Should I convert my tax infested IRA to a tax free Roth IRA?

Should you convert to a Roth IRA? Could it possibly save you tens of thousands if not hundreds of thousands of dollars in potential taxes? What are the pros and cons? And how does it impact your overall retirement income plan?

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, host of The Retirement Income show, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®)and author of the upcoming book Core Four.
When we talk about generating a retirement income plan and building a retirement income plan customized to your goals, what’s most important to you about your money, there are a lot of things that go into those considerations.

When we look at what’s most important to you, and start to map out a strategy for generating income, reducing taxes, making sure you don’t run out of income, and also making sure your spouse is okay if something should happen to you, there’s a lot of work that goes into that, and one of the strategies available to us is to take advantage of the fact that taxes are on sale today.
Right now, under the current tax law, you have the greatest opportunity in the history of your lifetime to take money from your tax infested IRA accounts and convert that over to a tax free Roth IRA. But for some of you, it may not be the right thing to do. And for others, it could potentially save you tens of thousands, if not hundreds of thousands or even more, in retirement income, in taxes on your retirement income.

We’re going to go through today and talk about some of the considerations that you should understand before making this decision and talking to a tax advisor or your financial professional. So when we look at, so this is an example of an analysis we recently did for a new client, and one of their primary concerns was taxes are going to be a lot higher in the future, and we want to take advantage while taxes are on sale today. So we do this analysis to look to see how much should we convert to a Roth IRA? What are the taxes that we will pay now? And what are the taxes that we will potentially save down the road? And how does it impact portfolio longevity and retirement income, account balances and many other factors.

So when we look here, the blue lines right here are representative of total taxes paid on an aggressive Roth conversion strategy over the next several years. So this is converting from IRA to Roth IRA up to the 32% tax bracket. And as you can see, it generates a good amount of taxes in the beginning years, and what this does is this reduces the overall account balances. But it’s a planning strategy that over time, what we’re trying to do is to take tax risk off the table.

So this chart, total tax chart, shows us for the first let’s call it eight, nine years of retirement here as the conversion is taking place, there are a lot higher taxes than an opposing strategy, what we call conventional wisdom. So conventional wisdom is recommended by many, many firms today, the big brokerage firms, the big publicly traded companies, for years, they’ve told you to defer your IRAs until you’re 70 and a half and live off your non IRA money first.

Well, while they’re telling you to do that, we’re telling you to consider an alternative strategy, because if you believe taxes could be higher in the future like we do, this is something that should be interesting, and you should consider looking at a different retirement distribution strategy.

So this is just a visual of total taxes paid in the upfront years from doing a Roth conversion. But as you see, as we get out here, in 2029, 2030 and beyond, the orange lines, these huge lines, this is representative of the potential future income taxes you would pay by not doing any Roth conversion strategy and following that conventional wisdom advice.

So total taxes, you get 50, 70, 100, 125, 150 $175,000 a year, and this doesn’t take into account what happens if taxes are much higher in the future. So we’re just looking at current tax law with the sunset provision in 2025 of the Trump tax cuts. So taxes are on sale right now, if there was a flashing sale, let’s say out of the department store and you wanted to get some new clothes, for me, I want to go to the department store while the sale is going on. I don’t want to wait until the sale is over and then go shopping. And by not looking at Roth conversion, that’s kind of what you’re doing. You’re waiting for the sale to get over, letting the IRAs balloon in value, and then carrying this tax risk where you have to take all the money out and tax rates we know will be higher in 2026, they could potentially be much higher in 2026 and beyond if legislation is enacted to increase the personal income tax rates.

Another side effect of not doing Roth conversions are required minimum distributions. So this chart shows a comparison of doing the aggressive Roth conversion strategy and paying the taxes while taxes are on sale, versus not doing it, following the conventional wisdom advice. And as we can see here, once we get to required minimum distribution age, which is 70 and a half, you are forced to start distributing money from your retirement accounts, required minimum distributions jump from 50,000 to 100,000 to 150,000 to 200 to 225,000, for this particular family.

Now, when you have high required minimum distributions, you’re effectively forcing money out of your IRAs in a time period where taxes could potentially be much higher and this is what we call carrying tax risk into retirement. Now, we don’t have any blue lines here, and the reason is, is we’ve done the Roth conversion strategy while taxes are on sale, getting those IRA balances down, converted to a tax free place, so we’re not forced into required minimum distributions of these exorbitant amounts down the road in 5, 10, 15, 20 years.

So one of the downsides, though, to doing a Roth conversion, is what we call the crossover point. So yes, when we do a Roth conversion, we’re reducing our future income taxes, we’re taking tax risk off the table, we are protecting our spouse if something should happen to us, because when one spouse passes away, the surviving spouse goes into the single filing tax brackets, which are much more punitive than the married filing jointly tax brackets.

But what we have to consider is this tradeoff between account balances, that you can have money invested and earning interest and compounding for your future, versus carrying tax risk and having more income being forced out of your IRA in potentially future higher tax rate environments. So what this graph here depicts is the crossover point. So the orange line is account balances without doing any Roth conversions, just following the conventional wisdom, letting your IRAs defer until age 70 strategy, whereas the blue line here is the more aggressive converting to the 32% tax bracket strategy.

So the account balances are less when we’re doing Roth conversions, because we’re taking money and we’re sending it to the government to pay taxes in this low tax rate environment. The crossover point for this family is around 85, 86, when it comes to account balances. But, big caveat here, when we look at account balances here, this is a higher net worth couple starting with about $4 million of net worth, and how much money you have also does dictate to a certain extent whether you should do Roth conversions or not. There are many, many variables that go into it, it’s not just the taxes that you could potentially pay.

So when we look at, on the left side here, we have converting aggressively up to the 32% tax bracket. On the right side, we have the conventional wisdom. When we look out here, let’s say age 75, there’s about 6.9 million in the account balance total for the Roth conversion strategy.

The same year, there’s about 8.3 million in the conventional wisdom strategy. So yes, we have higher account balances by not doing the Roth IRA, but my question to you is, is all of that money really yours? Because you have a partner in that account, Uncle Sam is your partner, and if we needed to get in and take a million dollars out for health care, for medical, passing it on to the next generation, whatever it might be, or income, we don’t really have 8.3 million, because a good portion of that distribution is going to have to go to the government.

So yes, your account balances are much higher when you don’t do the Roth conversion, but you’re carrying that partner in your retirement account throughout retirement, which leaves us exposed to potentially higher income tax rates and potentially punitive legislative action that could upon distribution really destroy a lot of our IRA account balances. So a lot of things to consider when we start talking about Roth conversions. Not only is it the total taxes we’d pay initially and how that impacts the taxes or lack of taxes we’ll pay in the future, we also have to consider required minimum distributions, account crossover point, future legislation, tax risk, legacy goals with the new secure act that is going through Congress it looks like your IRAs, upon passing to the next generation, are going to have to be distributed over a period of either five years or 10 years. So your kids are going to be forced to take the money out of their retirement accounts anyways, and pay income taxes in these future years where we could have higher rates.

So not only did these considerations go into it, as well as many others that I can’t cover entirely in this video, you also have to look at the effect of high required minimum distributions have on other aspects of the tax code in a retirement plan.

So I’ve already went through this, yes, if we have high required minimum distributions, this is the chart I’m talking about over here, we’re not doing any conversions, letting the IRA balances balloon and being forced at 70 and a half to start distributing, we understand that, yes, we could potentially have higher income tax rates. But we also have to understand that we can get bumped into Medicare tax brackets.

This is called IRMAA, IRMAA, and it stands for income related monthly adjustment amount. And your Medicare Part B premiums can go from $135 per month per spouse, right now under current law, to over $400 per month per spouse. So you’re talking over $10,000, potentially, in increased Medicare taxes, by having these higher required minimum distributions being forced out of your accounts, and putting you into these excise taxes, these Medicare surcharges.

And then additionally, we have the 3.8% net investment income tax. So when you have high required minimum distributions, you have to not only be concerned about higher income taxes, but potentially higher Medicare taxes, and also the 3.8% investment income tax, plus more legislative risk, any other laws that get passed in the future that are going after people with high incomes or high asset levels, high required minimum distributions by not doing any Roth conversions could potentially bump you into some of those higher brackets and higher tax thresholds, thereby reducing the longevity of your portfolio and giving you less income in retirement.

So the last thing just to reiterate, that I think is very, very important and this is one of the most punitive aspects of the tax code, is when one spouse passes away, the surviving spouse goes into the single tax brackets. So I recently did an analysis for a couple, and they had about $100,000 of income, and one of his most important goals was, Troy, what happens if my wife, I want to make sure my wife is okay if I pass away, what type of income tax situation will she be in?

Well, when we did the analysis, they lost one Social Security check, because when a spouse passes away, you lose a Social Security check. Their income went from 100,000 to 85,000, but their taxes went from 10,000 a year to 17,000 a year. So a 70% increase in taxes just by going from the married filing jointly brackets to the single brackets. And keep in mind that’s with a $15,000 lesser income, because one Social Security check went away.

As you can see, there are a ton of variables that go into trying to determine Should I convert to a Roth IRA? How much should I convert to a Roth IRA? And how does it impact my overall retirement income plan?

I encourage you, if you have these questions, reach out to us, send us an email, give us a call, and we can help you figure this out for your particular retirement based on what’s most important to you with your money. Understand that a lot of these decisions should be worked through with a financial professional who is proficient in retirement income planning, because every decision you make will have lasting impacts on how long the money lasts, how much income you’ll have in retirement, and how many taxes or how much you’ll pay in tax over the course of a 20, 30 maybe 40 year retirement, so I encourage you find someone who knows what they’re doing.

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