069 Should You Convert Your IRA to a Roth IRA?

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This is the Affluent Entrepreneur show for entrepreneurs that want to operate at a high level and achieve financial liberation. I'm your host, Mel Abraham, and I'll be sharing with you what it takes to create success beyond wealth so you can have a richer, more fulfilling lifestyle. In this show, you'll learn how business and money intersect so you can scale your business, scale your money, and scale your life while creating a deeper impact and living with complete freedom. Because that's what it really means to be an affluent entrepreneur.

All right, so the question is, should you convert your IRAs into Roth IRAs? Now, the first thing is, what the heck is a Roth ira? Well, here's the thing. It is a special kind of retirement account. Now, you have a couple of different types of accounts. You've got accounts that are built with after tax dollars. In other words, you pay taxes on it. You put it in an account. It's like your savings account. It's your brokerage account, your investment account. And anything that happens in that account you pay tax on. So if you buy and sell a stock, you'll pay tax on it. Okay, Then you have accounts that are tax deferred, where you put money in, like an IRA account, a regular individual retirement account. You put money into the account, you take a tax deduction for it. So you get a benefit today and then it grows tax free.

For the time that it grows. But when you take it out is when you pay the tax. So it's tax deferred, really, if you will. So that growth you don't pay tax on until you take it out. And when you take it out, you'll pay tax on it. And usually an IRA, it's 59 and a half, you can't take it out without penalty until you're age 59 and a half.

And then there's the Roth and the Roth IRA. You don't get a tax benefit today. You're putting money in and you don't get a tax deduction. But.

All the money that grows, grows tax free. And when you take it out, it's 100% tax free. In other words, if you put $5,000 in a year into a Roth IRA and it grows to a million dollars, okay, you're not taking a tax deduction for the 5000, but when you go to take the million dollars out, you don't pay any tax on it at all. That's the beauty behind a Roth. So how does this play out? And let's just talk about some of the rules around the Roth, just so we have an understanding of it. Roth IRAs. Roth IRAs, you can put in up to $6,000 a year each individual if you have earned income. So you got to have earned income. So as long as I have $6,000 in earned income, I can effectively put money into a Roth up to the max. Now, if you're 50 or over, they give you a little more leeway. They call it a catch up contribution. So instead of 6,000, I can actually push it to 7,000. Okay, so you can put $6,000 or $7,000 if you're 50 or over into a Roth IRA. You get no tax deduction for it and it will grow tax free. Now, there are income limitations on this. Not everyone can qualify.

To contribute to a Roth. If you are a single individual, you start to lose the ability to contribute to a Roth at 129,000. And if you have 144,000 in income, you're not qualified. You can't put any money into a Roth. If you're married, that limit goes up to 214,000. So if your income is combined income is over 214,000, you can't contribute to a Roth. Now, we can bypass those doing something called a backdoor Roth, which I'm not going to talk about in this episode, but I want you to understand the benefits of a Roth. And then let's talk about the conversion because. And where this plays in. Okay, because you may have money in an ira like I have money in my IRA account.

And I can then convert it to a Roth. And what it takes to do that. And why would I even do that? Well, there's a couple benefits to having a Roth account. First off is that it grows tax free. When I decide to take money out of a Roth I pay no taxes on any of the money or any of the growth, unlike every other retirement account. Second, there is something called required minimum distributions. Okay, Regular retirement accounts and IRA accounts require. The IRS is going to say you took a tax deduction for it. You've sat on the money long enough. Now we want our taxes. So at age, the year that you turn 72, you will be required to take what they call a minimum distribution. There's a table to calculate it so they call them RMDs, required minimum distributions. So if you have a regular retirement account, in all likelihood you will have RMDs at age 72 unless they change it. That means that you're going to be forced to take money out and pay taxes and you might not even need the money. My mom is that way. She doesn't need the money from the IRA, but because she's over 72, she's 87 years old, she has to take a portion of the money each year and pay tax on it. With a Roth, there is no such thing as RMDs, so you'll never be forced to take the money out at any age. Now the beautiful thing with that is if you want to transfer the account upon death to someone, there's no tax impact. You can transfer to your child, your, your, your, you know, grandchild, whatever. But if you do that with an, with an IRA account, the person who inherits it will ultimately have to pay the tax on that account when they take the money out, which they have to do within a 10 year period. So Roth IRAs have a tremendous amount of power and benefit, especially if you are young. Okay, but what we want to talk about is the conversion. In other words, I have money in a regular ira, I have money in a regular retirement account. Should I convert it to a Roth? In other words, should I turn around and say I want to pay the tax today and then get the benefits for the Roth IRA for the rest of the time of having the account? Okay, and that's what you're doing. If I have $100,000 in an IRA account, I can convert it to Roth, I pay the tax on it. And now it gets all the benefits of the Roth. No RMDs, gross tax free, easier estate planning, all those things.

So the conversion is not a contribution. So you don't have a problem with the income limits that we talked about to contribute to a Roth. So even if you, even if you're making a million dollars, even if you're making half a million dollars, in other words, you're way over the the limits to contribute to a Roth, you still can convert your, your IRA to a Roth, and there's unlimited conversion. You can convert it however you want to do it. How? If you've got a million dollars, you can convert a million dollars in a year. I'm not recommending that because you would have to pay the full tax on the million dollars. Okay, so you don't want to necessarily do that. You got to have the tax. And there's one little catch.

When you convert a regular IRA to a Roth ira, it must stay in the Roth for at least five years. For at least five years. If it doesn't stay in the Roth for five years, then you will be subject to penalties. Okay? So you need to know that you don't need the money for at least five years beginning in the year of conversion. Okay, so, so if I convert something into a Roth in 2022, then I can't touch that money until 2027, 2028. So I need to know that I have something to carry myself. So who should convert, when should you convert, and who shouldn't convert? Well, who shouldn't convert is someone who is under 59 and a half. In other words, you aren't at the age when you can draw it out and you don't have the cash to pay the tax. Why does this matter.

When you convert an IRA to Roth? Let's say I have $100,000 and I'm going to convert it to a Roth. In fact, I'll pencil this out on the iPad so you can see it. So I have an IRA account that has $100,000 in it. I want to convert it to a Roth. In the year that I convert it to a Roth, I have to pay the tax on it.

Now, let's just assume for argument's sake that I'm in the 25% tax bracket. Just to make the math easy for this feeble old mind, that means that I have to pay $25,000 in taxes now. So what happens is I cannot take a distribution from a Roth or an IRA without penalty. If I am, if I am less than 59 and a half. So let's assume that I am 50 years of age, 50 years old.

I can't. If I turn around and say, okay, I'm going to take the 100,000, convert it to a Roth, and I'm going to pay the 25,000.

In tax from the money from the Roth, well, they're going to say that that 25,000 is a distribution and guess what? You're going to pay tax on it and you're going to have to pay a penalty of 10% to the feds and you might have a state penalty. We have a state penalty in California. Of course we do. It's California. So point being is that if you are under 59 and a half and you want to convert to a Roth, you must have the ability, the liquid cash, to pay this so you avoid any penalties on the conversion. So you have to have the cash available to pay the tax. Now, if you're over 59 and a half, there's no penalty. You can take it and pay it from the Roth funds and it doesn't matter. So this. So if you're under 59 and a half and you don't have the cash to pay the taxes, you can't do a conversion because it's going to trigger a penalty at a minimum of 10%. Okay, who else should not consider converting? Someone that is still working and is working and has. Is in a high tax bracket because you're going to be paying taxes at a high rate. And so why would you do that? Okay, so that's number two. Number three, let's say that you have an IRA that's going to be inherited. It's going to be inherited by a child, a grandchild, and they are in a lower tax bracket than you are. So you're in a 35% tax bracket, but because they're just starting, they're in a 15% tax bracket, you might let them inherit the IRA and know that they're going to have to pay the 15% tax on it versus you paying 35%. So I wouldn't do a conversion in that case.

The other one that I wouldn't do is if you need the money within the five years, remember there's a five year hold that you have to hold it for five years. So if you need the money in five years, within five years, do not convert it to a Roth. Just leave it as a regular ira. You also have to be aware of a conversion if you're in your in higher years and you're on Social Security, can trigger Medicare premiums because it will increase your income. It's what we call a shadow tax that can come into play. Just this is why you need a plan or you need someone there to walk through it. Remember this conversion, it's a permanent decision. You can't say, I want to take it back. Once you convert it to Roth, you can't go back. So know that it's permanent. You can choose not to do it. I've chosen not to do it for a variety of reasons. You could give your IRA to a charity and then you don't need to do a conversion and pay the tax.

And then lastly, if you don't have the cash to pay the tax on the conversion, which I kind of talked about. So those are the reasons I wouldn't do a conversion.

The people that should do the conversion, though, is the people that are what I say are in their gap years. The gap years are the years between their working years and their Social Security years, potentially that our income rates, I mean, our income tax rates have dropped. So all of a sudden I found myself in a year where my income, income is down, so my tax rates are down. This might be the year to try and convert some of them at a lower tax rate than before. So you want to plan for the conversion based upon what tax rate you're going to be at at the time of retirement, which is hard to predict because tax rates change all the time. But looking at what you anticipate compared to where you're at, which means that you want to look at your current tax bracket, you want to look at the potential future tax bracket based upon the income that you're going to receive in the future and the income that you're receiving now. And depending on those tax brackets, you can sit back and say, I'm going to save. I'm going to save hundreds of thousands of dollars by paying the tax today, or I'm going to save hundreds of thousands of dollars by not paying the tax. If you're going to be in a higher tax bracket later on, you might want to consider a Roth conversion. If you're going to be in a lower tax bracket later on, then you might want to not consider it. This is a somewhat of a. It's an easy thing to do, but it's a. It has mathematics to it to see whether it's right for you. This is something that I would tell you not to do on your own, that I would tell you to get some guidance with it, that someone can analyze your tax returns, ask you some questions, do some calculations and tell you what the cost of the conversion is in taxes and tell you what you. What it could be because it becomes a math problem in that regard. So I would say to take a look at, if you've got regular IRA accounts to just examine it, tax rates are probably going to continue going to go up, just like interest rates. I'm guessing we're going to see an increase in tax rates. So is it possible that if you have a dip in your income that maybe we do a conversion this year? Yeah, it's possible. Okay. So, you know, should you do a Roth conversion? It's a personal situation. It's situational. It's not just black and white. It's based on your circumstances. So I hope that this helps shed some light on what a Roth is, what a Roth conversion is and isn't, when it should be done, who should be considering it, how to go about it to make that happen. And there's a lot of things around investment accounts and what accounts I should have because I have a Roth, I have an ira, I have a brokerage account, and I did another video that talks about the best investment accounts to use. I'll make sure that I hook that up for you here, here. And I'm going to hook up another video on what to do with your cash. How do you allocate your cash for more effective wealth creation and wealth building in there? So we'll hook both those up to keep you moving forward on your path to financial freedom. I hope that you found this of value. And if you have any questions, any comments or anything that comes up, do me a favor, post in the comments, send me a dm, send me a note. I'll make sure that we get back to you. I'll bring it on the show if it makes sense, if it's going to serve the community, because that's what I, what I'm here to do is to help you on the journey and on the path to financial freedom. So this is a place for us to have safe, sane conversations around money and wealth. So let's keep the conversation going and until we see each other in another episode, another show, or on the road, always, always strive to live a life that outlives you. See you soon. Cheers.

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