6 Common Roth Conversion & I-Bond Questions Answered!

Troy Sharpe: Today we’re going to answer some of the most common questions that we receive from the Roth conversion videos. Hopefully, these answers, in a general sense, help you all understand more about some of the topics that come up in these tax planning videos.

Troy: Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, certified financial planner professional, host of the Retirement Income Show, and I’m also a certified tax specialist.

One recent comment said, “Troy, if the limit is 6,000 or 7,000 per year, how in the world are you converting $100,000 in these videos?” The answer there is pretty simple. 6,000 or 7,000 depending on your age, younger than 50 or over 50, is the contribution limit into a Roth IRA. It’s not a limit on how much you can convert. There is no limitation on conversions.

Now, for Roth contributions, this means taking money out of your bank account, essentially, or paycheck, wherever you get that income from or those assets, putting it into a Roth IRA. There is not only an annual contribution limit based on your age but there’s an income limit as well. If you make too much income, you cannot contribute to a Roth. Now, technically, you could do what’s called a backdoor Roth IRA.

I did a video on the backdoor Roth IRA a couple of years ago, you can click on it right here. The title of it is “How to contribute to a Roth IRA if you make too much money”. I will say that there’s pending legislation that could take that backdoor Roth strategy away.

Now, if you consider this strategy, you have to be aware of what’s called the pro-rata rule. As I said, I did that video a couple of years ago. I’m pretty certain I talked about the pro-rata rule in there, but if I did not, Google it, check it out. You want to make sure you do not run afoul of that pro-rata rule because it could make that whole backdoor Roth strategy a bad idea.

Someone asked me, “Troy, the pending legislation, the Secure Act 2.0, if it increases the required minimum distribution age from 72 to 75, how does that increase my tax strategy?

My conversion strategy?” I don’t know your personal situation, and we can’t give personal advice here but the simple answer to the question, the general answer is, if they increase the RMD age from 72 to 75, it simply leaves us more time to get those conversions done before those RMDs kick in, because once those RMDs kick in, we cannot take that distribution and put it into a Roth. We have to take that and put it into a normal account. We can invest it but you cannot put it into a Roth.

Once those RMDs start, that distribution increases your taxable income. You can still do a Roth of additional conversions on top of that but, typically, it doesn’t make sense unless increasing the legacy that you give to children or grandchildren tax-free is the primary objective.

“Can I make several Roth conversions in a single year?” Simple answer here is yes. A lot of times our clients won’t know how much income they’re going to make until the end of the year because they’re still working. We’ll do a partial conversion in the beginning of the year and then in November, December we’ll do an analysis of their income tax situation. Then if we’re targeting the 22% or the 24% bracket or some other threshold, we’ll fill up the income tax bracket to that targeted level in November or December, so you can do the same.

The next comment or question I received is, “Troy, should I use my IRA dollars to pay the taxes on the conversion that I’m making?” As an example, let’s say we want to do a conversion of $100,000. Should I convert that 100? Then if I owe $20,000, should I take that $20,000 out of the IRA to pay taxes? Theoretically or ideally, no, you would take that from somewhere else, but if that’s all the money that you have, IRA dollars, that’s a personal analysis that needs to be done.

Now, we don’t give personal advice on this channel. We can’t do that. We do that for clients that hire us to do a specific job, but some general rules of thumb are, the younger you are, the better the outcome likely will be if you’re going to use IRA dollars to pay those taxes. Also, the longer you live, that will increase the likelihood of that strategy making sense.

For some of you out there, paying the taxes from the IRA is a strategy that will not be a viable one if you’re looking for the best mathematical outcome. Now, there could be other goals, such as you want to pass on as much money in your retirement to your children or grandchildren tax-free, and you’re willing to pay a little bit extra because you’re concerned that when they’re older, taxes will be much higher.

A lot of circumstances. This is an analysis that needs to be done. Can’t tell you exactly what to do, but those are some of the concepts that we would think through or have a discussion with you about if you were a client of ours.
Now, the comment we received said, “Troy, if I don’t need IRA income today and I do a Roth conversion, won’t that increase my taxes today?” Yes, absolutely, doing a Roth conversion will increase your taxes today, but you’re asking the wrong question. The question is, “How do I pay the least amount of tax over the course of my retirement?”

You have to keep in mind that required distributions once you hit 72, possibly 75 under this new legislation, you have to start taking out 4%, 4.5%, 5% per year, and that increases. It can get up to 6, 6.5, 7, 7.5, and 8. Let’s say you’re 60 and in 20 years, you leave all that money inside your IRA and it balloons, let’s say it doubles twice because you’re an aggressive investor or one and a half times, then you have to take out 5%, 5.5% on top of your social security, on top of your dividends, other income, what tax rate are you paying then? What dollar amounts in taxes are you paying then?

If you can get that whole thing converted and that costs you 200,000 today, but if you don’t do it and it’s going to cost you a million dollars over the next 30 years, well, that’s for you to decide which way you want to go, but keep that in mind. Also, what about your legacy desires? The children and grandchildren. They have to fully distribute that account over a certain number of years, right now it’s 10.

If they have good incomes all of a sudden your $2 million IRA or whatever its value is, when it goes to them, they have to take it out, pay income tax on top of income that they’re already receiving. It could very easily, and if you bring estate taxes or certain states have inheritance taxes, you could easily see a 30% to 50% wipeout of that entire account value. Possibly 78% if it’s worth enough and there’s an estate tax situation. Yes, there needs to be an analysis done, but if you do a Roth conversion, it will increase your taxes today.

I got another comment from someone who said, “Troy, I’m in my 30s, I’m saving 15% of my paycheck into the Roth part of my 401k. Another 8% of my paycheck I’m saving in the traditional part of my 401k, and my company is matching that going into the traditional part as well.” The question was, “Should I go ahead and pay taxes on that 8% that I’m putting into the traditional part, just go ahead and put that into the Roth today?”
Again, we can’t give personal advice here, especially just through the video, but generally speaking, you want to put money into the account that’s going to give you the best after-tax impact over the course of time. What is a general rule of thumb? If I were having this conversation with someone, I’d say, “Look, what is your income bracket? What are you currently paying today?”

Doing some basic Math, you probably make around about $100,000 a year if you’re putting the maximum amount into your 401k. Me, personally, knowing that that’s a 10%, roughly, effective tax on $100,000 of income, probably less because you’re making these deductions, you then have the standard deduction, you may have children where you’re getting some type of tax credit or other deduction, you’re probably looking at a 7% maybe 6% effective tax rate on that $100,000.

In this example, I would just have a conversation with you and say, “You know what? Is it worth saving that 6% today and then having that money grow tax-deferred into the deductible part of your 401k, or should you go ahead and just pay that 6% tax, put it into the Roth, and let it grow over time so all of those earnings are tax-free? That’s the thought process I would go through with someone in that situation. Again, it depends on the simple belief, do you think taxes will be higher in the future than what you can pay today to get it out? Understanding at about $100,000 of income, this can change a little bit if you’re single or married.

You’re probably looking at, with those deductions, somewhere between let’s call it a 5% to 10% effective tax rate that you would want to compare that to in the future.

The last question or comment I received was from a couple people and it was on the i-bond video that I did. The question was or the comment was, “Troy, you forgot about the best part, you can get around–” This was my interpretation of the comment, “As you can get around the annual limits by gifting an i-bond to your spouse.” According to my understanding, that is not the case.

This is right from TreasuryDirect and it says, “How much in i-bonds can I buy as gifts?” The purchase amount of a gift bond counts toward the annual limit of the recipient, not the giver. If I understood the comment correctly, the thing with i-bonds is each spouse can only buy 10,000 per year. You can buy an additional 5,000 per year with your tax refund. A couple could get 25,000 per year.

I interpreted the comment to say, “Well, I could buy an additional 20,000, 10,000, 10,000, husband, wife, if the intention is to gift them to each other.” My understanding based on the TreasuryDirect website here is that the purchase amount of a gift bond counts towards the annual limit of the recipient. If I bought a gift for my wife, she would then not be able to annually, or that year, buy one for herself. I do not believe that that gets around the rules.

Now, if I interpret that comment wrong, I apologize, but I want to make sure other people who may have read that don’t believe that they can go out and buy their own plus buy one for a gift and then have their spouse do the same thing and it might get you in trouble. I wanted to address that as well.

All right, please, keep sending the comments in, let me know what you think about this video, the other videos. I’m going to try to be more proactive about putting videos out like this to answer some of the comments and questions, because I just tend to kind of– It takes us down a little bit of a rabbit hole where I can talk a little bit more in-depth about a topic, as opposed to just commenting on the keyboard.

Again, we can’t give personal financial advice, but I do appreciate the comments. I really appreciate everyone watching the channel. Share this video with a friend or family member. Of course, subscribe if you haven’t already, and let me know what you think in the comments down below.