12 Ways a Roth IRA Conversion Could Save You Thousands or More in Retirement

We’ve talked about Roth conversions on this channel for 5-plus years now, but I don’t know if I’ve ever just succinctly put the list down and discussed with examples each of them and how they benefit you in retirement. That’s what we’re going to do today.

Pay Less Taxes Over Time

The first, and for many of you, the primary reason to consider a Roth conversion is to pay less tax over time. Now, we do thousands of tax analyses for prospective clients, for existing clients every single year.

I’d say probably around 80-85% of those tax analyses, it shows that mathematically, you will end up with more money in your pocket, pay less tax over time if you implement a strategic Roth Conversion Strategy . We work with thousands of people just like you, doing these analyses every single year, and time and time again, it shows that this can be a benefit for you in your retirement.

Now, the more money you have inside of your retirement account, the bigger the tax problem that you probably have is. You don’t have to have a ton of money inside your retirement account, though. If we look at this example here, this is a couple about to retire. They have $500,000 inside the retirement account, about $500,000 outside. We just look at a simple apples-to-apples comparison. They’re spending about $80,000 inclusive of Social Security income.

Of course, that’s increasing with inflation over time, a moderate growth portfolio. Total taxes with the dynamic Roth Conversion Strategy , about $7,200 versus over here, no Roth Conversion Strategy . We call this the base case or just conventional wisdom, where you allow your IRAs to defer until RMD age, 73 or 75, depending how old you are now, and then you start taking those mandatory distributions while withdrawing from your non-IRA assets first. This has been conventional wisdom for many years.

For most of you, though, we do find that you will end up paying more taxes if you follow this advice. $175,000 in taxes paid following the older conventional wisdom recommendation, whereas more of a dynamic implementation of a Roth Conversion Strategy , only $7,200 on $80,000 of income. This is with Social Security, too. Everyone’s situation is different. Of course, how much you spend, how long you live, how you invest your money, the composition of your accounts, how much is IRA, non-IRA, do you have a pension, rental income, all of these other things, these are all pieces of the puzzle.

They’re all part of that domino chain as well because once you get to retirement, every single decision you make tips over another domino. We’ve talked about this ad nauseum on this channel. We have tons of videos where you can go into these case studies much more deeply if this is the first time you’re tuning in. If you follow the channel for some time, you know where to find these videos, and we’ve went through this.

Protect Against Higher Taxes in the Future

The very first reason to consider a Roth Conversion is to pay less tax over time. The second reason to consider a Roth Conversion Strategy is to protect against higher taxes in the future. Now, you’ve already noticed that I have the U.S. debt clock behind me. For those of you who have not seen this, it is quite shocking. Here we are. We’re mid-July 2024. We’re at almost $35 trillion in national debt.

If we look at federal debt to GDP ratio back in 1960, 52% of our GDP annually, that was how much we spent. Half of our GDP right now, we’re up to 122%. We spend far more money than we actually produce as a nation. Largest budget items, Medicare and Medicaid, $1.789 trillion. Social Security, $1.45 trillion. Defense, $900 billion. Interest on the debt, $900 billion. These are all mandatory budget items. They’re constitutionally mandated to be paid.

As soon as the money comes into the Treasury from your tax revenue, the money goes right back out to pay these things. Now, Social Security, Medicare, Medicaid, those are FICA payments. They’re transfer taxes that come out of your paychecks. When we look at future of Social Security and Medicare, these are unfunded liabilities. These are monies that we are promised to pay.

Right now, we have a little over $2 trillion. I want to say $2.5 trillion in reserves for the Social Security Trust Fund. It’s projected to exhaust in 2033, so about nine years. We have right now, $27 trillion in Social Security payments that are unfunded, meaning we don’t have money in the reserves. We don’t have the projected income coming in to cover them. Out of the $34, $35 trillion in debt, only $8.5 trillion is held by foreign countries. That means the other let’s call it $26 trillion or so, $27, we owe it to ourselves.

We are basically printing money to fund our liabilities. We’ve accumulated $26 trillion in debt to ourselves. This is really mind-blowing when you think about it. We’re going to have to continue to print money to spend the way that we’ve been spending and the way we’re most likely going to continue to spend. That is why, I don’t know for sure that taxes are going to be higher in the future, but when you look at the math and you start to apply some common sense here, it is not out of the realm of possibility that taxes are much higher in the future.

You have to ask yourself, is it more likely that Congress gets together and they really decide to pull back the spending, or is it more likely they reached into your pocket and ask you to pay for what they’re doing here?

Reduce Your Future RMD Withdrawals

The third reason to consider Roth Conversions is to reduce your future RMD withdrawal. RMDs are Required Minimum Distributions where you take your age to determine your withdrawal factor. Depending on how old you are today, it’s either 73 or 75.

If you’ve never heard of RMDs, simply look them up, but your required minimum distribution is based on your age today, and they start at age 73 or 75. Now, it’s an increasing percentage. Let’s say it starts around 4.5%. You have to pull out more and more, a larger percent from your account every single year. Many of you will be 75, 77, 78, 80, and you’re going to be forced to withdraw income that you don’t necessarily need. That means you’re going to be paying taxes on income you don’t need.

By doing the Roth Conversion Strategy , you no longer have to take RMDs. You completely take that requirement off the table. Essentially, you’re doing some proactive planning. We’re taking money from the IRA now, putting it into a tax-free environment, the Roth IRA and we’re not going to be forced to withdraw income in the future. Now, as you’re about to see, those forced withdrawals in the future can have some pretty negative consequences on other aspects of your Social Security, dividend, capital gains, and some other items.

Avoid Medicare Premium Increases with IRMAA

Table Source: Nerdwallet.com

The fourth reason is to potentially stay away from increased Medicare premiums. This is known as IRMAA. It’s an Income-Related Monthly Adjustment Amount. It’s an acronym, IRMAA. We have here what those tax brackets are for if you file as a single person, if you file married filing jointly, married separate. If your income is less than or equal to 103,000 or less than or equal to 206, you pay 174.70 for your Part B premiums. This is per month per spouse. As your income increases, single, married, so potentially do your Medicare Part B and Part D premiums.

Now, we just talked about RMDs, and I talked about the domino effect there. This is one of the dominoes that you have to be aware of. By doing Roth conversions, because that eliminates the need for required distributions in the future, you are eliminating this from possibly happening out of your control. Now, if you just have tons of income and it’s not because of IRA distributions, it is what it is. You’re going to pay these premiums.

Too often over the years, we’ve seen people who come in and they say, “Troy, I’ve been working with XYZ for so many years. I just found out about these IRMAA things. I can’t believe they didn’t plan for this. Can you do anything to help me?” At that point, it’s typically too late unless you do some pretty big conversions or just spend a lot of the IRA at that time. Roth IRA distributions are really cool. They’re a special class. They’re very unique when it comes to tax-free income.

They’re superior to municipal bond income because they don’t increase your modified adjusted gross income, which is used to calculate not only this but the taxation of your dividends and capital gains and other items in the tax code.

Reduce Social Security Taxation

The fifth reason to consider Roth conversions is you can potentially reduce the taxation of Social Security. Now, what we have here is a itemization of someone’s 1040, so your personal U.S. tax return. You’re retired, no wages.

We have about 15,000 of municipal bond interest. We have about $15,000 of qualified dividends. $30,000 of IRA distributions and gross Social Security of $40,000. Taxable Social Security is $34,000. Social Security is a preferentially taxed income. If you manage it appropriately, you can potentially reduce the tax that you pay on it. Once you cross certain thresholds, if you’re married, filing jointly, you’re single, these thresholds are different, but once you cross certain thresholds, up to 85% of your Social Security can be subject to income tax.

Now, because the way the tax code is written, and the easiest way to think about this is a net. If I take a net and I throw it out into the ocean floor and I just start dragging it in, I’m going to pick up a lot of different things in that net that are going to come on the seafloor. The tax code is very similar. The different sources of income that you have, the IRS is essentially throwing the net out there, and based on the character of those sources of income, you can drag other items into a state of taxation that otherwise would not.

Tax Impact Chart, Source: Holistiplan.com

If instead of having this IRA distribution being $30,000, if we had previously converted to a Roth IRA, I make this zero because again, Roth IRAs are income tax-free. Look what happens here to our Social Security. It went from being $34,000 of it subject to income tax to now only $18,000 of it is subject to income tax. Now, come down here, our total tax liability, $155. Without that IRA distribution, we pay basically zero taxes, $155. Now we’re paying $7,742 on taxes. Even though our marginal rate is 22%, it’s actually 25.8% we’re paying on that retirement account distribution.

Now, again, stay with me here. It’s how the tax code is written, and this is how that net works. We’re dragging more items into a state of taxation that were otherwise not taxed. We’re now paying tax on Social Security. We’re now paying tax on dividends, and we’re also paying income tax on that IRA distribution. Even though it’s 22% on that IRA distribution, because we’re also paying taxes on these other sources of income we previously were not, we’re increasing the overall effective tax rate of that distribution.

Let me show you. What we have here is a visualization of that net dragging more sources of income into a state of taxation that previously were not. The pink represents Social Security. The red represents the taxation of dividends, and then the blue down here is ordinary income. That’s the character of various sources of income and which tax rules they are subject to. Down here on the x-axis, we have each incremental $1,000 of more income.

As we have $1,000 more of ordinary income, we start to see things get dragged into a state of taxation, and this is actually called the Social Security tax torpedo. I don’t know who came up with that. I talked about it on a webinar probably seven or eight years ago and got a lot of positive feedback from that because no one had really ever heard of it before. It all has to do with this net dragging more income into a state of taxation. Real simple, we pull let’s say, $5,000 more out of the IRA. 10% of that is going to be taxed ordinary income tax rates.

The Social Security Tax Torpedo and The Marginal Tax Rate

That is the actual IRA distribution itself, it’s taxed ordinary income tax rates. We’re bringing now 8.5% of Social Security into taxation. You add those two together, 18.5, that is our total effective tax rate on that single distribution from the IRA. Just want to jump to the torpedo here. Now look what happens. If we were to pull $17,000 out of the IRA, $17,000 additional, we’re actually paying almost 37% on that distribution from the IRA.

Tax Impact Chart Breakdown, Source: holistiplan.com

It’s not because we’re in the 37% tax bracket, it’s the accumulation of all these other sources of income that we’ve dragged into a state of taxation now. 12% would be the ordinary income tax rate, that’s the marginal income tax bracket. On that IRA distribution, that $17,000, we would pay 12% on that. Most people understand it. Now, the red, we’ve brought capital gains or dividends into a state of taxation. That is another 7.9%. 16.9% now on Social Security because we’ve dragged more Social Security into a state of taxation. All of that comes to total 36.8.

I was about to move on to number six, but Eric, many of you know behind the camera, actually asked a really good question here. He said, “Troy, why does it go back down?” It is a really good question. The answer is, remember, we had $15,000 of dividends. We had $40,000 of Social Security, but only up to 85% of it can be subject to income tax, no matter how much income you have. What happens is, the pink represents Social Security, the red represents the dividends.

Once we’ve taken so much out of the IRA, we have fully 100% taken that net and dragged all of that Social Security that can be taxed and all of those dividends that can be taxed, we fully drag them in. Now they’re 100% subject to their particular status within the tax code. Social Security, that would be 85% of that income. Dividends and capital gains, that’s 15%. We’ve dragged them all in. Now, the blue represents ordinary income or IRA withdrawal taxation.

Once we’ve dragged those all in, then every dollar we pull out of the IRA from that point forward is taxed at just your normal tax rate, your normal tax bracket. That’s what we call your marginal tax rate. Every additional dollar, what is it taxed at? Hopefully, that makes sense. Again, comment down below. Once you’ve dragged this money in, it’s fully taxed. You can’t go back and redo it. Now every single dollar is going to be taxed at the ordinary income tax rates. Hopefully, that’s not too confusing.

Reduce Taxes on Dividends

Reason number six to consider a Roth Conversion. You can reduce taxes potentially on your dividends. We just went through the calculation. We showed you how that net drags not only your social security into a state of taxation potentially, but also those dividends. Here are your brackets. If you’re single or married filing jointly, you are either in the 0%, 15%, or 20% bracket when it comes to paying taxes on your qualified dividends. These are investments that you have outside of your retirement account.

In order to be considered a qualified dividend, a couple qualifications here. One, it has to be a U.S. corporation, and then I think that you have to own it 60 days prior to the ex-dividend date, but you may want to Google that just to verify. I think it’s the 60 days pre and then the 60 days post. It’s 1201-day window. Maybe just Google that to be certain. By doing Roth conversions, we’re moving money out of that retirement account into the Roth. We’re not going to have required distributions later.

Capital Gains Tax Rates, Source: Nerdwallet.com

Whenever we need to withdraw for income purposes in retirement, it doesn’t increase your taxable income, your adjusted gross income, or modified adjusted gross income. Point being here, yes, you pay taxes up front, but if structured properly and part of a comprehensive plan, when we get into and throughout retirement, we could potentially be in the 0% bracket for dividends.

Reduce Taxes on Capital Gains

Reason number seven, I don’t have to go too far from this because this also applies to your long-term capital gains. This is the dividend tax rate table, but this is also your long-term capital gains table. Now, how do we use this in planning? Let’s say you come over, you become a client, and you have a lot of embedded gains inside of your non-IRA accounts. We also have this big tax infestation inside the retirement account.

One of the things our advisors and our financial planning team they’re going to look at is, okay, what’s the most efficient tax distribution strategy moving forward? Is it more important to rebalance the portfolio or to tackle the tax infestation in the retirement account? A lot of times– Maybe I should say some of the time, it makes more sense to defer the Roth IRA Conversion Strategy and instead start to rebalance the account. We’re going to want to keep more money inside the IRA, not make any distributions from there, maybe delay Social Security instead of turning it on. We could sell up to actually more than $100,000, sometimes $200,000, $300,000, $400,000 of stock.

As long as the long-term capital gain and all of your other sources of income, the taxable bottom line number falls below this, you would pay 0% taxes on the sale of those stocks. Again, work with a CPA on this if you have to. Work with someone who knows what they’re doing for sure. This is the table, not only for dividend taxation but also long-term capital gains.

Protect Yourself from New Kinds of Taxes

Reason number eight, you want to protect yourself from new taxes that may be introduced in the future.

Now, we went through the debt clock. We have a lot of money that we owe in the future, whether it’s to ourselves or whether it’s to mandatory or discretionary items in the federal budget. New taxes that are in existence today that weren’t always there, one that comes to mind is the net investment income tax. It’s a 3.8% surcharge on your dividends and your capital gains, but all investment income. That came about I believe it was in the Affordable Care Act in 2008.

Another one that we talked about in this video is the IRMAA surcharges, the increase to your Medicare Part B and Part D premiums. That wasn’t in existence until 2007. What happens is Congress gets together, they pass this massive bill, and then now that becomes the law of the land, and then somewhere in the thousands and thousands of pages, they input some type of new tax that impacts you if you have typically a certain level of income. It may not be income-based, but a lot of times it is.

Doing Roth Conversions, again, it eliminates the need to do those forced required distributions in the future. It gives you the flexibility today to withdraw income from that account without increasing your adjusted gross income, possibly pushing you into a bracket where you are now subject to some future tax that’s not yet been introduced. This is part of the tax risk conversation.

A lot of times, mathematically, it may not make sense for you. I shouldn’t say a lot of times, but sometimes it may not make sense for you mathematically. Was working with a client recently, pretty wealthy, had a lot of money, and mathematically, it just didn’t make sense to do Roth Conversions because there was so much money in the IRA. They would have ended up with more at the end of the day if they did not than if they did. They wanted to take that tax risk off the table, everything that we’re talking about here.

Understanding the possibility of new taxes being introduced, doing Roth cCnversions could potentially help you eliminate or avoid those.

Avoid Potential Means Testing on Your Income

Reason number nine, avoid a potential means testing of your income to reduce your Social Security benefits. The most recent Social Security trustees report says that in 2033, the trust fund, the reserves will be exhausted. We should have enough income coming in to pay 77% of benefits that are owed. Now, we looked at here the Social Security liability. This is fast-forwarded to 2028, but a $35 trillion unfunded liability, meaning that is money that we do not have to pay future Social Security benefits.

It’s going to be very hard for them to fill that gap. It’s going to be impossible to fill that gap from raising taxes. They’re going to have to look at the other side of the equation, which is reducing the cash outflow. Again, this is not set in stone. It’s just my opinion, but I believe it is likely at some point over the next 10 years, there will be some type of means testing introduced for Social Security. If you make $100,000 a year or $200,000 a year or $400,000, I don’t know what that level will be.

The point is, by doing a Roth Conversions, what you could potentially do is get that money out of your retirement account today, pay taxes today at today’s rates, take advantage of the opportunities that are there, but eliminate the tax risk of deferring this can into the future and then being forced to distribute it and have very high adjusted gross income levels that now put you also not only into net investment income tax that we talked about, IRMAA potentially, but now also maybe some means testing on your Social Security or some other benefit.

Avoid the Single-Filing Tax Trap

Tax Brackets Chart, Source: nerdwallet.com

Reason number 10, filing the single-filer tax trap. If you’re married filing jointly right now, this applies to you. Unfortunately, one spouse does typically pre-decease the other. Only in the year of death of your spouse, do you still get to file as married filing jointly? The exception to that law is if you have a dependent child still at home. Now, most of you in your 60s or 70s, you do not have a dependent child at home, but if you do, you get two additional years to file married filing jointly.

I believe this is one of the most punitive aspects of the tax code. It’s something that we all have to consider. Here are your tax brackets and here are your tax rates. Now, this is 2024. These will all be higher in 2026. If the Trump Tax Cuts and Jobs Act does not get extended. I just want to show you the difference here. We start to get right here. At the 12% rate, you can have up to $94,000 of income if you’re married filing jointly. It gets cut in half basically. 47,000 is your threshold as a single filer. You will lose one social security check.

A lot of times we still see, even with that loss of income, that taxes for the surviving spouse are actually higher. You actually pay more dollars in taxes because of this punitive single-filer tax trap. Not only are you dealing with the loss of a spouse, all of the issues that come along with that, but without proper planning, then a lot of times you could also end up paying more taxes or at least a higher proportion of your overall income going to the government. Number 11, leave more money to your family.

The SECURE Act, this is version 2.0, but it simply says money inside your retirement account must be fully distributed within 10 years of the date of death. If you leave this money to your children or grandchildren, then it all has to be distributed within 10 years of your date of death. The Roth IRA does as well, but the difference between the two, one is a tax-deferred account, of course. Let’s say, $1 million, your kids don’t need it, they’re working, they’re successful, it grows for 10 years, and now it’s worth $2 million.

They have to fully distribute that $2 million IRA. If they are working, if they have decent jobs, those IRA distributions are going to go on top of all their other income. Now, if you think taxes might be higher in the future, let’s say your kids have combined income of maybe $150,000, $200,000 a year, now you put $2 million IRA because you gave them a million, they didn’t touch it grew to $2 million, they have to take it back. Now all of a sudden, what are tax rates going to be in 20, 25, 30 years on $2.5 million of income? 40%, 50%, 60%?

Do they live in a state that has income taxes? All questions for you to consider. Whereas if you pay the taxes now, gradually get that money into a Roth IRA, you pass them the Roth, 100% income tax free, it compounds for an additional 10 years in the same scenario, let’s say the $1 million grows to $2 million, they take the full $2 million out, no taxes, whatever, it doesn’t increase the tax on their salaries, wages, other income that they have. They fully inherit that $2 million.

Strategically, if it’s important to you to leave money to family, the Roth IRA Conversion now has additional benefits in that regard as well.

Leave More Money to Your Family

Last one here, number 12 reason. For me, this is one of the most important just because I like to have control of my own destiny, of my own future, hence that’s why I started Oak Harvest Financial Group, but signing up for my own plan and having control over my own plan as opposed to the government’s plan. One of the things that I’ve seen year over year over year is that when people call in from the radio show, they reach out to us from YouTube, maybe some live events that we’re doing, and they say, “Troy, I just wish I would’ve met you 10 years ago. I wish I would’ve met you six years ago. I wish I would’ve met you last year.” Now they’re at a point to where it’s either too late to make any significant change because they’re already taking required minimum distributions, or some other factor has caused them to be in a position to where they can’t make the changes that we would have made to put them into what we feel is a better position at this stage of life.

Have Full Control Over Your Own Plan

Number 12, what I say is to have your own plan. Don’t sign up for the government’s plan. Trust me, the government has a plan for your retirement account. It’s 73 or 75, you’re forced to start taking distributions, it’s an increasing distribution, and when you pass away and that money goes to your kids, it all has to come out within 10 years. That’s the government’s plan. It may be fine with you. If that’s fine with you, then sign up for it. You don’t have to do anything. It will be taken care of for you.

I’m the type of person I like to have my own plan, my own strategy, I like to optimize things, I like to be in control of what I can control. These are very simple things that I feel you can control as well. For me, one of the most important, just to have a plan that I am following that I can put myself into a better position. I hope these 12 tips have helped open your eyes in understanding how Roth Conversions could potentially benefit you in your retirement. Let’s hear what you think, put them in the comments down below, and we look forward to seeing you real soon.

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