5 Costly Mistakes to Avoid in a Roth IRA Conversion

Hey, this is Craig. Welcome back to the channel. So today I'm going to talk about the common mistakes to avoid when you're doing Roth conversions, when you're converting your IRA over to a Roth. What I've learned over time is that over the last, I guess since 2019, up until just a couple years ago, we talk to a lot of people every week through marketing and stuff that we do to try to help people with this problem of finding the actual optimal way to do Roth conversions. And we learned that people were embracing the idea, but they really didn't know what they were doing, or they were just going with just kind of financial media type of generalities. And so they were making a lot of mistakes. So I thought I'd take a few minutes and just kind of run through the five biggest mistakes that we see people make. Getting your IRA converted to a Roth is important. Whether you're an IRA millionaire or not, it's important that you consider what can happen to the good side for you if you get this done. If you have a more modest balance, then it's probably not as critical that you do it fast and aggressive, like we do with folks that have. Have saved significant amounts of money. But it's still important to consider at any level whether or not it makes sense for you or not. I just know that if you are what I call that IRA millionaire, that chances are pretty high that you're leaving a lot of money on the table if you do not get this right. So let me just kind of tackle five of the biggest mistakes. And even if you hang around, I've even got kind of a bonus one in there for you that probably should be obvious, but I'm going to give it to you anyway. So the very first mistake and the most common mistake that I see people make is they just want to convert to the top of their current tax bracket. While this makes a whole lot of logical sense, it really is rooted in fear of paying too much tax, not understanding the benefits of really getting the tax paid sooner rather than later. So what I know from what we've witnessed thousands of times over and over and over and through proprietary software that we use with our advisors all over the country, is that in order for you to get the big benefits from Roth conversion, you simply have to get to a higher tax bracket than what you're in right now, than what you're probably comfortable with right now, and you probably have to convert it a lot faster than what you're probably comfortable with right now. I know, I know. Your Financial advisor tells you maybe you make too much money and so you shouldn't do conversions. Or they tell you, nah, just convert to the top of the tax bracket and you trust them. They have a relationship, they've done you a solid in other areas of your life. Unfortunately, in this particular area, they're just wrong. They don't specialize in this. They are a general practitioner in the areas that you've asked them to and they just don't know. Maybe you have your own spreadsheets and your own spreadsheets tell you that it's not in your best interest to convert beyond the top of your current tax bracket. You might be right. The chances of you being right are pretty slim. Probably what's happened is that you haven't considered some of the other factors that go into determining the real life, what you should do. And that's not me being saying anything other than I'm just trying to take the little time that I have with you in a video like this and help you understand that we have, we have never seen an IRA millionaire where it was in their best interest to delay doing conversions or to only stop at the top of their current tax bracket if they were in one of the middle tax bracket. So the second mistake, and we hear this a lot too, not so much anymore. Although two, three, four years ago, one of the biggest excuses that people made for not doing Roth conversions more aggressively is they were concerned that their Medicare premiums were going to go up. Make no mistake, your Medicare premiums will go up for a short period of time. If you are Medicare eligible or become at Medicare eligible, they're going to go up for a short period of time because Medicare Part B and Part D are income based premiums, meaning your income on your tax return is what has a significant impact on what those premiums are going to be. And so when you do Roth conversions, you willingly throw taxable income onto that tax return, which causes you to get to higher and higher thresholds. The reality though is that added amount of premium that you're going to pay for a few years pales in comparison to the tax benefits of getting that conversion done. And of course, that's part of what we have to prove to clients and prove to ourselves is that you're really much better off. And most of the time what we actually see is clients that do aggressive conversions. We're able to demonstrate at least 80 and a lot of times well over $100,000 of Medicare premium savings for them over their lifetime. And that's really the big Issue here is we're looking at tax avoidance over your lifetime tax Medicare premium savings over your lifetime, and what your net present value or your net worth is going to, how it can be impacted to the better by doing these Roth conversions. The third mistake is kind of likened to the first two, but it really has to do with. With people get afraid that, well, gosh, if I do these conversions, all this added income is going to make now more of my Social Security taxed. That's also true, but it's only for a short period of time. The amount of Social Security that is taxable is based on all your other income. And many of you, if that's the only income you have that's taxable is just your Social Security. If you add much to it at all, it's going to cause it to go from 50% tax to 85% tax. But if you have these large IRAs, what's going to happen is the growth in those IRAs over time is going to cause those required minimum distributions when you reach your magic age to get higher and higher and higher. And so at the end of the day, you're going to end up with higher Medicare premiums anyway if you don't do the conversions, and you're going to end up with more of your Social Security tax anyway. So all we're doing with aggressive Roth conversions is we're getting ahead of that and we're strategically planning it so that you have control over when you pay the higher Medicare premiums and when you pay the higher Social Security tax. And you do it when it's beneficial to you, as opposed to just kind of rolling with the punches. It means subjected to all these higher fees and taxes for the rest of your life. So that's the third mistake is stopping doing Roth conversions because you're concerned that your Social Security is going to be taxed higher. The fourth mistake is really just not paying attention to what the mess that you're leaving to your heirs. You know, if you leave a couple million dollars at the end of your life to your heirs and you, you understand the way that those, that they have to now pay tax on that, at some point, you're really throwing that into a position later down the road where there's probably a lot more money now it's coming into their life at a time where it may be causing them to have, have to pay a higher tax rate on that money because they took it out of the IRA. Of course, with the Secure Act 1.0, it made it to where now everybody has to. Pretty much everybody has to take all the money out within a 10 year period of time. Well, you leave a couple million dollars to somebody and they got to take another 200, $250,000 a year. Or if they make the mistake of just kicking the can down the road and leaving it there, now they're taking it out and they're paying tax at 30, 40%. And now you add state tax on top of that. It's a big deal. What we find is that it's pretty easy if you just have two heirs. It's pretty easy to imagine where a third of your IRA is going to end up in tax to the government. A third goes to the other two kids. If you end up with more than two kids, the math works out to where it's pretty easy to see that the government actually gets a higher proportion of the IRA than any of the individual heirs do. So without strategic planning, it can turn out to be just a tax nightmare. It's everybody paying their own share, but collectively more tax got paid than if you'd have just done it during your lifetime. So it's real important to get a game plan ahead of time to make the most strategic use of moving that money over to a Roth. Because when it gets to that Roth ira, now nobody ever pays any tax on it. They still are required to take it out of the Roth, but that does not create a taxable event upon doing that. So those are the first four. The fifth mistake, just overlooking the fact that maybe you have a charitable intent, maybe you and your spouse enjoy giving to your church or educational institution or causes that you really care about. There are very specific strategies that you can use that you can marry that charitable gift with your Roth conversion through something called a donor advised fund. And you can get a huge tax deduction in the year that you do a huge Roth conversion. Now you've given away the money, but now it's sitting in a pot and you can continue to give it over your lifetime, but you used it strategically to be able to help the charities and the people and to save yourself a lot of tax. The other thing we found too, which is really different from when I started in the financial planning business, gosh, almost 40 years ago now, is that generation. They grew up through the Depression and so they liked, they really had to hold on to their money. And you probably are like, I am. Your parents were those people. Right? They grew up through those time frames. And so it was really important. Or grandparents, one of the two. Well, the baby boomer generation has, interestingly enough, had a lot different way of handling that. We see many of our clients like to give, make large gifts to their kids, help them with a house, help them with the grandkids education, take them on big trips. So it's more of a mindset of enjoying the act of giving and watching what it does for the, for the family or the people you care about while they're alive. And while you're alive, there are ways that you can consider the gifting and the charitable strategies as you start doing your Roth conversions. So the bonus mistake I told you about, mistake number six is probably the obvious. You maybe can tell through just this quick video that there are a lot of nuances when it comes to doing Roth conversions. So I'd say the bonus mistake is not seeking professional guidance from people who know what they're doing. I liken the analogy that, you know, you have this general practitioner in your life that cares about you, you've got a long relationship with them and they've been able to help you when you got a cold or when something starts going wrong, help you to manage your weight, whatever the case is. But when you come up with a significant threatening issue, they refer you to a specialist. And so when it comes to tax and Roth conversion strategy, we know from all the work that we've done that it really takes somebody that specializes in this area to make it work for you. Just because they're a CPA or a tax preparer doesn't mean that they necessarily understand this. We've had so many discussions, I'll say it nicely, and arguments to some degree with a lot of tax professionals, whether they be tax attorneys or CPAs or tax preparers or financial advisors, because they just don't understand this part of it. It's becoming more and more prevalent. There are a lot of people out talking about it, doing videos like this, but they don't really have a process or a system. And at the end of the day, what concerns me is that most of the people that are out talking to you about doing Roth conversions, what their real objective is, the way they get paid on it by selling you annuity or selling you a life insurance program. And they've come up with all kinds of crafty marketing schemes that tell you they're going to pay the tax for you or you can become your own bank. And at the end of the day, they just want to manage your money or to sell you an investment product. And there are nothing wrong with those. But that's not where, in my opinion, that's not where you get the best strategy. Get your strategy first and then go do all those things as they, as they're appropriate to you. So just really get to the right people that can really help you get the best decision for you. You know, our industry allows somebody to say they're a fiduciary on one hand and turn right around and sell you an annuity and manage your money for a fee on the other hand. Again, there's nothing wrong with that, but to me, it's not being a pure fiduciary where there's no potential conflicts of interest involved. So bottom line to all this is that actually doing the conversion itself is the easy part. The knowing that you have the right strategy is rife with a lot of mistakes a lot of people make. I think we've had less than a handful of people who've come to us that have done their own spreadsheets that actually got it right first go round. The challenge is that this probably is the first time most of the people that come to us have ever considered doing Roth conversion. So it's their first set of spreadsheets. Maybe they got hours and hours in it, but they don't have the at bats to be able to know how to really set up the problem and to investigate it. And we've had 14 years now, thousands of at bats to get this done. So just don't make the mistake of assuming that you got all of it squared away. My recommendation is make sure that you've looked at every single tax bracket, every different type of time frame that you could do it in, and just totally break the paradigms of what you think you should do and say, well, what if I did it this way? What if I did it this way? And just play with it and just really massage the numbers until they reveal themselves to you and make sure that you're looking at comparing after tax dollars to after tax dollars all the way through. So if you're a do it yourselfer, those are some important tips for you to go back and look at your own work. If you've had an advisor tell you bottom line, you shouldn't do Roth conversions and you've got larger IRAs, I couldn't tell you a good reason why you wouldn't. I can't come up with a way to give them the out of saying, well, they're probably right because I have not seen a case where somebody with large IRA did not benefit from doing massive aggressive Roth conversion. We have another video that you can click on. Roth IRA conversions for retirees video. Click on that. It's got some more information I think is pretty helpful to you. If you really like this kind of stuff and you want to stay up to date, you're on your journey of learning all this, Be sure to click the subscribe button. And there's some great stuff coming down the pikes. And Even in the YouTube channel itself, there's a lot of great videos that we've already recorded and put up there. We also have podcasts. You can go out to the website and check that out as well. All right, take care. Have a great day.