5 Ways to Pay Roth Conversion Taxes

How to pay taxes due on Roth conversions. And it really is the decision that quietly determines whether your Roth strategy actually works or not. All right, so there's like 5 different ways. So number one is the obvious way, you can pay with cash or investments. This is usually the most tax-efficient method. So these are like using a money market account or a checking account or CDs or a savings account, maybe even your brokerage account where you've got some money market or something like that in there. A lot A lot of people have to sell stocks out of their brokerage account to be able to save the taxes. And so they hesitate and they say, well, wait a minute, those gains from selling those investments is going to push me into higher brackets. And in reality, no, those gains are handled separately. And so if you've got a lot of stock that you've got a low basis on and you're afraid to do the conversions because of paying the taxes on those, if they're long-term gains, if you've had them over 12 months, then they do not push your ordinary income into a higher bracket. There are special long-term rates out there that are, that apply to the tax that you'll pay on that, and those are dependent on all your other income. So you're having large Roth conversions does cause the tax rate for long-term capital gains to go up, but the maximum rate on that is only 20%. And you can see on the screen kind of the, the way that those brackets work for married filing joint folks. So it's not a huge amount of tax, and it would be better— I mean, I would rather pay 20% long-term capital gain tax than to take more money out of my IRA and pay it at ordinary income taxes. So that's a smart way of doing it if you've got the brokerage accounts to make it work. So the second way is if you're still working, One of the neat little tricks that we've come up with is we teach our clients to redirect their 401 contributions instead of adding more money into that bucket. So you— that means you either stop or reduce your 401 contributions. You redirect those funds that you now have available to pay taxes on converting your existing IRAs or 401 accounts for those that allow it. You want to be sure not to lose your employer match through the process. But for those of you that are using catch-up provisions and maybe between you and a spouse are putting $50,000, $60,000 into a 401 plan, if you redirect that $40,000, $50,000, that means that there's a whole lot of money sitting there in order to do conversions. You notice the example I've given you on the screen is, is just exactly that. This couple redirected about $50,000 that they were putting into the 401 which was causing a bigger problem over time. And they use that $50,000 to do conversions. So depending on their tax rate, they're going to— that $50,000 could have been used to put another $50,000 in the 401, or in this case, use the $50,000 and convert $150,000 or $200,000 depending on what tax bracket you're in, which is just a really smart way of getting money over to the Roth, right? The number 3 way is to just pay taxes from the IRA itself. And this is what most of our clients use to pay taxes because most of them have pretty much all their savings in IRA accounts. So if you don't have the brokerage accounts, this still works if you don't have any other choices because you don't have other liquid assets available. There are a few caveats you can see here on the screen. It's not going to be beneficial to you if you're currently withdrawing a lot of money for living expenses. You know, if you're putting— if you're pulling out 4%, 5%, 6% or more every year out of your IRA for living expenses, Probably not a good plan to do the conversions and pay taxes out of the IRAs. Now, if you have other assets, you just chose to take it out of the IRA, then we can probably show you why it's better for you to take money out of the other assets, even though you're holding on to those under lock and key. But it's probably a much better deal and probably saves you hundreds of thousands of dollars by doing it that way. And one caution obviously is, um, if you're under 59 and a half, this is not going to work for you. Because the distribution to pay the taxes is going to force an early withdrawal penalty. And so you'd have to have money outside of the IRA to go do that. And so again, we got David and Carol, another— the same example. They had $1.2 million in IRAs, but they still avoided $800,000 of tax during their lifetime by using money from the IRA to pay the taxes. And on top of that, Another $900,000 of tax they saved and protected their heirs from having to pay along the way, all from just doing nothing but taking the money out of the IRA. Again, not the most effective way, but it still works for, for most IRA millionaires that we talk to. So the 4th way is to really consider the use of charitable giving to reduce taxes. If you're, if you are a giver anyway, then use charitable donations to offset that taxable income. And there are some limitations you want to check with your CPA and stuff like that on it, but you, for this to work, you need to already have charitable intent, meaning you already do a lot of giving, you already are interested in either your church or causes that you care about. So there's 2 different types of charitable giving that can help you. One is those that can be used annually to offset the RMDs, and then those that can be used in a really big way on the front end to offset taxes during your conversion years. And they fall into basically 3 different camps. QCDs are qualified charitable donations that you can use once you turn 70 and a half to offset your RMDs. They're limited every year, and it's a pretty big limitation, but I mean, it's a pretty, pretty high balance that you can use. But they're there that you can use those annually. But sometimes people have enough cash outside that they're able to really kind of aggregate it and do what's called a donor advised fund, which allows you to put hundreds of thousands of dollars over into a special account. You get a tax deduction for that full amount, subject to limitations that you got to think through. But let's say you could put $300,000 over into a donor advised fund. Then you got it. You and your spouse have a checkbook, and over the rest of your lifetime, and even leaving it to beneficiaries to do it for you, you can write checks to charities along the way and do what you want to. The benefit now is that you've got this huge amount that goes against your first or second year charitable— I mean, your first or second year Roth contribute conversions that you're doing, right? So that allows you to take a big sum of money, offset a big amount that was distributed for the conversions, and, and save a whole lot tax on the front end. The other is a charitable remainder trust that still has the large donation on the front end. The difference is that you get benefit on the back side of it as opposed to the other. So the donor advised fund and the QCD are really the primary ways. If you're doing QCDs, it's really important to know that the QCD has— the distribution to the charity has to come directly from the custodian to the charity. You can't take a check and then write it and say, well, I used it out of my RMD. It has to— the sequence has to happen just right. So number 5 is just to optimize your tax plan and to minimize your tax bill. So, you know, you just got to really have to determine the conversion plan that lets you keep the most for your family, the one that makes you pay the least amount of tax, the one that leaves you with the most net worth to give to your families. And online calculators, we've been through every one of them we can find, and they're very faulty. Most of the software out there that you can buy commercially through ads on the internet or through your advisor, most of those software programs are lacking. If they do the math right, they don't present it in a way that it's easy for you to really understand it. It's not necessarily done as a way to find the absolute best game plan that gives you the absolute most clarity over the decision. It's mainly designed as a way to answer just a really simple question. Should I do it over 3 years, 5 years, or 7 years or something like that? Well, what if 6 years is the optimal and it saves you $200,000? Well, under that scenario where most software lives, where it is up to the intuition of the person using the software, then you just end up speculating and you don't really get the most clarity over what is really the best decision for you. So if you want to optimize your tax plan and you want to get the most amount of clarity that you possibly can and have the least amount of pain of paying taxes, then you simply have to convert faster, you have to convert at higher brackets, and you have to really focus on lifetime math as opposed to this year's math. And we've found, we've seen this over and over and over that a lot of people say, well, I'm going to retire in a couple years. I'll do this then. I'm in too high of a tax bracket. I'm going to wait. Future lower tax rates rarely, if ever, offset that many more years of growth that now you have to go convert. The theory is sound, but there's an error in the calculations. It just doesn't work out in real life that way. So let me give you some pro tips on paying the taxes, just kind of a few of the mechanics here. If you don't pay enough of the tax that you owe on time, you can owe a penalty. So I'm going to give you a couple good guidelines that I think you can take with you. If you— if your total tax payments, so all your withholding plus any estimated tax payments you pay because of doing the conversions, if they don't cover 90% of your tax bill, you could owe a penalty. So make sure that you get at least 90%. But if you want to really be sure, then what you want to do is you want to meet the Safe Harbor rule, which is to avoid a penalty, you have to pay in at least 110% of what last year's tax bill was. So that's the number for those that have adjusted gross income of $150,000 or more in the married filing joint bracket. So for example, if your total tax last year was $50,000, Then be sure to pay at least $55,000. So the way you pay them is through— these days you can do it online, right? IRS Form 1040-ES is what you use to make tax payments. They have deadlines like everything else in life, 15 days after the end of each calendar quarter. And you got to make sure that when you do this, go ask the custodian to withhold a specific dollar amount. Don't overpay by just letting them use their standard percentages. You tell them how much you want them to send to the IRS, right? And you do that through having knowledge and a game plan up front so that you know what the outcome is going to be. Hey, if you've got $1 million or more in your IRAs, the IRS already has scheduled one of the biggest tax bills of your entire lifetime. It starts at 73 or 75 years old. The problem is most people just haven't seen the number yet. We have an RMD calculator that we've put together that'll give you an idea what the taxes are going to be over your lifetime as well as Maybe what's going to be left for your heirs if you leave it all to them. We've taken it a step further and we've cross-referenced that to people just like you that have been clients of ours, of over 3,000 of our clients. And we want to be able to give you an idea of what's possible for you to save if you get Roth conversions done right. So click the link below. It'll take you about 2 minutes and it'll be pretty alarming. Take care.