This is another episode of Ready for Retirement . I'm your host , james Canole , and I'm here to teach you how to get the most out of life with your money . And now on to the episode what's up .
James , how are you doing ? I'm doing well . Have you ever been happy to get a surgery ? No , I don't think most people are happy , but I have a weird situation where I was really happy about the thought of getting surgery because I thought it would fix all of my problems . I went to physical therapy . I got an MRI that set up this diagnosis .
I went to so many doctors . No one told me what to do . So at one point I was like look , just open me up and just fix me . I'm in that much agony because of my hip , because I play soccer too much and I love it . And that's another episode of my hip , because I play soccer too much and I love it , and that's another episode .
But I'll see people come to me and I'm sure you've seen it as well where they go . James , just tell me what Roth conversion do I do ? Is it the 22% bracket ? Well , it's going to become 25 . So I don't know what bracket do I do . They're conversion happy and they just want to do a conversion because they think it's going to fix all of their problems .
In the same way , I thought surgery would fix all of my problems . But before you do surgery , there are things we should look at , and so I want to talk to you today about when it does and does not make sense to do these Roth conversions .
I like that analogy because it is like surgery , because people don't realize this Roth conversions are painful up front . In the same way , surgery can be painful up front . And I mean that because what you're doing , the Roth conversion , is you're saying I'm going to pay more taxes today so that I don't have to pay as much in the future .
I'm going to pay taxes today at a lower rate so I don't have to pay them in the future at a higher rate , kind of like surgery . I'm going to go through the pain today so I can continue playing soccer and have this quality of life in the future . But perfect analogy . Where should we start with this ?
Because , to your point , people just say open me up , do surgery , do the conversions Not always the right approach ?
Let's start with the two people that deserve to get credit . And , as I bring this up on my screen , can you share with everyone who have not seen the last few episodes ? Who the heck we are , we're doing ?
this together . We have separate shows and have not seen the last few episodes . Who the heck we are ? We're doing this together . We have separate shows and I'll pull this up . Yes , I'm James . This is Ari . We uh , we work together with a lot of people did not know . Uh , ari has a podcast channel and a YouTube channel .
I have a podcast channel and a YouTube channel . You're watching . If you're on YouTube , you're watching this on my channel . If you're listening , you might be listening on Ari's early retirement podcast , or you might be listening to my ready for retirement podcast , because we're going to take the audio content and push it to both those places .
But we said , hey , we've been doing this for several years together now , separate channels . People are surprised sometimes when they say , oh , you're actually working together . We say , yes , so let's actually do a podcast episode where we get to banter back and forth about different things , not just about things that we want to banter about , but about comments .
We're getting on our YouTube videos feedback . We're getting from people listening so that we can answer a lot of the questions that many of you have .
Awesome . I'm going to steal one line that I believe it was your dad told you , and he said your job as an advisor is not just to advise , but teach people how to think , how to organize their brain . And so my hope is for some of you , as you take away from this episode today wow , I should never do a Roth conversion .
And anytime I see someone bring it up online or a neighbor , a coworker use this fancy conversion word , I'll get to go , I don't have to worry about it . And others of you are going to be like , wow , this is going to really change how much I can spend in retirement and legacy goals and yada yada .
So here are the two people that get credit for today's episode . Once again , if you have a comment that you want to leave , you want a question for us to address , please drop it in the comments and we will look to answer that in a future episode . So this comes from Linda Pipkins 4592 .
When is the best time to perform Roth conversions for a couple who is 64 and 60 with a pre-tax retirement value of two and a half million ? Also , how much per year ? Well , james , this is an easy answer . Um , always February 10th . Like , how does this person not know ? It's always . No , it's not February 10th . So , guys , that is the first question .
The second question for this is coming from thundersnow , and I just picked this , cause that's a cool username , thundersnow , you like that username . I'm following thundersnow , you like that username .
I'm following Thundersnow , whatever they're doing . Yeah , that's great .
Thundersnow that's the new name of our show . Do you have to be working to do a Roth conversion , or can it be done after retirement ? I can see how the biggest hesitation in doing a conversion is that you're guaranteeing that you'll pay taxes up front , since you don't know what brackets will be in the future . What do we think of these questions ?
Good questions and I think that these questions with Roth conversions in general , there's this thought that okay , there's a , there's a pretty quick answer to this , whereas the reality is it depends on so many things . The question is why ? Why are we doing Roth conversions , which for a lot of people may sound ridiculous ?
There's only one reason why , but it's not . Hey , some people do Roth conversions for themselves of how can I keep my lifetime tax bracket as low as possible . Some people do tax brackets for potentially a surviving spouse .
They know , hey , my health is not bad , I've got a younger spouse and I'm just speaking hypothetically my health's fine , but I've got a younger spouse and if I pass away , they're going to have single tax brackets as opposed to married . Finally , jointly , they're going to require distributions going to push them way up to the top of that .
I need to avoid that . Others do it for their kids . We actually don't need these assets , but we don't want our kids to have to inherit them and then be forced to distribute all their pre-tax account balances at a time that probably corresponds with their own peak earning years . We want this to be part of our estate plan or our transition plan .
Even so , understanding why you're doing . It is key because then you can look at . I guess I should say it this way my first thing already is when someone says how much should I do a Roth conversion , before answering I first want to start with why should you not do a Roth conversion ?
I want to see is there any way we can prevent you from paying taxes upfront , from eating your cauliflower upfront , like you talk about , and if there is great ? But sometimes we do the analysis , we do everything , we say no .
As much as it is going to hurt to write that check now , it's going to hurt a whole heck of a lot more than it will be to wait and do nothing and write a check for two times , three times the amount in the future .
I like that . Not going straight to surgery . When should we not do this ? When should someone not do this ? What are those simple things to first consider before going straight to surgery ?
First thing is you're going to be in a lower tax bracket in the future . So I'll bring up a recent example . I was talking to someone . Someone was working . They were 61 years old . This was a client . They were going to move to Texas when they retired . They were living in California . Today they were working and this is a little different .
They were really prioritizing doing Roth contributions to their 401k , so we'll tie this to the conversion piece . Now . They were working at a high income . They said we really want to have a tax efficient retirement and they're putting all their 401k into the Roth 401k .
And we looked at it and we said look , when you retire , your income is going to go way down because you're not going to be making this high six-figure job income anymore . Plus , when you retire , you're paying 9% 10% in California state taxes . Today You're moving to Texas and that state tax bracket will go away . So why are we paying into something ?
Why are we contributing to a Roth account which gives no tax benefits today , just so we can pull it out in the future when we're going to be in a lower tax bracket ? It's the opposite of what we should be doing . We should be saving money on taxes on the contribution and then pulling it out in the future .
So if you're in a position today where you're in a higher tax bracket now than you will be in the future , a Roth conversion doesn't really make sense . Now you have to think through marginal tax bracket versus effective tax bracket and there's some nuance to that .
But if you're not going to be in a higher tax bracket some of this we don't really know , because who knows where tax brackets are in 10 , 15 , 20 years . But that would be a good reason not to .
Another good reason not to and I don't want to take the whole show to talk about this , but I think this is important If you're charitably inclined , there's something called a qualified charitable distribution .
I was talking to a client one time and he said hey , I'm selling my business and I think we should take the proceeds , put it into a flip crud , nim crud , all this it is really sophisticated tax plan . Use a donor advice fund as a beneficiary of this . I said well , you really want to gift a lot of money , which is incredible .
Why don't instead this big , complicated estate transaction that's going to cost you a lot of money in attorney fees and be a lot to administer .
What if we just treat your 401k like your donor advice fund , like your giving account , from the standpoint of you can gift up to $100,000 per year from that directly to a charity via what's called a qualified charitable distribution , and that money is never taxable to you . You just gift it right from your IRA , as opposed to being forced to distribute it .
The bottom line is , though , the third reason I'll say is the main thing that prompts the need for Roth conversions is this thing called required minimum distributions , which is you might look at your income in the future and say , okay , well , I got social security , I've got a pension , I've got a little bit of income from investments .
I'm probably going to be in a low tax bracket , lower tax bracket , at least the name . Now , that may be true until you factor in these required distributions , where , if you've done a good job of saving and investing to pre-tax accounts , the IRS is going to say congratulations .
You are now required to take minimum amounts out of that each year , and that number grows , and so , even if you're not , I guess , discretionary spending that money , there's going to be some required spending of that , which could then push you into a higher tax bracket , prompting the need for Roth conversions today , but if you're not going to have a significant
RMD issue , that might be another reason not to . So before I ramble on too long , I'm going to turn it back to you to regain control over the show .
Okay , Best example on required minimum distributions . This is the first year I was working with you , James . We were in the office , little office together in Solana Beach , and if you remember the name of the client , you can say it .
I don't know if we're allowed and all that , but if we're allowed to say the name , he said James , do you know how I know I'm doing well , You're like I don't know . And he said it's when I know I have required minimum distributions beyond what I'm going to need .
And I remember both of us looking at each other a little bit and being like , oh , that's a cool definition . Do you remember what client that was ? By chance ? No , I don't .
I don't remember that .
Oh , I remember so clearly . So the client was like here we are , I'm sure , excited to begin discussing with clients , because you know in person back then and now we do a lot of our work literally all of our work virtually through Zoom . And I remember him saying hey guys , I get , we're going to talk about Roth conversions and I get that I need to do it .
I'm not saying I don't want to do it , I'm saying I know I'm in a good position financially when I need to take out more than I'll ever need . So yeah , there's a problem , but there's a good problem , I remember for me you're talking about .
Yeah , yeah , yeah , think of a few things . So I had one couple .
I spoke to and I said how much do you want to spend ? And they go , we'd love to spend 8,000 a month in retirement . I said , okay , what if I told you had to spend 10,000 a month ? They go , that sounds cool too , I go . What about 12,000 a month ? They go . Yeah , we could definitely do that , I go , okay .
So this number is moving pretty quickly here . I said what about 20,000 a month ? They go . I don't know if I could spend that amount , I go . What if I forced you to ? And they're like well , I just I mean I guess we could do it , but I just don't think we'd really need to . Like that wouldn't add to our quality of life .
And I said , yeah , but a real easy fix to decreasing the need to Roth conversions is spending more money . And you just told me you want to spend 8,000 a month and then in the span of about six seconds you are willing to spend 12,000 a month .
So we need to really determine how much you'd love to spend and you can spend more and there's less of a need to do a Roth conversion . So fix number one that I see is easy is spend more money . Fix number two that I see is easy Retire earlier . I don't want someone to retire too early and run the risk of running out .
But we also , as a true fiduciary , our role is to go , got it . What is the true goal of the client ? Can we act in their best interest ? Sometimes , acting in their best interest is saying look , you told me that you have health conditions and that you don't know how long you're going to be in this state of mind .
And I'm not saying this is you , james , or any of you listening right now . But I'll joke that I'm the meanest advisor . I'm not actually mean , okay , I'm just transparent . And the reason I say that is because some people just like this couple here . If I go back and share this screen just for this example .
Here they are literally asking when is the best time to do Roth conversions . I already told them it's February 12th , but they didn't hear me . So now , when is the best time for a couple of 64 and 60 with two and a half million ? How much per year ? Hey , when do you want to stop working ? Hey , how much per year ?
Hey , when do you want to stop working ? Hey , how much do you really want ?
to spend any thoughts . Yeah , I think that um , big picture thought that I'm going to come back to this is someone said this might have been you , this might have been someone else . Someone's saying , hey , roth conversion is kind of like a buzzword today , roth conversion is kind of bad today and it's like , yeah , I , I can see what they mean by that .
Of everyone . To your point , is Roth conversion happy ? And I think that that can be a problem when people think that the sign of a successful financial plan is the Roth conversion strategy that saves you the most amount of money . How do you gauge the success of your tax strategy ?
Well , if I can show you that this strategy saves you $2 million and this one saves you one , obviously the one with $2 million savings is better . Right , you would think that , but you then go back to well , what does that mean ?
That means you're decreasing your personal spending already in retirement so that you can keep your tax bracket super low , so that you can free up more space than the tax brackets we want to fill up , so that we can do more Roth conversions . So don't take that trip .
Don't spend time going to those shows with your wife , don't do the things that you want to do , because I can save you $2 million in taxes instead of 1 million . Well , that's the worst advice in the world . We got to remember what the main goal here is . We got to keep the main thing .
The main thing and the main thing is not tax savings , the main thing is live the life you want to live . We talk about our mission of helping people get the most out of life with their money , not necessarily just maximizing money for the sake of maximizing money .
And once you fully optimized your life , then let's maximize the tax savings that can be maximized from there . But if all you're looking at is a Roth conversion piece , the best way to optimize that is to minimize your quality of life , minimize your own spending .
So I forget what your actual question was , but I just wanted to tie that in because this should never be the primary thing . This should be a secondary thing . And even going back to our process with clients , where does it start ? We'll talk about purpose what do you want to do ? What's important to you ?
Then the next step is the income plan to maximize income , to support that . Then the next step is the investment strategy to fully support that . Then , finally , we'll talk about taxes , because that's not the first domino . It's not even the second domino to fall . It's okay Once these other things have been optimized .
It's the order of operations by which you look at things . Taxes are super important , but do not ever let it become the main thing .
I definitely think going through a brief financial example would help people understand if they should worry about conversions . So let's take this couple , linda Pipkins . They've got two and a half million bucks and they said they're 64 and 60 .
Well , let's assume that RMDs for them begin at 75 and let's just assume their investments do really well and it doubles and let's just assume from two and a half million to 5 million bucks 75 . So call it 11 years and 15 years later they've now got 5 million bucks and let's assume they didn't do any conversions . They never heard us do any episode .
They don't want to eat any cauliflower . Well , they've now got 5 million bucks at 75 in pre-tax accounts . They also have Social Security . I have no idea if they have rental income or inheritance , but let's just assume Social Security and $5 million pre-tax . And correct me if I'm wrong here because I might not recall but is it 3.8% that RMDs it starts in ?
the high threes , let's round up to four . So by like age , 76 , 77 , somewhere around there , your required distribution is based upon life expectancy and there's a table that the IRS uses , but call it 4% is the amount that you have to take out of your portfolio . Okay , that's $200,000 . And that's acting on top of social security .
And , by the way , if you have $2.5 million in your 401k today , in your early 60s , it means you've done pretty well . You probably have some brokerage done pretty well . You probably have some brokerage assets as well . You maybe have some real estate assets . You maybe equate some other things that will generate taxable income .
So it's not just this 200,000 required distribution which , by the way , will continue to go up each year in terms of how much you have to take out . It's social security plus dividends and interest , plus anything else you have , plus that . And so what you're doing is you're saying , okay , what will our tax bracket be in the future ?
And no , we don't know where tax rates are going to be . No , we don't know exactly what's going to happen . But a projection that's approximately right is way better than being precisely wrong , which is doing nothing . What tax bracket are we in today ? And then compare the two and if it's a much higher bracket in the future , consider a conversion today .
Now , the caveat to that is , if today you're still working , it's not just looking at today . In the future , it's also looking at the in-between years . Today , for example , if you're in the 22% bracket , and in the future you might be in the 32% bracket . You might jump to the conclusion I should do a conversion .
Well , maybe , but what if the next 10 years you're in the 0% bracket because you retire and you're living on brokerage accounts or whatever ?
So , not to get too in depth , but look at the 30,000 foot view of what is my marginal tax bracket expected to be each and every year , assuming no conversions , so that I know what year should I fill up what tax brackets to normalize or even out where I'm paying the taxes and in doing so potentially save a whole lot of money .
And this might be a longer episode , because we just love this stuff , but I want to touch on briefly Irma , not for too long , but some people don't even know what Irma is , so I just want to allude to it , because some people make the mistake of going oh my gosh , I'm not going to do Roth conversions . That's going to increase my income .
And then there's this Irma thing . But I don't know if you're talking about a hurricane or if that's something else like what am I missing here ? So want to allude to that . But at the same time , I want to bring up a huge point that you just said , which is okay .
We have a tax window If we retire at 65 and social security doesn't begin until 70 and then RMDs don't begin until 75 . Well , to answer this , one of the questions here is do you have to be working to do a conversion ? Can it be done after ? You can do it at any time . It doesn't mean you should do it , but you can .
What we want I want to stop real quick on that point .
That's an excellent point , because a lot of people think , oh , you have to be working to make a Roth contribution . That is true , you have to have earned income to make a contribution . You can make a conversion whenever , whether you're working , not working .
It typically makes more sense when you're not working because income's lower , but you can do it whenever Good interruption , please keep doing that .
This on my screen you can see here . This is an example of someone who is in retirement and you can see this is Irma brackets . Now some of you are like I don't even know what you're talking about right now . Is that like your aunt , not my aunt , james ?
Do you mind breaking down what the heck Irma means , when people should or should not worry about this ?
Yeah , irma is a Medicare premium or not a premium . It's a surcharge to your premium . So when you get Medicare there's just a cost for your Part B premium . So for this year it's $174.70 . That's the 2024 number . Now that goes up as your income goes up . So you can see . If you're watching on YouTube , you can see this .
If you're listening on podcasts mine are always check it out on YouTube . James Canole is the podcast or the YouTube channel this is on you can see the numbers already shown here . Once your modified adjusted gross income exceeds these are 2024 numbers 206,000000 if you're married , half of that . If you're single , there's a premium adjustment .
You're paying an extra $70 for your Part B Medicare Part B , an extra $13 for your Medicare Part D . Those are monthly amounts . So an extra $83 per month . As your income continues to go up , those surcharges go up .
So it's not technically a tax in the standpoint like an income taxes of once your income goes over certain thresholds you move from the 10% bracket to 12% bracket , 12% to 22% , so on and so forth .
But it should be viewed as like a tax because the more your income goes up , it's not just your federal income taxes that you're paying more on , or your state income taxes . There's also potentially Medicare premium surcharges . I will say people sometimes get too hung up on this . They think , oh , I don't want to do a conversion because of the IRMA surcharge .
One way of thinking about it is the top of the 22% federal income tax bracket somewhat corresponds with the top of the first the threshold at which IRMA kicks in . Irma kicks in if you're married . What is it ? 206,000 , 203,000 . Yeah , 206,000 and above is when the first IRMA surcharge kicks in .
The top of the 22% bracket for married filing jointly is $201,050 . Divide those numbers in half if you want , for single . So if you're just converting up to top of the 22% bracket each time , you're not crossing that threshold .
The thing to be mindful of and this is where we're probably going to lose people and it gets confusing and I get that is one is measuring your taxable income . One is measuring your adjusted gross income , your modified adjusted gross income . So that's where it's a little bit more technical than is going to work out to describe on a podcast episode .
But do your tax prep when you do this , because I have a good one for that .
Yeah . So that's the equivalent of when I went to go get a surgery that I ended up not getting , and I'll do a separate episode on that in the future . If you guys really want to know which , you guys can , let me know in the comments if you care or not . I won't be offended either way . But we were debating which part of my hip should we attack from .
Is it from the back of the hip ? Is it the front ? What's going to create more scar tissue ? There's a level of this where when I go to my surgeon , I'm deferring to him who's seen the inside of hips and what creates most scar tissue .
So the risk to this in the same example you just shared there , james , of modified adjusted gross income versus taxable income some people they know enough to be dangerous and a lot of you guys listening are trying to optimize your financial strategy . So we're not mad at you . But you'll often say , oh my gosh , I'm retired , I'm 63 .
I'm going to go do a Roth conversion . And then two years later , you get all mad at me and I'm like , hey , what's what's going on ? And you're like you didn't tell him about this two year , look back thing and that impacts my Medicare and my , this , my .
There's so many different things , james and I try to pick and choose what's going to be the most bang for your buck in these episodes , so not going through every single thing there , but I hear you , yeah , and I'm Googling as we speak .
There's a form you can actually file to say , like there is a two-year look back , which is how it's calculated . You can go tell social security look my income for this .
For example , if your income two years ago was $300,000 and you're turning 65 , you're going to have an ERMA surcharge on your Medicare payments this year , unless you proactively go to social security . I'm trying to look up the form as we speak to SSA-44 , I believe it is where you can say look , that was two years ago and so you're exactly right .
You can be proactive about it , which is a great thing to do . To say this year is actually going to be a hundred thousand , so that surcharge shouldn't apply . But yes , that's that you got to keep both in mind .
Awesome . I know we have to pick and choose our moments and we're already at 24 , 25 minutes in here regarding Roth conversions . Any last things you want to leave people with regarding legacy , when can people do those QCDs you were talking ?
about QCDs . You can start doing as soon as age 70 and a half . Required distribution start at age 73 or 75 , depending on your birth year . It used to be 72 . Before that it used to be 70 and a half . There's a lot .
I think that the main thing like we talked about arias before just jumping into them , because it seems like there's almost this weirdly dopamine hit If I'm doing something proactive , I'm doing , I'm getting the surgery and thinking it's going to be okay , make sure it's the right thing to do . There's a lot of cases where it's not .
You know someone that has , I don't know when required . Required minimum distributions aren't going to be an issue . I just see too many people convert too much upfront . It's like you probably would have been fine with either no conversions or just at least a lesser amount .
There's another thing called a social security tax torpedo where the way social security is taxed is it's based upon what's called your provisional income , and as your taxable income increases , or as your provisional income increases , more and more of your social security benefit gets pulled into your taxable income calculation , and so what happens is you could be in a
12% bracket . But there's a social security tax torpedo zone where I've got a video , I'll try to link the show notes here . I walk through this , probably with way more clarity than I'm describing it here .
Not only are you converting , doing a Roth conversion at the 12% bracket , which seems like a no brainer , but you're also pulling more of your social security into your taxable income and then paying taxes on that too , and you're effectively paying a 22.2% tax , I believe it is , as opposed to just 12% federally .
So the main thing is really make sure it's the right thing . For many people it's absolutely the right thing . It's a no brainer . You should 100% do it . I just see too many people where it's not and they waste money when it wasn't required .
Love it . I'll leave you all with , unless , james , you have anything you want to chime in after this with the cauliflower example , which I share a lot . I don't have the shirt on me , but it's one of my favorite gifts I've received , where I'll explain a conversion .
Like eating cauliflower , I want you to eat a little bit of vegetables today to avoid having to eat a ton of cauliflower in the future , and I don't want any of you guys to be going oh my gosh , my whole retirement I'm going to eat so much vegetables , which is paying a lot in taxes . Now some of you are like I like cauliflower . It's a terrible example .
Tell me which vegetable you'd prefer and next time maybe next episode , james I'll whip out the shirt so everyone gets to see it . But that's all I've got on conversions .
That's it . Yeah , you may have shared this , but when you proposed to Alice , we sent Alice a big bouquet of roses and Ari a big bouquet of roses and Ari a big bouquet of cauliflower , and I don't know if you ever ate it , but you got it , but yeah eat your cauliflower when it makes sense , avoid it when it doesn't .
Yeah , that's my best man at the wedding . It's going to be the cauliflower .
Love it Well , cool , all right , that's all I got , anything else from you .
No , that's it . See you next time .
The last thing I'll say is this is being posted on my YouTube channel , just so people aren't confused . Ari has a podcast Early Retirement Podcast . We'll have a link out to that . Make sure you listen there . I have the podcast , the Ready for Retirement Podcast . We'll link out there . We both have been working together for a very long time .
Different shows People had no idea we worked together . So we're now doing this together and wanting to make sure that people that know me also know Ari and vice versa . So we are good . We'll have links to that and we'll see you all next time . Love you guys .
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