What is a Roth IRA Conversion and Who Should Consider It
Craig Wear explains Roth IRA conversions: moving pre-tax retirement money into a Roth account so it grows tax-free, requires no withdrawals in retirement, and passes tax-free to heirs. Best for people with large IRAs ($700k-$900k+) or those worried about leaving a tax bill to their kids.
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Well, hello. Hey, there is a lot of confusion out there about Roth conversions. What are they? What's the basics? You maybe are kind of listening to this whole Roth conversion conversation for the first time. Maybe you're doing your research of what is it, how does it work, what are the basics? And there's all, there's all kinds of kind of complicated, detailed information out there of which I'm probably guilty of putting out as well. But there's not a lot out there that just covers the fundamentals and the foundation behind why should I even consider it and who is a good candidate for it. So I thought I'd just make a few comments, give you some good information to something that maybe you can kind of hang your hat on of starting your journey of understanding the foundations behind it to where maybe I can give you enough information where you maybe say, yep, that's probably not me and I'm out. Or hey, well, maybe I need to look into this more and learn some more details. So hopefully this will be helpful to you in that regard. And we've got a lot of other things here on the channel that you can watch, videos that get into detail on all kinds of subjects, kind of surrounding Roth conversions in general, financial planning stuff. So as kind of an introductory comment, what I'll say is that Roth conversions are the process by which you take IRA 401k, 403b, any kind of pre tax money like that, and you willingly pay the tax on the front end so as to hopefully avoid a lot more tax at the back end, and you end up with your money that was in an IRA. Now in a Roth IRA, whether it's an IRA or whether it's a 401k or a 403b, it doesn't really matter. If it's a pre tax account like that, a contributory type of account, then the law says that you can convert that to a Roth. The nice thing is that once the money gets out of the IRA and into the Roth now, there are no more taxes on any of that growth for the rest of your life, number one. And number two, there are no required minimum distributions that you're forced to take, which is the big problem with IRAs, big IRAs. And the third is that your heirs don't even have to pay taxes when you're finished with it, you leave it to them. They don't have to pay the tax on their end as well. So the process of doing a Roth conversion is really simple. And once you've done it one time, it becomes really easy to understand. It's a little bit nerve wracking on the front end because you know you're creating a tax consequence. And so obviously we want to get that right. So it really could be just as simple as you calling your custodian, whether that's a Vanguard or a Fidelity or Schwab and telling them that I want to convert this amount from my IRA over to a Roth. Now they're going to want you to open up a Roth IRA first. They're going to want you to have it to be in the same name, Social Security, same Social Security number. And if you're going to pay the taxes from an account outside of your IRA, then you could just say, hey, move my 100 shares of Tesla with the market value of roughly X over to this Roth IRA and this is a conversion. And they're going to ask you how are you going to pay the taxes? And you're going to say, I got another account I'm paying the taxes with. So you'll go to bed tonight with the, with the Tesla stock in the IRA and you wake up tomorrow morning and it's in the Roth IRA and you owe the government some tax. And it's beyond the scope of this video to help you to understand how to handle the tax, but probably not a bad idea. We'll get in a little bit of the higher level tax implication in just a second. So what you've just done is you've taken money that's going to be that you've had tax deferred for all these years. You've decided that now's the time that you should pay tax on it so that you avoid paying a lot more tax later and it ends up in a totally tax free state, which is a beautiful thing. The process is really simple and if you're going to pay taxes from within the account, you then you have to, if the cash to pay the taxes is not already sitting in a money market or cash account, then you'll have to liquidate something in order to pay the taxes to get it done. So just kind of high level, the tax implications of doing a Roth IRA is that you've again you've chosen to take money that was pre tax, pay tax on it and never pay tax on the resulting balance after that. So it is a taxable event. You need to know that you need to not be afraid of that because oftentimes by getting ahead of the ira, by doing conversions, you're going to avoid a lot of money in income tax over your lifetime. The biggest benefit is that you've now removed the potential for these large required minimum distributions to come in and mess up your tax and your cash flow planning later. Now, inside of the Roth ira, there are no requirement of distributions like I've said. So that's not even if you want to use it and you want to take it out, it's not taxable income. You decide you want to take family on a nice vacation and pull out $20,000, it's not taxable. You need to replace one of your vehicles. I can't tell you how many times in my practice I used to have people tell me, hey, we need a new truck. It's going to cost about 50,000, which. That's been a while, right? Going to cost about 50,000. And would you raise the money? Sure, no problem. And when I'd ask, how do you want to pay the taxes? They would say, well, how much do you think that's going to be? And I would calculate it, and they would say, hold on just a minute, I'll call you back. And they would never. They would never take the money. They would just do without. And meanwhile, they had plenty of money, plenty of assets, but they didn't take the distribution because of the resulting taxes. If you get the Roth conversions done, you're taking control over all those kinds of decisions. And they can be for not. They can be great decisions for you. I've got some other videos that talk about when is it the right time and what are the specific recommendations for retirees that you ought to check out. And by the way, if you like kind of good, solid financial information from somebody that's not trying to sell you a financial product or manage your money or any of those kinds of things, then click the subscribe button. We'd love to have you on the channel. And you'll be one of the first to know. We put out new information like that, but some of the benefits, I guess some of the other benefits is that you've paid the tax, you're done on that account. Right? And nobody knows what the future holds positively or negatively as it relates to future tax brackets. But these are the lowest tax brackets we've had in 50 years. Today, it seems to make a lot of sense to consider the fact that now's the time to really develop a plan for paying the lowest amount of tax that you probably ever will over the rest of your life. So if you have a large IRA, let's say 7, 800, 900,000 or more, you probably need to look very seriously into doing Roth conversions because you're probably, if you don't do them, you're probably leaving a couple million dollars at the doorstep of the IRS of taxes that you're going to pay unnecessarily. If you're, let's say you're in your mid-70s and older and you're concerned about am I going to leave a mess to my heirs and they're just going to owe a lot of taxes and it's going to cause all their other stuff to be taxed, you're probably a good candidate, too. Or if you're in your last few years of working and you're making large contributions to the 401k, that's probably not your best strategy. It's probably a better strategy to use that cash that the same cash that you were putting in making up for all the lost contribution years into your 401k. It's better to use that cash and actually convert four or five times that amount than to continue making the problem bigger. In fact, I would even say you're better off to use cash flow to do conversions than to make large contributions to a Roth 401K. So those are some ideas of kind of who's. Who could benefit and where they're, where they become really beneficial. You know, there aren't really a lot of risks. A lot of people like to point to the unstable political environment and they don't do conversions because they're afraid that Congress is going to change the laws. And I, it's beyond the scope of this video, but that would be so contrary to everything they've ever done in the past. I just don't see that happening. I mean, gosh, we go out, we elect 435 people, then they just go out and do whatever they want to do anyway. I've got 38, 39 years in this industry. I don't say anything that severe. That is, that could really be a problem. And even if they did, what they probably would do is their first step will probably be to limit who can do Roth conversion. So they'll count the Roth conversion as part of your income and say one of the proposals was, I think it was around $400,000. If the total of all your other income and that conversion equals 400,000 or 450, whatever the number was, or more, then you can't do that much conversion, which really messes up being able to really get the problem taken care of. But again, I don't see that happening. But who knows, right? So if you're listening to this and you're kind of getting the idea, gosh, this may be something we need to look at. And it makes sense that if I don't have all these required forced taxable distributions coming to me for the rest of my life and my wife's life, it maybe makes sense to do Roth conversion. Some of the, I'd say the practical step for getting started is to speak to a firm that does nothing but this. That's what our firm does. We work specifically with people that have got, you know, 7, 800 to a million and above type of accounts. Not that they're the only ones that can benefit, but there is a, there are fees to what we do. And when you get to some of the more modest IRA balances, we find people kind of back away and they don't really want to pay for the service. So, you know, I would just keep that in mind in terms of that. But I would get with somebody that really does this a lot. So if you'd like to learn more about Roth conversion strategies for high income earners, click on the button and watch the next video. It will give you a great idea of what you maybe should think about doing if you're one of those high income people.
