Jumping into part two of your comments and questions answered pertaining to the Roth Conversion Ladder video. Now, the actual title of the video was I’m 60 With 1.5 Million: How A Roth Conversion Ladder Could Potentially Save Up To $600,000 In Taxes. We just did part one. We have so many comments on this video. We had to break it into two because I didn’t want it to go 45 or 50 minutes.
We’re very grateful for the time that you take to respond to the content that we put out there with very thoughtful comments and questions. We want to continue to answer your questions so we can encourage the conversation and help you become a more educated retirement investor.
When doing Roth Conversions, are you able to pay those taxes from IRA accounts?
Our first question here comes from nateCA, which I think might mean Nate from California. He says, “When doing Roth Conversions, are you able to pay those taxes from IRA accounts?” The simple answer is yes, you can. Just be aware, if you pay taxes from your IRA accounts, the amount that you’re sending to the government is also a taxable distribution. If you want to convert 50, you just simply fill out the form to withhold the amount of estimated taxes. Let’s say you think $10,000 will be owed. You do a $50,000 Roth Conversion, but you withhold 20%. 20% of 50 is 10, so $10,000 is going to go to the government, $40,000 is going to go to your Roth IRA.
$40,000 goes into the account, but you’re paying income taxes on $50,000. Just be aware that that is how that works. Also, be aware that the government expects you to pay estimated taxes in the quarter in which the taxable event occurs. The only exception to that is if you take advantage of what’s known as a safe harbor payment. Take a moment to look that up. There’s two different options for safe harbor, depending on what your income level is. Take a look at what that is, and that may help you if you’ve missed your estimated tax payments.
What about a partial conversion instead of the whole IRA conversion?
Our next comment comes from dcerar9559, and this may be one of the most impactful comments here because hopefully, it sheds a lot of light on many of your situations out there but also the big challenge that you have if you’re not exploring this strategy for your retirement. The gist here is that he says his circumstances are somewhat similar to the video, but he has a $120,000 pension plus $11,000 for medical with a 2% cost of living adjustment.
We don’t see many cost-of-living adjustment pensions anymore. They used to be a bit more common 10, 15 years ago, but we don’t see them often. Doesn’t qualify for Social Security, but he is eligible for Medicare. Has about $900,000 in non-qualified assets, so outside of the retirement account and about $1.6 million in a traditional IRA. He goes on to simply say, “I live well within my means. I don’t need to touch my investments for a very long time, if ever. I don’t see the advantage of doing the Roth conversion and paying $300,000 in taxes upfront to get that money converted over to Roth.”
I first want to ask you this question. If you don’t do any conversions whatsoever, how much tax will you end up paying? That’s the big question, because doing Roth conversions, for most of you, does not mean you’re paying extra taxes. You’re going to pay taxes, because once you hit 73 or 75, you’re forced to take that money out of the account, and then it’s a taxable distribution. With a $110,000 pension with $1.6 million in your IRA, depending on how old you are, I want to doubt if that was another $100,000, $120,000, $150,000 distribution at age 73.
Now, at age 83, that very well may be a $200,000, $250,000 distribution. Now, on top of your pension, dividends in the taxable account, you very well may be 80, 85 years old and have $400,000, $500,000 of taxable income. You are going to pay taxes, and that’s what I think a lot of people don’t understand when you look at it from this perspective. First, you have to answer the question, if I don’t do any conversions, how much tax will I pay? Then psychologically, we have to get over the hump that says, “Okay, it’s not if I’ll pay taxes, it’s simply when and how much.” Those are the only two things that you control.
If you don’t do any conversions, you sign up for the IRS’s plan, and the IRS has a plan to get that money out of your retirement account and collect the taxes that have been deferred for decades. Answer the question, how much will you pay if you don’t do conversions? Then start to look at, well, would I rather pay $300,000, spread that out over a period of 3, 4, 5, 6, 7, 8 years, or would I permanently want to pay $60,000, $70,000, $80,000 per year for the next 20 years? Whatever those calculations come up to.
Also, don’t forget what we talked about in the last video, where taxes may be higher in the future, new taxes may come into existence that don’t currently exist today, but also if you’re married, one spouse predeceases the other, you drop from the married filing jointly to the single brackets, and now you’re in a world of pain. Now, you’re going to pay a lot more tax than you would have otherwise. $300,000 is going to seem like a bargain.
Okay, last comment for this video. Once we post these, I’m pretty sure we’re going to have more comments. We’re going to do videos that we go deeper into some of these comments. Because again, we’re really appreciative for the time that you take to respond to these questions. They give us a lot of good ideas that help you, that help many others. Keep them coming. We’re going to keep responding, keep doing videos, keep providing more educational content.
Are Roth Conversion taxes easier to handle than Social Security and Traditional IRA taxes?
We have another good one right here. MyHockey says, “Wonderful video. Help confirmed I’m on the right road for Roth conversions.” Wants me to speak a little bit slower, so I will try to do that. I get excited. I’m very passionate about this stuff. I think it comes through when I’m starting to go through the content. What he says here is he wants to keep things simple. He’s taking care of three seniors. Social Security and taxes become very complex as you get older in life. He feels that the Roth IRA is a lot more simple to deal with when you’re doing distributions because things are just more simple.
You’re absolutely right because distributions from a Roth IRA are, as we all know, 100% tax-free. One thing that I don’t think a lot of people are aware of is that tax-free income does not increase what’s known as your modified adjusted gross income. Why is this important? Because your modified adjusted gross income impacts many other aspects of your income that’s taxed in retirement.
For example, if you have municipal bonds, which also provide tax-free income, versus a Roth IRA where you make tax-free distributions. Even though you don’t pay income tax, federal income tax, on those muni bonds, that income still increases your modified adjusted gross income, which tips over the domino, potentially causing your Social Security to be taxed at higher rates. Not just potentially, almost certainly, it will because your Social Security to be taxed more so than Roth IRA distributions.
Not all tax-free income is created equally. There’s a domino effect within the tax code. This is just one example. Not only will the Roth IRA distributions not increase your modified adjusted gross income under current law, they also will not increase your Social Security taxation, bump you into IRMA tax brackets, which again, tax-free income from municipal bonds could potentially increase your Medicare premiums. Because that’s how the tax code works.
Just be aware, there’s a domino effect inside the tax code. When you generate income, it bumps up your threshold for modified adjusted gross income in a lot of circumstances, which tips over maybe another domino where certain income is taxed that otherwise would not be, or certain taxes come into effect that otherwise you would not be faced with.
Simplicity is really the key to all things financial and retirement planning. Unfortunately, not all of this is super simple to begin with. Creating visibility, having a plan, sticking to it, having that discipline does tend to make things more simple later in life because those tax-free distributions don’t impact anything else, and everything becomes a bit more easy when you get a little bit older.
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What is a Roth Conversion Ladder and how can it potentially save you $600k in taxes? Head over to the original video to find out.