3 Biggest Fears of Roth Conversions

Welcome to another edition of the what's Next Retirement Podcast with Craig Weir. Life is full of transitions that have a financial impact now and in your future. When finances are affected, there are always questions to ask and choices to make. As an independent certified financial planner for well over 30 years, Craig has helped Americans make decisions that give them their best financial futures. The experiences with so many clients has given him a unique experience perspective to help with what's next for you as you navigate the unknowns of your own life. What's next? Answers to the retirement issues on your mind.

Hey there, this is Craig Weir. Thanks for joining me. Back to the what's Next for Retirement podcast. I hope you're having a great week. And this was one of the podcasts that for sure, if you are happen to download it and listening a run or a drive or the gym, you're gonna want to probably come back and be able to play it on a device. So you can see this is going to be riddled with a lot of information and a lot of numbers, you know, and I'm going to try not to get too deep in the woods, but I'm talking about a subject that is unfortunately just all about the numbers. So I want to kind of deal with one of the biggest objections that I think a lot of people have or questions they have and in fact sometimes even fears that have about doing Roth conversions. And that is the notion that if they do a Roth conversion, they're going to pay taxes on the portion of the IRA that they do the conversion on and the dilution of their account. And the amount of those taxes is going to be a bad deal for them. And those that have a little bit of financial savvy like to talk about it as the time value of money aspect. So the belief is that if I give up some of the taxes on the front end, I'm going to have less money there in the future. And I'm about to demonstrate to you that it is not at all that case. It seems that way, but when you do, when you look at the big picture and the entire picture, then for most everybody, it doesn't matter. The only person, the only people this really doesn't apply to are people that don't have any heirs and you're going to leave all your money to a charity, then this part probably isn't as applicable. But Roth conversions are still very much well worth it if you are what I call the IRA millionaire and you really want to save taxes during your life. But the time value of money thing is A little bit skewed if all you're going to do is leave your money to your heir. So I'll just leave that there because this is not about a charitable giving strategy at all. So what I'd like to do is I'll just show you a couple things that I think make a lot of sense. A lot of people believe, you know, you shouldn't convert because you'll have more for retirement if you don't pay the taxes now. And it sounds really logical, but it just won't stand up to the facts. This is where it's going to get kind of detail written. I'll do the best I can to describe it for those of you guys listening in. But for those of you that are watching, you've got on your screen, you got all the numbers in front of you you can look at. So this whole pay now or pay later thing, let's just analyze it. So let's say you had $100,000 in your IRA that you could either convert or not convert. But you're concerned that if you convert it, you're going to lose access to money and you're going to have less money later. So let's take that $100,000 and let's just kind of assume that you're going to leave it there for 12 years and your average annual rate of return is 6%. I'm using this really funky little mathematical thing is called the rule of 72, right? So 6 times 12 is 72, and it works for any two numbers that equal 72. You can take the number of years and divide it into 72, and that tells you what rate of return you're getting. Or you can take the number of years. I mean, you can take 72 divided by the 6%, and that tells you how many years it takes money to double. So kind of a little bonus tip there, right? So $100,000 12 years from now at 6% is about $200,000 on your statement. So every year you're going to open up your statement, you're going to see that thing growing, and remember, it's still in an ira, and so it's tax deferred, and you get all the benefits of that. We got several people we talk to say to us, you know, I'm not going to pay taxes until I absolutely have to. And I'm about to show you why that's really not a good idea at all. It sounds good, but it doesn't work out. So if you owed, say, a 25% was owed in taxes on that 200,000 whenever somebody pulled it out, either you through required distributions or your heirs through inheritance. Whatever you're looking at, the government's going to get it, so they're going to get their due, right? So a $200,000 statement value, it may look great, but I mean, I think we're all adults here, you know that part of that is what you owe to the IRS. So let's use 25% and the numbers. It doesn't matter what the number is, the math still works. But we'll take 25% because it's easy for me to do the math and you to understand it like this. Take 25% off of 200,000, you're left with $150,000 of what I call real value, real net after tax value. All right, so let's look at the other side of the equation. Let's say you're going to convert it instead. Well, when you convert money from that ira, you got to pay taxes now. And that's, that's kind of the, the whole crux of the, of the argument. So now you take that 100,000 and you pay your 25% in taxes and you got $75,000 value. So now you start with 75,000, you got 12 years at 6%, same rate of return, same time frame, and what do you have? Shazam. For those of you watching this, you're seeing that that ending value is the same exact hundred and fifty thousand dollars of tax free value. So what happened there? Well, what happened is, and you can see on this screen in the, the pay me now or pay me later situation, all you're really doing over time is you're building a greater deferred tax liability to the government. Your real net after tax number is different than what the value of your account is. And if we take that on this next screen and we compare that to the Roth after tax tax free value where it's already been taxed, you can see the amount that's really your money is the year after year after year after year. And so leaving the money in there doesn't really create more value for you. It just creates a greater contingent liability by the irs. Well, and some people like to say, yeah, but I'll have greater income that I can pull out of that. Well, that's the whole problem with the money in the first place. You're also going to have a much greater required minimum distribution that has to start coming out at 72 or 3 or 75, depending how old you Are so you're going to have that to be able to deal with. What I'm interested, ladies and gentlemen, is how much is my money, not how much of my holding of the IRS is, but how much is really my money. What's what belongs to Craig. And you see in this pay now or pay later scenario where really the whole time value of money thing is almost a moot point, we've done this with just a lot of clients. We got a lot of success stories of typical IRA millionaires. You know, whether they're single or married or whether they're retired or just kind of making plans to retire. Some of them have saved a million plus in pre tax money in 401k accounts and a lot of them have very little savings outside of their company retirement plan to be able to pay the taxes on. But some have, and you may be one of them, the large savings in addition to those IRAs or company plans. And I've got a couple of real quick cases I'm going to show you. But most people have Social Security, they got some pensions and the typical client is distributing very little of their IRA to live off of every year. And I'm not going to show you the impact of charitable giving plans, but if you have a big charitable intent and you like to give and you, you know, that's part of your strategy that can fit into this whole game plan as well. But what happens when you get it right is really an optimal game plan, the optimal strategy. And again, this is kind of heavy laden with numbers, but for those of you that are watching this as opposed to listening to it, you can see I've shown you the difference between a good plan, a better plan or the best plan. And this is a lady, I call her Kate to protect her privacy. A single lady came to us in her late 60s. She had about a million bucks saved up. Her total required, her projected required minimum distributions, if she didn't do any Roth conversions at all, was going to be about $2.2 million. If she just converted at her current tax bracket because she didn't want to spend the money on taxes because of the time value thing or whatever reason she come up with, she would save a little bit of money. And at her current tax bracket her RMD will go down to 1.883 million. But at the optimal strategy that we converted her over a short period of time, four, five, six, seven years, whatever the number was, she had no RMDs. She saved, you can tell there she saved about $93,000 in Medicare premiums compared to just going to the top of her tax bracket. And her total tax avoidance went from no tax avoidance in the no conversion to her in her current tax bracket. She would avoid it, about 250,000 of taxes. But if she got to her optimal strategy, she was going to save $1.4 million of taxes. So the time value of money factor is not nearly as significant as the amount of taxes that she's going to pay. Now, the time value money is important in that you want to make sure you're making a good financial decision. And we'll talk about that in a minute. Here's Doug and Bev. They're married, both in their late 60s. You can see that for them they had, I think they had about 800, $900,000 saved up. They're going to lower their projected Medicare premiums by about $120,000 and their total tax avoidance was just short of $600,000. I'm saying all this just to help you to understand that the time value of money issue is not a big issue. What is important is the amount of taxes and what the damage that's going to do in other areas of your life. But it is important to get the best financial decision, not just a great tax decision. And what we like to do is create a tax adjusted net worth calculation. And we like to be able to compare a variety of different tax bracket conversions as well as things that aren't straight tax brackets, but asymmetrical conversions along the way. What we're always looking for is how much do you have in your pocket at the end of the day, net of what you owe the irs. And if you wait, you lose. Your required minimum distributions are going to be two or three times the value of your IRA over your lifetime. You're going to lose a year of tax free growth that could have happened in a Roth instead of in your IRA to just build greater tax liability. Your Medicare Part B and D are likely going to increase due to your RMD later in life if you wait. And there's something that I talk about a lot that I'm sure I didn't come up with it, but I don't know where I stole it from. Something called the widow's trap. So you get started doing conversions and you're married and all of a sudden one of the spouses is no longer in the picture. Now all of a sudden you got this trap. The remaining spouse is left with all the money and half the tax bracket bandwidth to make the conversions. With the other is you're going to lose another year of the remaining lower tax rates that were created by the tax cut job acts from 2017. So my suggestion is you get with it, get working on it, get your Roth conversion game plan optimized as best you can. But don't worry about the time value money thing. It's really not as big a deal as what you might think it is. Now we when we do work for clients, we provide the tax adjusted net worth. We also are in the process of integrating net present value calculations and they both are pretty much consistent across the way. So I'm not saying it's not important to know the answer to that, but I'm showing you some really simple math that kind of cuts away all the confusion and makes it really simple. So I appreciate you joining me. I know it was a short podcast this time, but sometimes the short ones are the best ones, right? So hope you have a great day and check out the show notes for links to where you can get additional information. We've got a bunch of free books and free information that we can plug into prior webinars that we did, and new webinars coming up. So thanks a bunch. And if you haven't subscribed, smash the button subscribe so you'll be up to date when I come up with some new stuff. Thanks a bunch. Talk to you later.

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