Is A Roth Conversion Right For You?

Most people are sitting on a ticking tax time bomb — and they don't even know it.
In this episode of MasterPlan, we dig into Roth conversions: what they actually are, why they matter more right now than ever, and how to think through whether one makes sense for your situation.
The problem most retirees face is that decades of contributing to traditional 401(k)s and IRAs has built up a massive pile of money — money that the IRS hasn't touched yet. And when it's time to pull it out, that bill can be a lot bigger than people expect.

We walk through:

0:00 — The Tax Problem Nobody Sees Coming
0:15 — Welcome + What This Episode Covers
0:45 — Why Taxes Are "On Sale" Right Now
1:30 — Traditional vs. Roth: The Core Difference
3:00 — How a Roth Conversion Actually Works
4:30 — The Two Ways to Get Money Into a Roth
6:00 — Contribution Limits + Income Thresholds
7:30 — The Right Way to Pay the Tax Bill
9:00 — Bracket Arbitrage: Spreading Conversions Strategically
11:00 — IRMAA: The Medicare Surcharge Nobody Warns You About
13:00 — RMDs and Why They Sneak Up on People
15:30 — The Legacy Advantage of a Roth
17:00 — Why Doing Nothing Has a Real Cost

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Call 770-980-9262 to speak directly with someone about your retirement planning needs.

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Advisory services offered through MasterPlan Retirement Consultants, Inc., a Registered Investment Advisor in the state of Georgia. Insurance, tax and commodities services offered through Fricks and Associates, Inc. dba MasterPlan Retirement Consultants. The aforementioned are affiliated companies.

Transcript

Welcome And Roth Conversion Preview

SPEAKER_00 0:14

Is a Roth conversion right for you? Hey folks, welcome back and thank you for joining us. Welcome to Master Plan Retirement Consultants Retirement Roadmap. My name is Evan. With me, as always, retirement planner Mark Fricks. During this episode, we'll explore Roth conversions, including what they are, who they may benefit, and the important considerations anyone should think about before making a decision. Mark, we are huge fans of Roth Conversions here at Master Plan. We're huge fans of Roth in general, whether you're contributing to it or converting. We're going to walk through a little bit of that today, but before we really get into the nuts and bolts of the Roth Conversions, I want to talk about the looming tax problem that so many Americans, especially retirees, folks who have been working for the past 20, 30 years, they may not realize they've built themselves a big tax problem inadvertently.

SPEAKER_01 1:11

This is kind of the basis of uh one of our best classes, most attended classes, which is about tax planning. And and so the whole basis of the class is that we are in a window of taxes being on sale. So do you need a tax deduction on a 401k money going in? Is that critical now? Do you uh can you afford a little bit of tax to do a Roth conversion? And um and should we real quickly just remind people what the difference is?

SPEAKER_00 1:36

Oh sure, go for it.

Traditional Vs Roth Basics

SPEAKER_01 1:37

Let's do that real quickly. So an IRA, a 401k traditional, those types of accounts are accounts where you get a tax deduction when the money goes in. So if they withhold money over the course of a year at my job and I put in$12,000 for the year,$12,000 comes off my paycheck or comes off my wages or W 2 or whatever however you want to put it. So I pay less taxes that year, and then it grows tax-free, which is a powerful tax deferral is very powerful. Uh but the problem is this. When it comes out fully 100% taxable at whatever rate you're at. And the question I ask in class is what rate will you be in in five ten, uh, five years, ten years, twenty years? We don't know, first of all, what's your income. Most of our clients enjoy the same income in retirement as they did when they worked, and but now you've lost some deductions. But also what will the tax brackets look like in five, ten, or twenty years? Our belief is, I mean, I'd I'd put my house on the fact that taxes are going to be more in the future. Too many factors coming into play here. And so uh a Roth, uh whether it be in a 401k Roth or a personal Roth, you do not get a deduction going in. So you lose a little bit of a tax advantage for that year. Yeah. But you never pay taxes on it again. While it grows and when it comes out, doesn't matter what tax bracket you are in. And so that we think is the way to go. And especially with Roth conversions again, being uh taxes being less expensive now, historically less expensive, then a great time uh for that window, uh use that window to avoid less taxes. Also when the markets are down. Yeah. Good time to convert, because if your IRA is a little bit smaller, you can convert the same number of shares into a Roth and let it grow over in the Roth as well. So I just wanted to make sure we laid some foundation. Not everybody has the same level of knowledge for sure.

How 401Ks Created Tax Snowballs

SPEAKER_00 3:24

Absolutely. And it's uh it's not really anyone's fault at this point. I mean, back in 1979 they introduced the first 401ks. Um, and then there became a phase out. You know, before that, uh employers provided pensions to their employees for retirement. That was a defined benefit plan, meaning the benefit in the future was defined. You knew what you were gonna get in retirement. They transitioned to 401ks, which is why we don't see many pensions anymore. Uh 401ks are defined contribution plans. You know what you're putting in, you don't know what's going to be there in retirement. Now, hopefully it grows, you're getting a match, the market grows long term, you have a nice little nest egg for you waiting in retirement, but you don't know what that is. But the bigger tax consideration is think about your big uh uh 401k or IRA or retirement account. Think about that number in your head, and then how much of that actually belongs to you? Because a portion of that is gonna go to the government when you w make every individual withdrawal. It's the highest tax rate on any retirement account. It's gonna be at whatever bracket you're at that year. So as Mark said, we already don't know what our tax brackets are gonna be in the future. We expect them to be higher for multiple reasons. Um, but also every withdrawal you make from an IRA or 401k adds to your income for that year. So each each withdrawal is actually bumping you towards the next bracket as well. So we have this big snowball tax issue in retirement that most people who are retiring now did not have the opportunity until about five or ten years ago to contribute to Roths within a 401. The Roths weren't really talked about. When when you talk about this all the time in the 80s, when you were introduced to your first 401k at a job that you worked at, um they didn't tell you any ins and outs of the 401k or any any advice on investing or said how do you spell 401k?

Roth Contributions Limits And Paycheck Impact

SPEAKER_01 5:12

What is it? I don't I don't know what it is. So And it's interesting the way that they transitioned from pensions to the 401k. What an opportunity for corporate America. Yeah. They took the risk off of them because they were managing the pension plans to make sure enough money was there to pay you, but now they pass the risk on to the average American and no training. Right. We still, the majority of people we talk to, really don't know how the 401k works. They don't know the fees that are in there. You think you think they're low fee? We can pull it apart and show you. Um they don't know the limitations, things of that nature. So it it it was a way of transferring that risk from the companies to the individual. Hey, it's okay, we're gonna match you, you get a tax deduction, you're in the market, markets grow. Yeah, over time they do grow, um, but we don't know what our our money coming out is going to be, and of course the tax rate, we don't know what it's gonna be. A lot of unknowns.

SPEAKER_00 6:04

Yeah, and there are two ways to get money into a Roth contributions and conversions. Today we're talking a lot more about conversions, but contribution is basically how much, like in an IRA, how much per year you are allowed and permitted to put into a Roth or an IRA. Um right now the limit for under fifth age 50 is 7,500. So if you and your spouse both wanted to open a Roth, you could both do$7,500 each. Um at age 50, you get to put a little bit more as a catch-up contribution, which is$8,600 uh per individual. So And they don't both have to be working. And they don't, right, right. You can do a spousal IRA or a spousal Roth uh as well. So just as long as one person is working in your filing jointly. And make it enough earned income and filing jointly. Thank you. Yep. Absolutely. Now um do keep in mind there are income limits as well. If you make too much money in a given year, then you cannot contribute to a Roth. Um you'll have to contribute to an IRA. Without getting into the weeds of all that, just know the income limits for single filers is about$153,000. There is a phase out period to$168,000, but just keep that$153,000 in your mind. And then joint filers, um, the phase out begins at 2,000 200,042. 242,000. 242,000. Sorry, it's it's er it's morning still where we're filming. Um 242,000 and the phase out is about$10,000 to$52,000. Um without getting into weeds again, there uh is a way around that. It's called a backdoor Roth. I don't know that we'll be talking about that today, but we might. We'll see what time gets into, but that's something that you don't need to go into lightly without really understanding. Getting some help. You you could get yourself into trouble if you're not careful on that. Uh so that's the first way of getting money is contributions. And maybe your 401k even has a Roth portion. That would be fantastic to start easing in and trying to uh see what that looks like for you. Um but the quick warning before we real quickly.

SPEAKER_01 7:59

Um so if you do decide to go to work and say, hey, I want to have part of my 10% that I'm contributing, I want it to go to the Roth. Be very careful with that, because as you make that adjustment, uh you're no longer getting a tax deduction, so your paycheck will go down. So phase it over, say, okay, I'm putting in 10% a year, I'm gonna put 8% into the traditional and 2% into the Roth. Look at a couple of paychecks, say, hey, that wasn't that painful. My goal would be all of it going to the Roth. I mean, I sincerely uh encourage you to do that. You will you will one day visit my grave site and say thank you. Master plan, thank you, Evan, thank you, Mark.

Roth Conversion Mechanics And Timing

SPEAKER_00 8:39

But but see, but do be careful because it will affect your paycheck. Yeah, tell your kids too. If they've got a 401k, they're starting out, they have a lot of time, start maxing out that Roth. Um something else to keep in mind as well, the match from your employer currently will still have to go into the tax-deferred portion. So we're hoping may change, but not not yet. I don't know, maybe, because I'm sure they get some tax breaks with that. Um, America once again. Yeah. Um so then contributions is one way to get money into a Roth. The other way is conversions. And um a conversion is really simple. First of all, there's no limit to how much or how many times you can convert into a year. Um basically you have money in an IRA and you convert a portion or all of that money into a Roth. Um it's basically opening a Roth and signing a conversion form.

SPEAKER_01 9:30

Very simple. Um you cannot convert from a 401k. It has to first be in an IRA, although there are plans being changed where you can convert inside your 401k. I'm not sure if it's available. It is available. I'm seeing it more and more.

SPEAKER_00 9:44

The GSB you can, and then there are some more 401ks now that you can actually convert.

SPEAKER_01 9:48

But you have to pay the taxes out of pocket, which I prefer anyway, but there is that opportunity. And again, you know, part of our planning is how much can we afford to do? What tax bracket would that put us in? Yeah. Things of that nature. So it's not just a, hey, give me the form, I'll sign it. It is how much can we do and things of that nature. But go ahead.

Paying Conversion Taxes Without Penalties

SPEAKER_00 10:06

Uh well no, I that that's that's helpful. And um on that conversion, like Mark said, you're gonna pay taxes at whatever bracket you're at during that year. Keep in mind that conversion is going to add to your income for that year. So it's there's a little bit of tax bracket arbitrage, as we like to say. Um it's not necessarily let's do it every year sort of thing or all at once either. We want to have an idea of what is our income for this year, next year, next following year, maybe mid to late fall, start looking at you'll have an idea of what your income is going to be for that year. How close or how much over the next tax bracket are we willing to get into? Thankfully, uh we have a progressive tax system. Um so you know, if if you if you sneak into the next bracket a little bit, only that portion of money is taxed at that level. Everything else is taxed at the below brackets, um, which was not always the case in the history of our taxation. Um But yeah, it's a super powerful tool. Um there are a few caveats to keep in mind as well. If you are above 59 and a half, um that means you no longer have penalties on withdrawals from IRAs or Roths with 10% penalty. So that's penalty-free withdrawals. Um if you wanted to convert, you could pay the taxes, as Mark said, write a check to the IRS to cover the taxes on that conversion, or because you're over 59 and a half, you could actually withhold the taxes from the conversion, meaning when that IRA money, as it transfers over to the Roth, a portion is withheld from that and sent to the IRS to cover your taxes. So your Roth is going to be a little smaller because you're withholding. Um, but that's better than nothing. Getting money into the Roth is good. The where we get in trouble is if you're under 59.5, um, you can still withhold, but that withheld tax amount that's sent to the IRS is considered a withdrawal. So you're actually going to be penalized on that taxed portion uh about 10%.

SPEAKER_01 12:03

Yeah, we've had a couple of clients that have said, I don't mind, that's fine, I'll pay a little bit of a penalty, 10% on the tax. Uh, but it is better for both reasons, like you said, to avoid the penalty, paying it out of pocket if you're under 59 and a half, but also having the equal amount of money in your Roth that you had in the IRA. Uh so you know, it it's everybody's different, every situation is different. That's why we look at each case differently. Um and again, love spreading it out, uh, like you said, over maybe a three-year period, five-year period. You have to be careful because we we do believe uh once the current administration is gone, that the, you know, we know in politics things swing real far to the left, then real far to the right, and then real far to the left. And so we know that um the next administration, the next Congress, uh they see that big deficit. Uh they see uh Social Security being hurt, things of that nature, and and I can see taxes beginning to creep upwards. Uh so we we have less of a window than maybe we think that we have. So uh if if you can do conversions, if you can afford to do it over the next five years, uh certainly we put together a plan with somebody that understands all the rules, like we do, from tax planning, the holistic approach, uh, to make sure because there are some errors, we're not can't even get into all of them today, I don't believe. All the little potholes or uh cliffs you can you can fall off, you've got to be careful with them.

SPEAKER_00 13:25

Yeah. Mark, you mentioned this earlier, and uh it's a good consideration. Not a lot of people want to take a pay cut uh in retirement. Once they've been working for 30 years or however long, um they don't want to cut back on their lifestyle. Now they want to enjoy life and sometimes even have a few years of where they're really experiencing a lot more, maybe traveling or whatever. Um most of our clients don't go into retirement looking for a pay cut. They want to maintain a level of quality of life that they're used to. Um and as we believe tax brackets are historically low right now, that that's uh a truth. That's not what we believe it is to the truth. We're historically low in our tax brackets right now. We do believe, however, that they will be higher in the future. They were supposed to go up uh December 2020. Yeah, end of 2025. Um, extended.

Retirement Income Planning And Free Consult

SPEAKER_01 14:17

Man, I will say this just to kind of uh telegate on that. Um when a client first comes in, you know, one of the things we do, in fact, we're gonna uh talk about this in just a second. Uh you have a complimentary consultation uh offer to those that are listening and watching, uh, will be wrong a series of reports. Well, the first number we have to have is what do you think you need in retirement? We start with what are you bringing in now? What's your net amount? What are you spending per month now? Uh and then we might adjust it a little bit based on, you know, that our house is gonna be paid off or this is gonna happen, but we start with that number because people, again, they like you just said, they want the same amount coming in coming in. That was not the philosophy, that was not the thinking back in the 80s when I first got into financial services. It was, hey, everybody's gonna be in a lower tax bracket because they're gonna spend less and they're going. No. Uh and also you lose, like I said earlier, we do lose some um, you know, we're not putting money in a 401k anymore. So maybe you're making$200,000 a year, but maybe$30,000 of that's going into your 401k. So you're not really bringing home$200,000, you're paying taxes on$200,000. Uh you might be paying for health insurance at work, you might be having disability at work. All these things are going to disappear. So what's coming in the house is the number we try to come up with. Uh by the way, those reports I just mentioned, uh, masterplanretire.com is the name of our website. There is a button on that website that says schedule a meeting. Why is that important? If you choose to uh to press that button, uh uh what whatever the right wording is for that, click that button. Thank you. Uh I'm old school. Um, then our calendar pops up and you have an opportunity to grab a spot and spend some time on uh uh with us uh locally. You can come to the office, we can zoom, we can have a phone call. And this is this first meeting is about you. It's about your dreams, your thoughts, your fears about retirement. Whether you're 35 or 75, it's not ever too late or too early. Uh but we will, based on that conversation, run a series of six to eight reports to illustrate not only are you on pace for retirement or on pace not to run out of money, but what could trip you up? Would tire would higher taxes affect you greatly? Would higher inflation, would the passing of your spouse if you're married, or or uh what about um long-term care? I mean, a huge problem in in today's uh society about how do we pay for that care because we're living longer. What a great opportunity to take a look at real numbers to figure out where you stand. So again, Masterplan Retire.com, also a treasure trove of other resources, other uh episodes of this as well. Um and also call us, 770-980-9262. We still have phones here, uh, so give us a call and uh we can get that scheduled for you as well.

Medicare IRMAA And The Two-Year Lookback

SPEAKER_00 17:02

So we anticipate being in an equal or higher tax bracket in retirement, not a lower one typically. Um the majority of our retirement assets are in fully taxable accounts at whatever bracket we're in for that year. Our Social Security is taxable based on our income level. For most people, it's majority of it is taxable. And if you're blessed to have a pension, it's mostly or all taxable. Right. And so most people's retirement, and even pensions, yeah, it could be taxable, are taxable. So most people's retirement income sources are taxable, if not fully taxable, Social Security is largely up to 85% taxable for most people. So if you are at in retirement on a fixed budget, you have fixed income coming in that's completely taxable, you do have uh vulnerability to the IRS. You have vulnerability to tax law. Um so we believe that Roth money having tax not even this is not a conversation for these so much, but there are other things to convert into as well beyond Roth's that are also tax-free vehicles. We've gotten into those in the past, maybe we'll do an uh another episode in the future. But tax-free money, period, um, is such a powerful tool, and we don't believe necessarily in all or nothing. Um we believe believe in tax diversification. It's good to have a little bit of everything because there may be years where you need to spend down some of that tax-deferred money and and build up some of that tax-free money, and then maybe one year you need to pull more from tax-free because you've got a higher um bracket that year or whatnot. Um, but we do believe in tax diversification, so we want to outline the problem and the importance of making sure that we have um some Roth money available to us. Um again, like everything else, there are some caveats to keep in mind on your conversions. Um one big one that gets overlooked all the time is a little thing called IRMA.

RMD Pressure And Roth Freedom

SPEAKER_01 18:52

At age 65, most of us sign up for Medicare. Medicare Part A, you've been paying for for the last 35, 45 years. So there's no cost in retirement for most people. Part B, which covers everything besides hospital, which is doctor visits and x-rays and all these kinds of things, uh, it has a cost to it. Right now, I think it's currently$204,$206 a month, uh, unless your income is higher. And then it goes up up to five different levels. I think the highest level is over$500, maybe$600 now. Um in addition to that$200, by the way. And so part of what that income that pushes you into Irma, paying more for Medicare Part B, is Roth conversion. So again, if you're under the age of 63, because it's a there's a two-year look back, good time to be more aggressive with that as well. Right? And so uh have to think about that. I want you to think about something that that kind of piggybacks on what Evan's been uh talking about. We've been spitting out a lot of rules and and and our thoughts about uh Roth conversion. I want you to think about real world for just a minute. Let's say that you feel pretty comfortable and you're ready to retire and you think$5,000 a month coming in, I think is a pretty healthy, you know, we can do everything we want, including entertainment, some light travel, um everything we need. Taxes go up by 20 percent, which is what they were projected to do last year. Okay. Now you're making$4,000 a year coming in, I mean per month. You just took a 20% pay cut. Can you make it? Most people would have to increase the amount coming out of their IRA, which does what? Increases you run out of money quicker and makes you pay more taxes. So it is real world critical to think about this. So I just wanted to kind of bring that back to earth and say all these reasons why, but really it's down to the fact that you run out of money quicker, you pay more taxes. And so uh it it should we just think it's so critical. Yeah.

SPEAKER_00 20:50

A couple of other really powerful, powerful things about the Roths. Um, one, everyone, uh not everyone, but if you are 70 and a half, 273, depending on what year you turn that age, you're familiar with required minimum distributions, RMDs. If you have an IRA or 401k, um at a certain age, you are required by the government to take withdrawals, start taking annual withdrawals, whether you need the money or not. Um and that is basically so that the government can get their tax money. Um now, if you're born 1960 or later, the age of RMDs is 75. Correct. Um it was originally 70 and a half, then they bumped it up. 72, then 72, 73. Now it's 75 for those born after 1960. But whether you need it or not, if you have an IRA or 401k, you are required to start taking annual distributions. And now that the first year starts around 3% or so, but the formula increases every year. So you think about a large IRA or two, all of them have an RMD on them. There's RMD planning, all that kind of good stuff you have to consider. That's something that we do with our clients as as well. We have to track annual RMDs, make sure they're taken out for our Clients by the end of the year. Well, Roth's, guess what? They're tax-free. There are no RDs on Roth. So that money is yours. We don't like people telling us what to do with our money any more than the next person. Especially not the IRS. Right. Yeah.

SPEAKER_01 22:13

And let's uh a real world again. So I can't tell you how many clients have have come in, and we've been working with them for five years, ten years. We've been preaching Roth conversions. They've done some, but they're like, oh, I had to pay$10,000 in taxes. I hate it. I hate it. And then they turn 73 or whatever age, depending on when this happened. And all of a sudden, that$500,000 IRA, a million dollar IRA, that first year on a million dollar IRA, they have to take out$37,000. That's just the first year. The next year it's like 4.5%. The next year it's like 5.2%. By the time they reach age 80, it's like 8%. 8% of$500,000, 8% of a million.

SPEAKER_00 22:51

Yeah.

SPEAKER_01 22:52

They have to take out on top of everything else they've been doing. And so that's when it bites them and they're like, wish I'd listened to you five years ago, ten years ago, I should have been more aggressive. It's real. And that's without taxes going up. Imagine five years from now they're having to take out 10% of their IRA and taxes are 20% 20% higher again. So just again, let's be real world about this.

Legacy Planning And Final Warnings

SPEAKER_00 23:16

So we are running out of time. There are a couple of things I do want to mention before we're gone though. And one is the fact that uh there are no RMDs on a Roth. It's also a great legacy to leave behind because um if you leave behind an IRA to your non-spousal heirs to your kids, they have 10 years to empty that IRA and that's fully taxable to them. To them. A Roth, you still have to empty it in ten years if you inherit it from a parent, but again, it's tax-free now forever until it's completely out of the Roth. We want to make sure, folks, that you are not going to your Schwab or Fidelity site and just converting everything at once without a strategy. Um we stretch our conversion strategies over ten or five, ten years, depending on the client. Um again, it's a year-by-year thing too. Um so speak to a financial professional, speak to your tax professional as well, um, and strategize for your long-term tax strategy in retirement.

Closing Thoughts

SPEAKER_01 24:10

And there's several potholes we didn't mention that can can bite you as well. You have to be very careful. So uh make sure you get help for sure. Um glad you joined us, and until we see each other next time, uh plan well and prosper. Take care.