The Best Time of Year for a Roth IRA Conversion

Hello, this is Craig Weir again. You know, one of the questions that we get all the time from people calling in is when is the best time of year for me to do my conversions? So I'm loaded, I'm ready to go. I know what my game plan is, but when do I do it? When do I pull the trigger on it? Today, what I want to do is I want to cover how to handle when you do it and also how to deal with the taxes once you've actually done the conversion. Just some general ideas and some practical tips for, for you, the big picture is if you're an IRA millionaire, you don't want to wait to get conversions done. A lot of people think that they need to wait till they're going to be in a lower tax bracket. That's probably a big mistake. Or a lot of people say, well, I'm going to wait, do less conversions because of Social Security benefits or because of Medicare premiums. That's also a big mistake. So in general, you want to get when you know that it's good for you, you need to get started. You don't want to wait for, gosh, I'm retiring in a year or two and I'll wait till then. Those are really big mistakes. The added growth on your account compounded over years just does not make it worth it. So when it's time to do the conversion, when it's time to initiate the game plan, when do you do it during the year? Well, this one's going to kind of come down to you. You've got to decide which game plan you're going to go with the plan. A game plan is you got to take a stand. You got to decide, do I believe the stock market is going to go up or go down? Or if you're in bonds, do I think interest rates are going to go up or go down? And I know it can be a little bit complicated, but just generally, what is your belief about the rest of the year once you decide that you're going to do conversions? Because if you believe the market is going to go up, then certainly you want to do the conversions now. So all the growth that would have occurred in that tax deferred account now happens over in your Roth account. On the other hand, if you believe that the market's going to go down and prices are going to go down, then you want to wait and convert those shares at a lower price so you pay lower tax on this, on getting those shares converted. So that's the take a stand method. You got to decide what you believe about the markets. But you definitely want to get the conversions done before the end of the year. Once you decide and once you know what your game plan is going to be. Plan B is I'll just call it the hedge your bet strategy, which is basically you saying, look, I really don't know whether the market's going to go up or down. I just know I got to get these conversions done, But I want to do it where it makes sense. So in that case, you want to go toward a more systematic conversion plan. Whether you do it weekly, monthly. Most people opt for a calendar quarter. So at the beginning of every calendar quarter, you divide what your total conversion is going to be by the appropriate amount, and that's the amount that you convert on that calendar quarter. Some people like to do it more frequently. They like to do it monthly, and that's fine. There's no right or wrong on this. The whole game plan is, look, if I don't know, I don't have a crystal ball whether the market's going up or down, then what you're trying to do is get some conversions happening systematically throughout the year. Now, remember, if you go with that hedger timing, if you do have a market correction of 10, 12%, like we normally do during the course of a year, man, boom, jump on it. That's the time to really start throwing in. Maybe you do a couple quarters at once, or maybe you just do the rest of it for the whole year, thinking, gosh, I may not have a better opportunity than that. So when it comes to timing, those are your two options. I wish I could tell you what is absolutely best, but it really depends on your attitudes and what you're going to try to get accomplished with it. We like to encourage people to just get the conversions done and get it over with, because the taxation on potential growth is huge. And just the frame of mind that you get in of actually executing it and not having to touch it all throughout the year is pretty significant for a lot of people. The downside of doing Roth conversions is you got to pay the tax. The upside about Roth conversions is you end up saving a ton of tax over your lifetime by getting it done sooner rather than later. But when you do a Roth conversion, you're taking money that you agreed with the IRS back when you did it, that you're going to get a tax deduction at the time you made the contribution, but you're not going to pay the tax until you take it out. Now you create a taxable event and that's what everybody's afraid of. But if you do the math on it and you're an IRA millionaire and things are really valuable to you to get the conversions done. And even if you don't have a million dollars in your IRAs, there still are a lot of benefits of doing Roth conversions. But in either of those cases, it becomes a taxable event. The deal that you made with the IRS was that when you take that money out, you got to pay tax. So it's probably most recommended to pay the tax at the time you do the conversion. If you are not really on top of your taxes and watching it real closely, you're better off just to pay the tax at the time that you do the conversion. Or you can do it on a quarterly basis through estimated tax payments. Either way works. You just gotta make sure that you get the tax in. It's not usually a good idea to wait till April 15 to pay the taxes, because it's very possible to that you could have penalties because you didn't get enough paid in at the right time. Throughout the course of the year. There are penalties that the IRS assesses for underpayment of taxes. That means if you owe $100,000 of tax because of the conversion, but you only paid in 50,000 because of your other income, then there's a potential if you wait till April, that you got to pay a penalty because you didn't get it paid in at the time that you did the conversion. There are a couple ways that you can avoid that underpayment penalty, and those are what the IRS calls safe harbor limits. You want to at least pay in 90% of what you owe for this year to avoid a penalty. So if you calculate and you project that your total taxes are going to be 100,000, you want to at least get 90,000 paid in, or 110% of your total taxes from last year can get paid in. That's if you have adjusted gross income above 150,000. If your adjusted gross income is below 150,000, then that safe harbor test is 100% of your last year taxes. So it's pretty simple. You either pay 90% of what you would owe this year, or you make sure you get 100 or 110% of last year's taxes paid in. That's pretty simple. As you can tell, there are a lot of moving pieces in doing Roth conversions. There's nothing really complicated about it. There's just a lot of things that you have to coordinate and they have to work together in an overall game plan. I highly recommend that if you're a do it yourselfer on your taxes, I think it's worth it to you to hire a professional, at least for the first couple years that you're doing Roth conversions, until you really get the cadence down of what you should be doing. If you are a do it yourselfer and you've got your own spreadsheets about how much you should do, or you have some paradigms about being afraid of getting up to the next tax bracket or Medicare issues and those kinds of things, then I would suggest that you get with somebody that's really experienced in dealing with Roth conversions. And of course, that's where our CFPs around the country come in, is to help you to really understand that you're getting the best bang for your buck and that you're really doing this the right way. So hopefully these last few minutes have been helpful to you and it'll help you in your own journey to take the stress levels down just a little bit so you have a little bit more clarity on what is best for you. Thanks for joining in. Take care.