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How to Avoid a Roth Conversion Disaster!

Season #2

 Today we're going to talk about the biggest mistakes people make with Roth conversions and how to avoid them. We're also going to talk about how Aunt Irma and Uncle Ronald, r m d, and our good old friend, uncle Sam, so stick around while we go through the nitty gritty of what you need to know before doing a Roth conversion.

What is a Roth conversion?

So a Roth conversion is essentially when we decide to pay taxes on our retirement accounts and choose when and how we pay taxes.

Ordinarily, we would pay taxes when we take the money out of the account and we would take it, out in retirement. A Roth conversion is saying, Hey, I'm gonna pull out more money than I need. I am going to pay taxes on that immediately, and I'm going to put it in this Roth. Now the benefit of this Roth account is that it grows tax free, and when we take the money out, it's tax free on the distributions.

Of course, there's an asterisk with that, that we'll talk about more about, but essentially that's what it is. It's paying taxes when it's convenient to you and not when it's convenient. In Congress,

What About IRMMA?

So I think that, these are nice hypothetical discussions and like lots of things in finance, we can get caught in the weeds.

We can talk about, like what's theoretically the best decision to do, right? What's the best stock to buy? What's the best bond to buy? What's the best, R M D or Roth conversion? But at the end of the day, all of the hypothetical decisions and all the hypothetically best things to do really don't carry any water or hold any water when it comes to your retirement because this is your retirement we're talking about.

We're talking about the money that you need to live on, the money that you need to count on. Then you need to be there for the rest of your life and your spouse's life and maybe even your children, right? So when we are talking about. What we need to look at is really, is it going to create the experience that we want to have?

Is the decisions that we are making as converting, doing this Roth conversion? Is it going to help our retirement? Is it gonna make our money last longer? Is it gonna give us more income in retirement? Or is it gonna detract from that? Because at the end of the day, that is the only thing that.

Not some theoretical decision of, will this theoretically save me money if I live to 120? Maybe theoretically, but I don't care about theory, I care about practice. And so that's really, when it comes down to it, I think that every single person, it has a unique decision, right? And how much to convert, if you should convert when you should.

That is a uniquely personal decision, and I really, it really gets to me when he will make these blatant statements out there and they say, oh, everyone should convert. Everyone should do this. Everyone should do that. No, you are not everyone. You are a unique human being.

The Biggest Roth Conversion Mistake

I think probably the biggest mistake that I see people making, especially right now is to do these massive Roth conversions upfront. I, for some people I recommend Roth conversions for the vast majority of people.

I actually show them that. Either doing a small conversion or not doing any conversion at all is beneficial for them, but I do tell them right the concerns that we have today about doing Roth conversions, like the fact that our tax code is scheduled to expire in 2026. The fact that every administration comes in and puts their stamp on the tax code, the fact that we have high inflation, the fact that we have, interest rates are rising, which means that the Federal deficit and the Federal Debt service cost is gonna go up, right?

All of these are reasons why we should be concerned about taxes increasing. . But the thing that I also tell everyone is that you can bet that Congress is going to have a way to protect their money and that in the United States, the tax code is not set up to collect revenue. It's actually an extension of our economic policy.

It is a way of for the government to incentivize behaviors that drive our economic. And so there will always be opportunities for us to reduce our taxable income in retirement to be able to reduce the impact that has. And so what we wanna be is strategic about the decisions that we make, and make sure that we have as many options as possible.

Now ha. Having said all that, there are people, right? If you have all your money tied up in a retirement account, right then you are right for Congress to come after. And we might want to do a Roth conversion at that point. Not because we're worried about taxes, but because we don't want to have Congress be able to dictate when and how we take money out and we don't wanna be subject to the whims of Congress.

And when we do that, we wanna make sure that we do it in a way that's beneficial to our retire. And that it doesn't detract from our retirement. And the answer for that is gonna be different for every single person. It's gonna depend on your tax bracket. It's gonna depend on how much money you need, how much money you need in retirement, right?

What your shortfall is, how much your, what your health is, how well your age is. There are so many factors that are individual.

Is This Strategy Right For You?

 I get this question all the time, right? Almost every single conversation I have with a new person begins with I read this article, or my current advisor told me X, Y, Z. What are your opinions about it? And I always, my answer is always the same. It's, those are great ideas. And they work for a certain set, a subset of people, right? They're the perfect solution for a certain person. Now, I don't know if you are that person, right? And from the information that you've given, You don't know if you're that person, and I don't know if you're that person.

And the only way we're gonna figure it out is to actually map it out, right? Let's put pen to paper. Let's map out the future, figure out what it, what exactly will impact us and will this have a positive or negative impact? And when people say but by the Wall Street Journal said this, or, Montley Fool said this.

The answer is they're selling headlines. They're selling views, right? And when you're trying to, when you're trying to get people to read something, when you're trying to engage people, you say really strong, bold statements, right? Because that attracts people. It riles people up. It makes people feel like, this is the truth, right?

And either I feel strongly for or against it, and it gets people engaged. Your retire. Is not a political statement. Your retirement is not, some headline that gets viewership. It is, it, I it is your experience, right? It is th your life and we don't want to, have some headline truth.

We want to have the experience that we've worked really hard to have, and the only way we're gonna do that is by doing the hard work. Don't let anyone convince you that there's a shortcut to doing the.

Common Roth Conversion Mistakes

when we look at Roth conversions, right? And we look at the mistakes that, people make or that, even advisors and financial professionals and the media, right? The things that they espouse, right? So the things that you will encounter are taxes are gonna go up. So let's convert it also where at lower taxes, right?

Which, there may be truth to taxes are going to go up. I do believe that taxes are gonna go up, but that doesn't mean it's gonna go up for you. But the other thing is if you're gonna pay a whole bunch of money in taxes now that's gonna decrease your portfolio value, which means it's gonna decrease the amount of money that you have to grow your assets on, right?

And depending on where you are in retirement, it's gonna determine how much of an impact that's gonna have on your retirement lifestyle, right? Because that's gonna directly impact how much money you have. So mistake number one would be converting too much upfront. Mistake number two is if you don't have anything converted, and you do need to.

Convert right, than not doing the conversion. So it's, it's two sides to that coin. So you have to every single year look and make the decision of, do I do a Roth conversion this year? If so, how much do I do? And it is very much a game day decision. The next thing is you wanna look at, how does this affect your overall picture?

So you have, are there things you can do to take advantage? Which we can talk more about the five year rule, which is a negative impact, right? So I can, when I take that money outta my retirement account, I don't necessarily have to put it into a Roth account. I can put it in a brokerage account if I put it in a brokerage account, right?

I have to pay taxes every time I have capital. But it also means I can harvest lost losses. It also means that I can borrow money against it, which means that when the market, if the market is down and I have a significant amount in my brokerage account, I can borrow live off of that and then repay that loan when the market recovers.

That's one of the things that the wealthy do to stay wealthy. It's how they, how their investments are constantly growing because they don't have to tap into it when the market is down, right? So that's something that you can do by, again, not doing a Roth conversion. Now, five year rule is something that kind of rears its ugly head, where when you do a Roth conversion, Congress says we don't want you just doing this conversion and then getting money tax free, growing it and having it tax free.

You don't get this benefit for. So in order to get this benefit, you're gonna have to hold that money in this Roth account for at least five years and not touch it. You have to be over 59 and a half, which you'll pro, you're probably already at that point. But you gotta, it is gotta sit there, right?

It's gotta mature, it's gotta, marinate and. . If you are living off of this money, then you're not gonna see that benefit and you're gonna actually get hit by a 10% tax penalty. So we need to be careful about that. And we need to be careful about things like Irma, which is, the Medicare premium, which is tied to your income.

So if we do these Roth conversions and that jacks up our taxable income, , all of a sudden our Medicare premiums make up go up, which also is the flip side, the argument when people say, why? Actually you should do these high Roth conversions early so that later in life your retirement premiums are lower.

How To Avoid Roth Conversion Mistakes

Number one, make decisions based on the future that we know is going to happen and the likelihood of it's that it's actually gonna happen, right?

It's easy to get scared about unknowns, right? We don't know what the tax code is gonna be like in two years. We don't know what tax rates are gonna be. Like, we don't know. We can't make decisions based on unknowns. We have to make decisions based on. And we need to know what our income's gonna be in retirement what our distributions are gonna be in retirement.

Let's try to make these decisions based upon evidence. I'm a firm believer that any financial decision you need, you make needs to be overwhelmingly obvious. If you do not feel like this decision is overwhelmingly obvious that you should be making it, then it is probably the wrong.

Want help deciding if a Roth conversion is right for you? Book a free appointment with our team and we'll help you decide.