to 32%. 

So, the first thing that we do in talking about a Roth conversion for my clients is look at what their income in retirement is going to be and how much we can convert of the Roth before it causes them to take a major jump in the taxes that they pay from the distributions that would come from their traditional IRA and into their Roth IRA.

Once we determine this,

I usually recommend a Roth conversion because clients are living longer and taxes could likely be higher.

And it’s something that we do based on the assumption that if my clients are in their sixties, and certainly in their fifties, we’re going to convert. One of the reasons that I like Roth IRAs is because it also helps with planning when it comes time to start receiving income during retirement. With Roth IRAs, my clients can enjoy tax free withdrawals in retirement.

It worth trying to plan for my clients and deciding how much income they’re going to have during retirement. We also have to watch the tax brackets during the planning phase, because we can take money from a Roth or from a taxable account and that money will not be counted toward their income or provisional income. The provisional income is used to determine how much social security’s going to be taxed. So now we just have income coming from the traditional IRA, it’s always going to be counted toward the tax bracket. 

The other thing that Roth allows us to do with its tax free withdrawals is help the client avoid getting bumped up into the next bracket. And I want to pause right there and talk about the brackets again.

One of the things that I do with my clients in retirement is if they’re in the 10 to 12% bracket, and usually that will be my married couple clients, they’re retired and they’re not making more than 83,500 a year, which is the current 12% bracket, the second bracket. And what we’ll sometimes do is convert the money from their traditional IRA into a Roth. And yes, it will bump them up, this will be one year they’ll end up paying 24% tax on the money that goes above the 83,000 for their income. However, for the rest of their life as we’re planning their income, we will be able to keep them in the 12% bracket where it is today.

Large amount in 401(k) and IRA

So, in other words, if they’re making 70,000 a year and they need 90 or they need a hundred and all we can do is get them 30 or 40,000 to get them up above what their basic living expenses are and it jumps them up into the next bracket, I’ll recommend they go ahead and do the conversion. And it could be a $200,000 conversion. I just did $140,000 conversion with a client of mine because they had about 90% of their investible assets in a rollover IRA. This is very common though for people who worked at a company a long time and built up a nice-sized 401k. 

No RMDs for Roths

The other thing I like is you can watch your money grow tax free longer inside a Roth. Those traditional IRAs are forcing you to start taking required minimum distributions at the age of 72. However, with Roths, you don’t ever have to take required minimum distributions. Why? Because with Roth IRAs, you don’t pay taxes. There is no incentive for the government to force you to take required minimum distributions on a Roth because the government’s not going to receive taxes anyway.

No Federal Tax on Inherited Roth Withdrawals 

The other great thing with a Roth that I like is that my clients can leave money to their estate or their family, and the recipient does not have to pay taxes on the withdrawal. They don’t have to pay any federal income tax on their withdrawals as long as the Roth’s been open for at least five years. And with the new estate planning taxes due to increase, this is another great income planning tool as well as an estate tax planning tool.

I work on the assumption with my clients that we’re going to try to get as much money as we can into a Roth without taking them into tax brackets where it would end up costing their family more in the long run. And for me, with my plan with my clients, I draw the line at the 24% income tax. Unless they’re ultra-high net worth and we see the estate tax laws changing and they can convert over and they’ll only have to pay 37% tax. That’s the only situation where I would recommend a Roth conversion above the 24%. 

Once we convert money from a traditional, where it would run their income up to the tip of the 24% bracket, at that point we stop and try it again the next year if the client wants to. But the more money that a person who is retired has in a Roth IRA the better it is for tax planning purposes when they’re retired and start to make withdrawals.

Set Up A Call

If you would like to know how to structure a Roth conversion for your particular situation, then click on the following link to set up what we call a retirement-ready success call. It is a no cost, no obligation, 20-minute call where you will go over where you are now, where you want to be, and I’ll share with you some other tips that my clients use to make Roth conversions.

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