You’re 60 with $1.5 million. Today we’re going to look at two different scenarios, A and B. Everything is absolutely identical in these two scenarios except for one thing. That one thing leads to an estimated $1 million more in ending account balances, and about $600,000 less in estimated taxes paid. As a bonus, I’m going to throw in some important concepts that tie into retirement income planning and tax planning that you should know to benefit your retirement.
Key Parameters and Account Composition of the Hypothetical Case Study
First, we have the base parameters of this hypothetical case study. They both have Social Security and both are 60 years old right now. Her Social Security is $1,500 a month at her full retirement age. His Social Security is $3,600 per month at his full retirement age. That’s $67,000 for both of them. Spending level is $84,000 per year, increasing with inflation over time.
The $1.5 million of retirement savings is broken down into $1.2 million of IRA dollars and $300,000 of non-IRA dollars. There will be a few layers to this video. What we’re going to do is we’re going to look at the comparative analysis between that one thing that’s different between A and B, which is the tax conversion strategy, and also the income distribution strategy.
We’re going to layer in some finer points of the overall strategies and the analysis, but also give you some concepts that you can hopefully apply to your own retirement and your thinking about your distribution and tax strategy.
Here we have Scenario A. Here we have Scenario B. Everything is identical. The base parameters, like we said, the spending level, the Social Security amounts, the portfolio allocation, the rate of return, the longevity. The only thing that’s different here is Step 2 and Step 3, income planning and tax planning.
Scenario A, we see an estimated ending value of $2.44 million versus Scenario B, an ending value of $1.4 million. Total taxes paid, $230,000 versus almost $800,000 in taxes paid. Again, nothing is different except for the income strategy and the tax strategy. We’re going to dive in to what exactly helps us have $1 million in estimated more account balance and pay about $600,000 in less taxes.
Upcoming Tax Law Changes to Know
The first big difference here is the tax strategy, or the Roth conversion strategy. What we have, this is Option A. This is the one with more value. This is the one with less taxes. We see Roth conversions planned for 1, 2, 3, 4, the first four years of retirement. This is ’23, ’24, ’25, and 2026. It’s important to point out that in 2026, the Trump tax cuts go away. They sunset at the end of 2025. This means the tax brackets will be more compressed, meaning you can withdraw less from your retirement accounts before you approach that next tier, the next tax bracket. Also the tax rates will be higher in 2026. This is already the law. Unless something changes, some type of legislative action either extends the Trump tax cuts, which I think is unlikely, or some type of new tax legislation gets passed prior to the sunsetting of the Trump tax cuts at the end of 2025, which I also think is somewhat unlikely, but it’s possible.
Roth Conversion Ladder – What is it?
One thing I want to point out here is sometimes you’ll hear people refer to this as a Roth Conversion Ladder. We even put this in the title of the video because we find that many people are searching that term. This is why they call it a ladder. We’re converting different amounts over time into the Roth IRA. We’re laddering that. As opposed to just doing one large conversion at once, we’re doing a series of smaller sequential Roth conversions, optimizing the strategy by targeting a specific tax rate.
The Roth conversion here, this is option A. This is the one with less taxes and more estimated ending balance. Option B is no Roth conversions. It’s what we call the conventional wisdom method. It’s important to point out that the conventional wisdom method has been given as advice in this country for decades, and for most of you, it’s the exact wrong way to distribute your retirement savings. What that conventional wisdom advice is and has been is to defer your retirement accounts as long as possible. Allow that compounding interest in that tax-deferred account to benefit from the fact that you don’t have to pay taxes annually. What you do with conventional wisdom is to withdraw from your non-retirement account assets first until they’re exhausted, then you spend down that retirement account. If you’re an avid watcher of this channel, and you actually see in this video today, what type of problem that can create later in life, because you’re forced to start distributing money from that account, and if you have any significant savings, around $1 million, $1.5 million, $2 million plus in that retirement account, you can be in a very precarious position later, have tremendous tax risk because those required distributions, when added onto your Social Security income, any other sources of income that you may have, can put you into much higher tax brackets, which has a domino effect across the entire tax spectrum, I mean your Social Security check, potentially your Medicare premiums. It creates excise taxes possibly with your investment income. It can really be a problem. For most of you, the conventional wisdom is not the right way to distribute from your retirement savings.
Here are the actual dollar amounts of that bar chart. We have $153, $143, $138, $93, and then a couple of small conversions here in 2027 and 2028. This is important to point out. If you have $1.5 million and you’re 60 years old, this is not instructions or advice on what you should do. This ties into the overall plan. In this hypothetical case study, I really want to show you what’s happening so you can understand where the value comes from, how less taxes are paid, and how that translates into about a million dollars in estimated increased account balances at the end of the plan.
Now I want to show you the over time income distribution strategy, but also introduce a couple of concepts. These are some of the layers that I talked about in the beginning of the video. As we can see here, this column here, this is distributions from the tax deferred. It’s important to point out that these are not distributions that you’re living off of. We’re taking those and we’re putting them into the Roth IRA. We’re paying taxes from the taxable account, the non-qualified, and we’re also supplementing our living expenses with the non-qualified distributions.
Over here is the column for Roth. Now, once we’ve exhausted the taxable because we’ve been paying taxes and funding our retirement lifestyle from the non-qualified account while doing these Roth conversions, we now enter into a different phase. This is a multi-distribution account phase where we’re taking some, after the conversions are done, we’re taking retirement withdrawals from the IRA, but then starting to couple them to fill gaps and target specific tax brackets from the Roth IRA.
Down here, we start to see a reduction in Roth account withdrawals, and a reduction in IRA withdrawals because Social Security is starting to turn on and come into the picture.
The concepts. The first one is what we call a multi-account distribution strategy. It’s just exactly what it sounds. We’re distributing from multiple accounts, IRA, non-IRA, Roth, so we’re doing a combination.
The second concept is sequenced phases, meaning for a finite period of time, we are going to have a certain phase of distribution and tax strategy. Maybe that’s for three years or for four years, but then we stack that onto another phase of an income and tax strategy, and then oftentimes that’s stacked onto a third phase of an income and tax strategy. Here, we actually see that.
The first phase would be doing Roth conversions while spending down the non-qualified accounts to pay taxes and fund our lifestyle. The second phase would be we’re taking strictly from the IRA, continuing to spend that down so we don’t get into a big RMD problem later, targeting a specific tax bracket. Then the third phase is a multi-distribution account strategy, where we’re taking from two different accounts at the same time. We’re bringing Social Security into the picture, so that reduces the amount of income that we need to withdraw. Then the final phase here, which we actually don’t get into in this case study, would just be a single account distribution, and that would be a scenario to where we’ve used all of the IRA and we have nothing but Roth money left, which is 100% tax-free for all of your life, but also up to 10 years after you pass away and give it to your beneficiaries.
We have phased sequences, or sequenced phases, however you want to say that, combined with a multiple account distribution strategy. The sequenced phases, they last for a finite period of time and they’re stacked on top of one another. Then, of course, the multi-account distribution strategy, it’s just those phased sequences broken down into a different strategy over time.
The secret here is to identify which tax rate, or average tax rate, we’re trying to target which optimizes the amount of money that we have today, but also the amount of money that we have in the future while helping us to pay less taxes.
Withdrawing More than 4%: Balancing Risk and Security
One thing I want to point out here is the withdrawal rate chart. What we see here is we’re actually implementing the strategy, the withdrawing $84,000, doing the Roth conversion strategy. We’re taking more out than 4% in the first few years of retirement here. This flies into the face of that, again, conventional wisdom methodology for retirement account distribution. I’m completely fine taking more than the 4% out as long as we have a plan that keeps us connected to how those decisions are impacting our future security. That’s what’s most important.
We build plans all the time where people are withdrawing more than 4%. What you can’t plan on doing is withdrawing 7% or 8% out, and then doing that for 30 years, especially if you have an aggressive investment allocation. It’s fine as long as we stay connected to the plan, we’re willing to adjust when circumstances require it, such as crashing markets. Right now, for example, bonds have been down for three consecutive years. Stocks, really volatile ride over the past couple of years. We need to introduce more secure strategies into the overall retirement plan to increase the probability of success.
If we’re fine withdrawing more, even though it does fly in the face of that 4% rule, because we’re building custom plans for you and we’re staying connected to those plans. Very important concept, don’t feel that’s more than 4%, I can’t do this tax conversion strategy, I can’t spend more than that. Just stay connected and understand how those decisions are impacting your future security, and be willing to adjust as circumstances change.
I want to look at the comparative analysis now between these two different strategies, A and B, in multiple different forms. The first one is just this glide path here. What this is showing is the estimated account balances in the blue line, which is option A, the tax conversion strategy, which estimates to provide more value and pay less taxes over time, in the green line. This is very important to understand with what I just said about higher distribution rates, because when we implement the tax conversion strategy, one of the considerations is, I’m likely to have less money than I would otherwise, because I’m actually writing checks to the government, and that’s money I don’t have in the account to earn interest and to grow. If I continue to live my lifestyle, continue to do these conversions, we see quite clearly what happens. The estimated account balances decrease compared to the green line, which is option B, the less efficient conventional wisdom strategy.
First and foremost, you have to make sure emotionally that you’re anticipating this happening, because a lot of times what we’ve seen is people get going down a certain path, but then once we get into that path, it’s gut check time. Can you really stay committed to the plan? It’s one of the things that we require or have a conversation about requiring if we have this investment allocation, if we go down this tax conversion strategy. We don’t want to put one foot in and one foot out and be half in. If we’re going to execute a plan, we draw the plan up, we communicate the plan, we implement the plan, and then we execute it on an ongoing basis.
What’s important to point out here is that even though this green line is higher than the blue line, meaning you have more assets in this plan than the other one, those assets are less efficient. Your accounts in retirement are designed to provide income, and one of the key optimization strategies is to accept and believe the fact that higher account balances that produce less efficient income, tax-infested accounts which produce highly taxable income are less valuable than having smaller account balances that produce highly efficient after-tax income, or highly efficient income, and it’s highly efficient because it’s after-tax.
There are several reasons for that. One, if you don’t have to worry about taxes on your income that’s being distributed, it has a domino effect. It can help you pay less tax on Social Security, and other aspects of the tax code can benefit you. I’m not going to get into them all right now, but just trust me on that one. I will show you Social Security.
Number two, you have less tax risk in your overall portfolio. That means in the future, if tax rates rise, if laws change, government passes higher tax rates, it won’t impact you, so you’re removing that risk from your portfolio.
Number three, you can create the same effective return with less risk. Let me explain that for a second. If I have a tax-infested IRA account, and I need to generate 4%, because that 4% is going to be distributed, then I’m going to pay taxes on that income. I’m left with, say, 3.2%. To generate that same after-tax return in the Roth IRA, theoretically, I can have a more conservative portfolio to generate that 3.2% distributed tax-free, and now those two incomes are equal. I’ve been able to take less risk with my assets and generate the same income after taxes as the IRA example, where I have to take more risk, take that income out, and then pay taxes on it.
There are a couple more reasons, but I just want to focus on those three because I think they’re the most easy to explain, and also most easy to understand when it comes to generating after-tax income.
Optimizing Social Security: Maximizing Benefits
Here’s a big one. Required minimum distributions. The green, same thing. We see here that we have large required minimum distributions with a conventional wisdom method. They start out, let’s say, it’s around $67,000, and over time, you get up to $124,000, and even higher.
Versus the blue, the tax conversion and income distribution strategy that we’ve been talking about, very small force distribution. You don’t care if taxes go up in the future, you don’t care because your money is in a tax-free place. Because if you’re in this situation and you have to make these big distributions on top of social security, on top of any dividends or interest, possible rental income, now all of a sudden you’re mid-70s, early 80s, and you have $200,000, $300,000 of income, you are subject to tax risk. Meaning if tax rates go up at that time, there’s nothing you can do. You’re forced to distribute this money, you have those other income sources. It just, it is what it is.
For the final piece here, we’re going to look at where all the savings come from, but also the social security strategy, and tie this all together. Here we have tax strategy, income strategy we’ve been talking about versus the conventional wisdom.
First thing, in this more optimized strategy, the first spouse, the wife, is turning her social security on at 67. She’s receiving that income, then the husband turns his on, and we see how much Social Security becomes with that optimal Social Security strategy. It doesn’t mean you have to do this, but it is mathematically the most optimal given the circumstances.
Compared to the base, we just have both spouses turning Social Security on here at 67. We see, if we go out to 75, Social Security is $78,000 versus $91,000. More money from Social Security. Primarily, the benefits come from the tax savings. We are paying taxes because we’re doing these conversions. We’re withdrawing money from the accounts. Here’s our estimated taxes paid in the first, let’s say 10 years of retirement, compared to over here on the base strategy, we could pay no taxes for the first four years, but we’re not creating any benefits for the future. We’re not removing that tax risk, we’re not putting ourselves into a more optimal situation.
Then we simply see on a comparative basis, things start to even out in the middle rate here. Where it really becomes clear that there are benefits from the tax and income planning distribution strategy is when we look at these out years. Let’s say about age 70 on, so basically paying no taxes in this column, versus over here, we see what these taxes begin to look like, and as time goes on, tens of thousands of dollars and more taxes.
At age 70, this column is before-tax and after-tax balance. It’s just simply saying, okay, this is what we have before taxes still in the retirement accounts, this is the after-tax equivalent. $1.2 million versus $1.5 million. In the base strategy, we do have more assets. That was reflected in the line chart that I showed you. Again, those assets, if you look at them in terms of their ability to generate after-tax income and all the benefits that comes with that after-tax income, we see that it’s not as efficient. Even though we have more money, it’s simply not as efficient.
I’m not telling you one is better than the other. What I’m showing you are the concepts to consider when looking at how to distribute money from your retirement accounts. How much, from where, do I do Roth conversions, how does that impact you, how does that make you more secure over time. You ultimately make the decisions. Understanding these concepts that we see on a day-in and day out basis, and have been doing this analysis for many, many, many years and seeing these plans play out, is the goal with this video.
Final Analysis: The Roth Conversion Ladder’s Impact on Taxes and Wealth
Bringing it on home, we have the optimized tax and income distribution strategy compared to the base case here. We see almost $600,000 in estimated taxes saved. We went through how that is created, that savings, as well as an estimated $1 million in estimated account value from the tax and income strategy. That’s the one thing. That’s exactly what we did here. Everything else was the same. The rate of return, the longevity, the amount of withdrawals, the one thing that changed was the tax and income strategy. I guess technically that’s two things, but for us, we look at them all as one, because how much income and where you withdraw your income from determines how much tax you pay.
Understanding how those decisions impact your long-term security is what we call visibility, having visibility into the future and the impact of your decisions today.
If you have questions or comments, head to the video and post them because I plan on doing a response video to this one. I expect a lot of feedback. We’re going to find the best comments that we feel can benefit the most amount of people when we create that video.
➡️ Do you need a Retirement Success Plan that goes beyond allocating funds to truly fit your needs? We can help you create a retirement life plan customized for your retirement vision and legacy. Call us at (877) 404-0177 or click here to fill out this form for a free consultation.
Disclaimer: This video discusses fixed-income investing and utilizes the 10-year U.S. treasury as a general representative fixed-income investment. Conclusions reached, opinions stated, and downside risks and potential returns presented should not be construed as applying to other types of bonds or fixed-income assets. Other types of fixed-income products carry different levels of risk and return potential and should be evaluated as an element of a diversified portfolio with your specific risk tolerance, investment objectives, and timeline in mind. Nothing in this video is investment advice, an investment recommendation, or an offer to buy or sell any security. Investing involves risk.