Troy Sharpe: How does your life expectancy impact whether you should or should not do Roth conversions? Today’s video is inspired by a comment that we received from Golden Griffon. Once I read through the comment, it really got the wheels turning because we haven’t done a video like this, and we haven’t shown the impact of similar variables such as what happens if we have a normal life expectancy. If you’re age 65 and a male, actuarially, you should live to be about 83. If you’re 65 and a female, actuarially, you should live to be about 86.
Can we expect life expectancy to continue to increase?
Now, drugs like Ozempic, for example, the weight-loss drug, a recent study came out that showed taking it also reduces the risk of heart attack by about 20%. We’ve seen certain stocks in the market such as companies that do hip replacements and knee replacements take a hit and other companies, sleep apnea-type drugs. The thought is, if we’re skinnier and people are going to be able to take this magic pill or injection and lose weight, well, then other parts of our health should improve.
My point with this story is, even though that’s the average life expectancy, you have to consider your genetic makeup, your lifestyle choices, your current health, your family longevity, all these decisions. If you’re still going to the bar at 65 and smoking a pack of cigarettes, you’re probably not going to make it to age 83. If you’re working out, if you’re doing regular preventative checkups, and you’re living a pretty healthy lifestyle, planning to 83 or 86 if you’re a female may be shortchanging yourself.
As retirement planners, we get to know you, your particular situation. Of course, we’re going to build that box around you as opposed to just putting you into a box. For the purpose of these videos, we tend to show a little bit longer life expectancy. Usually, around age 90 or 95. One, if you think about it, if you pass away early and don’t do Roth conversions, or if you do Roth conversions, it really doesn’t matter too much for your life. If you don’t do them, then you pass away with a lot of money inside your retirement accounts.
It doesn’t matter. If you did do them, well, yes, you pass away with more money in your Roth IRA accounts. It doesn’t matter to you, but it will matter to your spouse or your children or grandchildren, to whomever you’re going to leave the account. We typically plan for a bit longer. Today’s video, I want to show you not only a shorter life expectancy, but we want to look at a single versus a married couple. We want to look at having $1 million in IRAs versus $2 million in IRAs. We want to look at all of these variables and see how they can impact the decision to do a Roth conversion.
Golden Griffon’s Comment: Why he believes Roth Conversions may not be right for most
Golden says, “Good video, though I’m not sure converting is best for the average person. For one, I think most Americans will have a substantially lower income in retirement.” We’re going to look into that. “Few have pensions, rentals, or other investments outside of a 401(k) or traditional IRA, so their future tax bracket will likely be lower and waiting could work out best in the long run.”
“Also, even if doing a conversion still works out better for the numbers, most won’t live the 29 years as your projection assumes. The life expectancy for the average American man at age 65 is only about 17 years. Again, good analysis, but people should realize that this isn’t a typical answer, and the main takeaway is you really need to carefully analyze and decide what is right for your particular situation.”
The last sentence, I 100% agree with. Most of that, I do agree with to an extent. Every single video that we do on here is not meant to provide advice. It’s strictly for educational purpose. What I’m trying to do is get you to understand some of the complexities that are involved with making these types of decisions if you do a Roth conversion. Well, that impacts your account balances.
It also changes the character of the money in those accounts, meaning it goes from tax-deferred and tax-infested to tax-free. It impacts your possible liquidity because you have to send money to the government. It could change when you take Social Security in the grand scheme of an overall analysis. A lot of different variables come into play when it comes time to make decisions.
The purpose of this channel has always been to educate you about what some of these impacts could be from the decisions that you could make. The overarching goal is to help create visibility. That’s the biggest challenge that I’ve seen over the course of my career, is we don’t have visibility into the future with respect to how the decisions we’re making today are impacting our financial security down the road. That’s really what all of these videos is about.
Setting up the variables we’re going to analyze
Okay, we’re going to look at a single person as well as a married couple, but there are some base facts that we’re going to keep the same throughout both analyses. 65-year-old male, 62-year-old female, not changing. When we look at the single person, we’re only going to look at the male. When we look at the married couple, of course, both. His Social Security is $2,500 per month. Her social security, $1,000 per month.
His life expectancy, age 83. Her life expectancy, age 86. We’re going to assume a 4% withdrawal. Even though if you’ve seen a lot of my videos, you know I don’t believe the 4% rule is optimal for most of you out there, but it is a rule of thumb and it’s something to keep an apples-to-apples comparison between these different scenarios. I’m also going to look at what happens if you have $1 million in IRAs versus $2 million in IRAs.
Both scenarios or all the scenarios are also going to assume a savings account, whether it’s a taxable brokerage or a bank, CDs, whatever it is, outside of a retirement account of about $250,000. Liquid net worth is either going to be $1.25 million or $2.25 million. I’ll let you know when we make these changes in the variables.
The First scenario: Single male, 65 years old, $1 million in retirement accounts
When we look at a ranking of some of the top tax and distribution strategies, this dynamic phases, and I’ll go through what the dynamic phases is, is ranked number one and it actually still does include Roth conversions. If we go down here to the first one that does not include Roth conversions, this OCW, which is opposite of conventional wisdom, which would be to withdraw from your IRAs first, let the non-IRAs defer.
I did a video like this a couple of weeks ago. It’s $2 million with $700,000 non-qual, $2 million in the IRAs. This opposite-of-conventional-wisdom strategy actually was one of the top-ranked, if not the top-ranked, if I remember correctly. “Early” just simply means we’re taking Social Security early. At this point, retiring at age 65. The thing I want to point out is we’re always ranking tax and distribution strategies by the total value provided to you in your retirement.
Total value is the sum of the total income that you will receive and the ending balances on an after-tax basis of your accounts. One thing to point out here. Now, there’s thousands of these potential strategies, but the top 5 to 10 to 15, when we rank them by total value, there’s not a tremendous amount of difference here. That’s the first thing I want to point out. The second thing I want to point out is this is just a snapshot in time.
Often, when we work with clients and we go through and we put in place what we’re going to do for step three of the retirement success plan, which is the tax plan, as well as step two, the income plan, this is the path or trajectory that we’re starting on today. 12 months from now, when we’re re-looking at the tax plan for the next calendar year, account values have completely changed. They may be invested differently, the IRA and the non-IRA.
We may have had surprise expenses. We may have new goals. All types of things change. Very well when we re-run the analysis and we re-look at the numbers next year, this may no longer be the path that we’re on. It may make sense to shift away from Roth conversions or let’s say the market’s down. It may make sense to take advantage of that opportunity and maybe accelerate the Roth conversions.
The second thing I want to point out here is this is just a snapshot in time. It’s not a permanent recommendation for a path that we will always continue down. The variables change, account values especially. We have to re-run the analysis and make the best decision with not just the mathematical, the black and white numbers, but also a lot of the subjective aspects of your retirement.
Okay, so high-level dynamic phases is starting in 2023. We’re going to use the conventional wisdom sequence while targeting Roth conversions up to the 24% tax bracket. Remember with the Tax Cuts and Jobs Act through 2025, we have a very, very large bucket for the 24% bracket. We can have over $360,000 of taxable income before you leave the 24% bracket. That’s roughly getting cut in half come 2026.
This particular tax plan, we’re going to target that 24% bracket up until 2026. Then we’re going to withdraw using the conventional wisdom sequence, which is taxable first, let the tax-deferred grow while using Roth conversions to target the 15% bracket. A little bit smaller bracket there. Then in 2031, we’re going to switch over to target the conventional wisdom sequence, but then Roth conversions to target a provisional income level of $44,000.
Provisional income, new word. I’m not going to spend a lot of time on this, but provisional income has to do with how Social Security is taxed. You essentially take all of your income plus one-half of your Social Security, plus any tax-free income from municipal bonds. Add that together, you get your provisional income, and that determines how much of your Social Security is taxed. By keeping it below $44,000, we’re going to have a tax advantage there when it comes to keeping more of our Social Security in our pocket.
On the surface here, we see, this is the dynamic phases. This is the base strategy. No Roth conversion. When we look at just ending value, $2.8 million versus $2.7 million. Again, we’re taking 4% here. This is the withdrawal. 4% of $1 million is about $40,000 a year. I put in about $3,500 a month. Not a huge difference in ending value, not a huge difference in total value. We do save some taxes. It’s about $66,000 in taxes and then we have a longevity of about 18 years, so from 65 up until about 83.
Comparing Outcomes by Account Value Only
First thing I want to point out is the comparison of account values. The blue line here, we have the dynamic phases. The green line, we have the base strategy. On a pre-tax basis, before we take into account how much of your IRA, Uncle Sam, the junior partner in your account owns and eventually will receive, that’s the pre-tax analysis. We see quite clearly that the base strategy, the green line, you have more money in your accounts when you’re looking at it on a pre-tax basis.
If we then simply look at it on an after-tax basis, we do see the dynamic phases strategy crosses over out here around, let’s say, age 77 to 82 or 81, somewhere in that area. We have more money on an after-tax basis. What does that mean for you? Well, if you have to go into your account and take money out for some type of unexpected expense, maybe something to help a child or a grandchild, or maybe it’s something medical, or maybe you want to go an around-the-world cruise for 200 days, whatever that is, your after-tax account balances, that’s how much you take out and then have remaining to do the comparison.
First thing is the required minimum distributions. We see if we do nothing, RMD started age 73, around $60,000. One of the questions that we often receive is, “What is the assumed rate of return here?” Typically, it’s right around about 6%, so not too aggressive. It’s representative of a moderate allocation to stocks and bonds and about 6%. Now, with the base strategy, we have Social Security of about $30,000.
Will most people be in a lower tax bracket in retirement?
I want to address the comment that most people will be in a lower tax bracket in retirement or have a lower income. Someone who saved up $1 million probably had a salary of somewhere between $50,000 to $100,000 over the course of their career. Now, of course, you could have had a lot more than that, maybe even less than that, depending on how aggressive you were with saving.
Typically, if we find someone that comes into our office and they have $1 million, they weren’t making $200,000 or $300,000 a year. They were just very diligent with how they saved. The notion that we will have less income or be in a lower tax bracket in retirement oftentimes overlooks what required minimum distributions will force us to take out, which is part of our income, which determines our tax bracket, but then also the power of Social Security.
When we look at age 73 here, we have about $33,000 of Social Security and we have about $60,000 of RMDs. Let’s call it $90,000. If we have any other income whatsoever, it’s $73,000, $75,000 as RMDs increase, Social Security increases as well. It’s not a foregone conclusion that you will be in a lower tax bracket in retirement. This doesn’t even take into consideration the fact that taxes could potentially be much higher in retirement.
Which potential outcome would you prefer?
To wrap up this first analysis here, again, not a ton of difference in the numbers, but there’s more to the story. Composition of accounts. If I were to simply ask you, all things else being equal, what would you rather have? The gold is tax-free, the blue is your tax-deferred, and the green is your non-qualified or your taxable accounts. All things being equal, if I were to simply give you this choice, A and B, and drop you at age 74, would you rather have more money inside the retirement accounts, or would you rather have more money inside the tax-free retirement accounts?
Well, all of you, of course, would say tax-free. Even though the numbers are the same and there isn’t on the surface, just looking at the mathematical side of it, an advantage to doing one or the other, I think when we start to look beyond the math, we would much rather be in this particular situation. Another example. Let’s say you want to give money to your kids. Well, if you give this to your kids, they’re going to be much happier than if you give this to your kids because the SECURE Act forces all of this retirement account money to be fully distributed from your IRA within 10 years of the date of death, by December 31st, 10 years after you die.
Well, depending on what state they live, this is $2 million in the IRA. Let’s say they receive that. Let’s say they’re married, making $100,000 a year. You take out $2 million from the retirement account, 30%, 40%, 50% of this possibly going to the government. This account, you give them this. Now, this is going to grow for another up to 10 years, still has to be distributed, but there are no taxes due. One other thing to point out here on this scenario, we see the tax impact.
We do have tax savings. This is the cumulative. At age 83, $203,000 of the dynamic phases. That’s how much estimated we will pay in tax versus the base strategy over here, $269,000. We do have that tax savings. It is important to see though, following the base strategy, we could have a lot fewer taxes paid in the beginning years versus over here doing Roth conversions because we have to pay the piper up front.
Then we get into a much lower tax risk zone. Meaning if tax rates go up, it doesn’t impact us. If hidden taxes come into the picture, the hidden tax is something that Congress passes like net investment income tax, which is if you have a certain level of income, now, your investments are taxed at a higher rate, your investment income, or IRMAA charges, which is a Medicare surcharge. It stands for income-related monthly adjustment amount.
Those types of taxes are hidden because they aren’t necessarily widely known by everyone, but also they’re not part of the federal income tax system. They’re excise taxes. They’re things that Congress passes to address certain shortfalls in the budget.
Changing life expectancy from 83 to 88
Okay, I’ve made the first adjustment and it’s to change life expectancy from 83 to 88. We see here. First, we have a couple, hundred thousand. Let’s call it $250,000 in estimated ending balances being higher.
We have $231,000 in estimated taxes paid versus $489,000. Pretty much a direct correlation between the amount of taxes saved and the increase in ending value. That’s 83 to 88. Again, you may not live to your average life expectancy, but you should understand the lifestyle choices that you’re making and how that compares to the overall average American. If you are getting preventative checkups, you may want to consider living a bit beyond.
I don’t want you to discount, though, the possibility that science will continue to advance our longevity. Not just possibility, but probability. We mentioned the Ozempic drug earlier in this video, which is a fairly new development, but fairly solid results at not only helping to reduce or increase weight loss but also reduce the risk of heart attack by about 20% in a massive study. Another example, we sponsored a big event with the Leukemia & Lymphoma Society a year or two ago.
I was talking with one of the doctors and he was telling me that just five years ago, there were several forms of adult leukemia that were basically death sentences. Now, today, due to all the donations and all the research and the scientific advances that they’ve achieved over the past five years, those diseases are no longer death sentences. They’re now completely treatable and even curable in a lot of instances. Please don’t discount the advances in medicine to potentially increase your life expectancy.
Okay, still on the single male, life expectancy, 83. I’ve increased the IRA balance from $1 million to $2 million, increased the spending from $3,500 a month to $7,000 a month. Again, when we look at the total value, we’re not seeing a huge difference between the top 5 to 10 ranked strategies. What is interesting here is that the conventional wisdom with taking Social Security early is now ranked number one.
We see, compared to the top-ranked Roth conversion strategy, negligible difference. Now, we start to look at some of the other considerations that we talked about earlier, and we’re going to get into especially when it comes to the married couples.
Unique considerations when it comes to doing or not doing Roth Conversions
I want to point out some unique considerations when it comes to not doing Roth conversions versus doing Roth conversions in this comparative analysis.
First, the glide path. The green is doing Roth conversions. The top-ranked one based on value, the blue is not. We see on a pre-tax basis, the Roth strategy never catches up. On an after-tax basis, it really only equals right out here at life expectancy age 83. Again, this is $2 million in retirement accounts, still single. Required minimum distributions. This is where we start to see the income bracket or tax income bracket potentially getting pushed up, which introduces more tax risk into the picture.
We see here with required minimum distributions, this is where income levels start to really get pushed up. It’s because we’re forced to take that money out of the retirement account. No matter whether we do Roth conversions or not, if we’re targeting one of these optimal strategies, RMD still start around $100,000 and they’re increasing throughout the rest of retirement.
When we have done a really good job saving throughout our accumulation years, when we get to retirement, again, the assumption that we will be in a lower tax bracket, oftentimes we just find it to be false. Now, if you have not saved a lot of money heading into retirement, well, yes, you’re going to be in a lot lower income tax bracket because you may just be depending on Social Security.
If that’s the case, well, that’s common sense. If you have saved $1 million, $1.5 million, $2 million, anything that is a significant amount of wealth to anticipate being in a lower tax bracket, unless you’re proactive about your Roth conversion strategy, is probably unlikely. As we begin to look at the ledgers here, again, we don’t see that much of a difference. One thing to note, though, is, mathematically, on the Roth conversion strategy, while we’re doing conversions, we are also deferring Social Security.
This does a couple of things. One, it leaves more room in the tax brackets for conversions because Social Security isn’t filling up that bucket. It gives us more security on the back end. When compared to not doing anything and taking Social Security early, we see total taxes paid, $534,000 versus $510,000. Ending before tax balance, $4.35 million, $4.2 million. After-tax balance, $3.5 million versus $3.55 million. Not a ton of difference between the two scenarios.
Composition of accounts. No Roth conversions, Roth conversions, we see really not a big difference with life expectancy at age 83. In this particular circumstance, living until age 83, the spending level, $2 million in IRAs, $250,000 in non-qual, we don’t see a big benefit to the Roth conversions. It’s just a matter of flavor. Do you want to go down that path or do you not? That’s just the analysis this year.
The importance of monitoring, assessing and adjusting
We would make a decision on what we want to do and then re-look at it next year because the analysis could completely change based on multiple different possibilities. Same scenario. I’ve just changed life expectancy from 83 until 88. Some savings and taxes, about $130,000. Account balances, $4.2 million versus $4.3 million, so we do see some modest benefit. Let’s look at the composition of accounts. We see here that even though there’s not a huge mathematical difference, you have to ask yourself, “Which situation would you rather be in?”
Here at age 78, it’s estimated we have about $800,000 inside that tax-free Roth IRA versus down here, everything is in the tax-deferred. Not a huge difference when we’re doing the mathematical analysis at life expectancy. Again, it’s some of these subjective things such as would we feel more comfortable having a diversified tax bucket at this stage of life if taxes went up or if hidden taxes came in, or let’s say we wanted to have one-time expenses that were fairly large. We’d like to be able to control from where we can pool income to determine how much goes on our tax return, which gives us the flexibility to pay less tax.
Married Couple Examples
All right. Now, we’re going to transition to the married couple. We’re going to wrap this video up. We’re not going to go too much longer, but we’re going to keep it at what we talked about earlier, 65 and 62. Here’s the Social Security levels, normal life expectancy for each, 4% withdrawal. We’re just going to look at $1 million and $2 million inside the IRA and the optimal Roth conversion strategy, and then a couple of considerations that are very important.
First thing we notice here with the top-ranked strategies, this is $1 million IRA balances spending the 4%. All of the top-ranked strategies involve Roth conversions. Think about it. If the husband passes away at age 83, but the wife here is three years younger and her life expectancy is longer, so we have a longer time frame. Typically, the longer time frame you have for either spouse, the more advantageous it will be to do Roth conversions because you’re going to give yourself more time to allow that account to compound tax-free, and you’re going to create a larger total value.
High-level numbers, we have about $500,000 in higher estimated ending balances, and let’s call it about $315,000 of less tax paid. We start with the glide path. On a pre-tax basis, we still don’t catch up until a little bit later in life. On an after-tax basis, this catch-up is much sooner. This is really around the early to mid-70s. Here’s the big one. We look at required minimum distributions. The green is not doing Roth conversions compared to if we’re doing Roth conversions.
We get into a situation where we aren’t forced to distribute so much from our account. That removes the potential for tax risk in the future to impact our security. Showing the ledger, base strategy, we pay very little taxes. We do get into a bit of a tax bind here. Here’s the thing I really want to point out, though. The age here is the husband’s life expectancy. He passes away at age 83. I want to point out that the taxes, even though we lose one Social Security check, we go from the married filing jointly tax bracket to the single tax bracket.
We see the Social Security drop from $58,000 to $39,000, but taxes actually go up from $31,000 to $34,000. This is a tax risk that is especially important for a married couple to consider. When we look at the Roth conversion strategy, husband still passes away at age 83. We see the drop in Social Security. Because we’ve integrated the tax plan with the income plan and Social Security, steps two and three of the retirement success plan, we see here that we’re not being hurt by transitioning from the married filing jointly brackets to the single brackets.
An ancillary benefit or a removal of a potential future tax risk is the Roth conversion strategy where we don’t have to worry about that transition. Finally, we have the composition of accounts, something else to consider when it comes to whether or not to do Roth conversions. When we look at doing conversions, different tax strategy than before, then, of course, than just the single person, it’s more Roth conversions. We see how much more we have in tax-free money versus the base strategy.