Don't Over Convert
Should you try to convert all your traditional retirement accounts to Roth accounts to save money on taxes? No. Converting them all will result in higher taxes.
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Full Transcript below:
00;00;00;00 - 00;00;25;00
Unknown
Welcome back to 30 Minute Money. I'm Scott Fitzgerald at Roc Vox Recording and Production. And with me is Steve Wershing from Focused Wealth Advisors. Hey, Scott, how you doing? Good to see you. I'm doing well. How are you? I'm doing very well. We were, We're going to talk about conversions. We're talking about conversions. Big fan of conversions.
00;00;25;00 - 00;00;44;18
Unknown
This is this is something that I've heard you say many, many times over, the years in this podcast. And so I'm very interested because thanks to you, I did actually finally get off my took us and started a Roth IRA. Oh. So, Excellent. Yeah. So I'm interested in. Don't over and over convert. Don't don't take it.
00;00;44;18 - 00;01;05;12
Unknown
You can do any you can take any good thing and do too much of it. So don't do too much of this. Right. And I bring this up because, this came out of a conversation that I had with somebody who was, you know, talking about potentially becoming a client and he had, you know, thought about a strategy about, you know, seeing how fast he could convert all of his retirement plans to, to Roth IRAs.
00;01;05;14 - 00;01;24;19
Unknown
And if you read the literature, if you see the articles and stuff, you might think that's a good idea. But it's actually not a way to optimize, so you don't want to convert everything. And that's what we wanted to talk about today. So, and there are a couple of reasons why you don't want to convert too much or too fast.
00;01;24;19 - 00;01;44;21
Unknown
And in this case, I was talking with somebody who was in the 24% tax bracket. and so, you know, let's let's go back to our the reason why we do this, the whole rationale is, you know, you want to pay tax when you're in a low bracket and defer to or avoid tax to the extent that you can when you're in a high bracket.
00;01;44;23 - 00;02;04;11
Unknown
And when I started in this business, you know, when the Earth was hot and flat and dinosaurs roamed freely, you know, the, you know, generally when people were paying a higher tax rate, when they were working and when they retired, they would go into a lower bracket. And so we all said defer, defer, make IRA contributions, put money in your 401 K.
00;02;04;17 - 00;02;22;02
Unknown
And we got so used to saying that that we kind of forgot why we were doing it. And now things are a little bit different. And there's a pretty good chance you could be in a higher tax bracket in retirement than you were when you were working. And if that's the case, you know, you don't want to you don't want to defer.
00;02;22;02 - 00;02;41;05
Unknown
You want to you want to pay tax now. But, but in this case, we're talking about somebody who was in a relatively higher tax bracket. And when he retired, which is only a few years away, he was going to drop precipitously, into a much lower bracket. So the first thing is we don't want to get carried away.
00;02;41;05 - 00;03;02;16
Unknown
I say in my webinars and my seminars that, you know, my second favorite tax bracket is the 24, 10% tax bracket because it's going away, you know, with when the Tax Cuts and Jobs Act sunsets, no more 24% tax bracket. And then you say the 12 is also going away. Yeah 12 is becoming 15 and the 22 is becoming 25.
00;03;02;16 - 00;03;18;14
Unknown
And I got you you know. So they're all going up. So I like the 24% tax bracket. And I think that we should use it. But it's it's case specific. So in this case he's in the 24% tax bracket now. But there's a pretty good chance in a in 3 or 4 years he's going to be in the 12% tax bracket.
00;03;18;17 - 00;03;36;10
Unknown
So let's not do a conversion because it's better to wait and pay tax at half the rate than to pay it at twice the rate today. So that's why we wouldn't you know, we would. So we don't necessarily want to convert if you're in a high bracket. so the question is how long you're going to be in the high bracket.
00;03;36;10 - 00;03;55;08
Unknown
If you're going to be in a lower bracket later than you may still want to convert, but but convert a little bit farther along. But then we get to the conversation about, you know, his strategy was to convert everything. And, you know, reading reading some of the articles, it would seem like that would make sense. But I try to get people into a into a balance.
00;03;55;08 - 00;04;20;28
Unknown
You know, you want to balance your savings across those three tax buckets taxable accounts, tax deferred accounts, tax free accounts and if you have a nice balance between those things, then you can do a lot to manage your taxes. Now, if you have money in deferred accounts, then yes, when you get to be 73 or 75, depending on what year you were born in, the government is going to force you to take money out of those.
00;04;20;28 - 00;04;44;22
Unknown
It's called required minimum distributions. And one of the big reasons that people convert into Roths is not just to get tax free income later, but to avoid those required minimum distributions. But there's something there's a there's there's a resource. There's a benefit that we have that we're forgetting. If you do that and that is the standard deduction. So you know against your income you get to deduct things before it's taxable.
00;04;44;24 - 00;05;09;02
Unknown
And if you don't have a lot that you can itemize, you and what most people do is they just take the standard deduction. Well in my in my view of the of the perfect world, you are required. Minimum distributions would equal your standard deduction. Because if whatever you know, if it's covered by the standard deduction, they wipe each other out and how much tax have you paid on that.
00;05;09;05 - 00;05;28;09
Unknown
You pay zero zero. Right. So it's an opportunity to take some money out of those accounts at a zero rate, which is even better than a 10 or 12% rate. So it's okay to leave some money in tax deferred accounts. because if you like, if in his case, if he converted now, he'd be paying 24% of the conversion.
00;05;28;11 - 00;05;51;02
Unknown
If he waited until retirement, he'd be paying 12% on the conversion to whatever extent he would take money out of those, whether he's forced to or not. Under the standard deduction, he'd be 0% on those distributions. So you don't necessarily have to go all the way. Now, I have a feeling that you're going to say something like, but this doesn't work for everyone.
00;05;51;04 - 00;06;10;26
Unknown
well, funny you should bring that up, but it doesn't work. Obviously, as case specific. Yeah, it depends on what bracket you're in now, what bracket you're going to be in later. you know, it depends on, where your income is coming from. I mean, there's a big difference between making, you know, $100,000 in CD interest versus making $100,000 in dividends.
00;06;11;02 - 00;06;36;12
Unknown
Right. It's they're taxed at different rates. So it is very specific. You need to look at your own situation. what I'm suggesting, though, is that if your goal is to convert all of your tax deferred accounts into tax free accounts, well, we might take a little more nuanced approach. We might we might not necessarily know because you don't have to convert everything to get the optimal tax outcome.
00;06;36;14 - 00;07;05;06
Unknown
You know, you can you can convert down to a certain point. And then each year, just like, you know, active tax management, I like to say it a lot. You know, active tax management is like vitamins and exercise. It works best if you do a little bit of at a time for a long period of time. You know, you look at each year and see which which kinds of accounts should you be pulling money out of, because you may be able to pull some money out of, out of something and pay 0% income tax, and you may even be able to sell some things at a profit and pay 0% capital gains.
00;07;05;12 - 00;07;11;29
Unknown
It all depends on what that particular year looks like.
00;07;12;01 - 00;07;46;23
Unknown
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00;07;46;25 - 00;08;08;09
Unknown
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00;08;08;09 - 00;08;37;14
Unknown
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00;08;37;17 - 00;09;04;11
Unknown
But like you said doesn't work for everybody. All the situations are different and don't over convert. Yes. Exactly what you're saying. Yeah. And and not only does it work differently for different people, it works differently for the same people in different years. Oh yeah. Because that's something that when you first told me about the Roth IRA and the difference between them in the tax bucket and the tax free and stuff like that, I was like, well, why can't you just take them all and make them in the tax free one or the tax?
00;09;04;13 - 00;09;25;02
Unknown
Yeah, this is why there are a lot of them. There are a lot of parts in this machine, a lot of parts. So what's your 30 minute action item? 30 minute action is what is your balance across those three tax buckets. Thanks again for listening and watching. To 30 minute money three zero minute money. You can find us on all the platforms like, share, subscribe and get in touch with Steve.
00;09;25;02 - 00;09;48;20
Unknown
Wershing at FocusedWealthadvisors.com. We'll catch you next time on 30 Minute Money.