Navigating Roth Conversions and the SALT Deduction Cap for Retirees
Freddie: The $40,000 SALT deduction cap affects many retirees in high tax states limiting how much they can deduct from their federal taxes. Roth conversions can complicate this further by raising income and shrinking deduction opportunities. Today we'll explore how to balance these competing tax rules.
Hello again everyone, and welcome to Leibel on Fire. Hello, Leibel and welcome back to the show.
Leibel: Hey, how are you doing
Freddie: today?
Unbelievable. So glad to be with you. And let's talk a little bit about the state and local taxes, the limit on what taxpayers can deduct and why is it so important for retirees in high tax states?
Leibel: Yeah, so just, just as a reminder, right, this goes back to, um, before the first Trump administration. So we were winding back the clock quite a bit here before the tax cut and jobs act, which got passed, uh, you know, in 2017 what it affected, right?
What we had was everyone item. Their tax returns are almost everyone did because almost nothing was excluded automatically. So if you were in a state where you had high property taxes, um, or you had state income tax, typically what happened was most people itemized their deductions and they were able to deduct from their taxes.
' cause the amount of taxes that they paid to their local and state governments and. When you think about it, it kind of makes sense, right? Why should you pay taxes on money that you're paying taxes to, right? It's going to the government. Why should you get back, get paid get taxed on that, uh, second time?
And so, you know, it's kind of a nice thing that the government did, which was, you know, if you pay taxes to one entity, don't pay money on that taxes to another entity, unfortunately. When the Tax Good and Jobs Act got passed, one of the concessions that was given to the, you know, um, to the, uh, at the time I think it was the Republicans gave it to the Democrat party, but it was the, it was a bipartisan bill.
And, uh, one of the concessions that was given to the critics of the bill was that if you had all these tax deductions, you're gonna be reducing the tax base by too much and you're gonna give too much incentives to these billionaires and these millionaires. And so. One of the things that went to the wayside and the compromise was, well, if we're giving people high standard deductions and we're gonna allow most people who are filing jointly to eliminate, $30,000 of income automatically.
Then the thing that we're itemizing right now, which is the SALT, right? The state and local taxes, that we're going to eliminate that, right? We're gonna say you can't itemize that anymore. And if you do itemize, you only get $10,000 instead of, I don't know if there was a limit before Now.
The proposal that came back, you know, was, uh, in this new round, in this big beautiful bill, is that we wanted to reintroduce that, right? People wanted to reintroduce that because it's kind of unfair to people who are in high income states. Uh, high tax states like California and New York and some others where you have, you know, state income tax of, six to 10% if not more.
And then you have, in addition to that, you have property taxes that are astronomical, right? So you can easily pay, right? 10, 20, 30, 40, 50, sometimes more. In. In taxes on your property. And when you're paying that kind of money on your property and you're paying state taxes and you're not, and now you're paying federal taxes of, you know, 30% on that's a lot of money that's going to governments out of your paycheck, right?
And so. Um, one of the things that kind of, you know, the concession this way, this time, going the other way was to reintroduce the SALT cap and put back some of those deductions that people had before. However, it's not, like everything the government does, it's not a clean cut and it only affects a very small percentage of people and not the percentage of people that most people would want it to affect.
Freddie: We're talking with LeBel Sternbach today about how Roth conversions can slash president trump's $40,000 state and local tax deduction for high earners. And I'm wondering, LeBel, how can a Roth conversion reduce or even eliminate the SALT deductions?
Leibel: Yeah, so, so kind of, you know, the government never does anything in a straight fashion and this is why.
You need to work with a tax advisor and, and not just a financial advisor and not just a CPA, but you need to work with somebody who kind of combines both of those disciplines and can advise you on the ways to maneuver through the tax code. Because the tax code, the United States Tax Code, it's an amazing thing.
It's an amazing vehicle for moving money from one part of the economy to the other. But because it is this vehicle that's not designed to generate revenue for the government, it's designed to stimulate our economy and to build industry. It does things that oftentimes are odd and, uh, creates these weird loopholes and these weird tax holes in the in the tax code that people can take advantage of.
Until they get closed up or that they're intentionally put there because the government wants to stimulate something. In this case when it comes to the SALT cap the SALT deduction. So the government, you know, had to put that in there in order to get votes in order to pass the bill. So, and they passed the bill because they needed.
To, we needed to keep the tax cut and Jobs act. We need to keep the tax codes going. We couldn't shut down the IRS. The IRS isn't capable of really changing the tax code. Um, the tables that they used to collect, we couldn't go back to how it was, it would totally screw up our economy. So. Kind of the concession was we're gonna keep our economy functioning, we're gonna keep the things, flowing the way that they're flowing.
But in order to get that passed, we needed to make this concession for the SALT cap because people, you know, were bitter about that. However. It wasn't passed as a straight line item of we're gonna restore this all cap. What it was passed as was. We're gonna give that, but we're gonna phase it out so that people who make over 500,000 don't get this deduction.
Right. We don't want this to be predominantly impacting the ultra wealthy. We want it to be going to the middle class. In doing that, the mechanism that they used and the mechanism that the tax code has built in for making sure that tax deductions go to the middle class and not to the ultra wealthy, is by putting in phase outs.
And phase outs are saying that if you are modified to adjust to the gross income or you're adjusted gross income, or whatever number they decide to use for it, some number that is your taxable income. If that number exceeds a certain threshold, they're gonna start phasing out how much of that deduction you get.
Which in theory sounds great. It means that, you know, people who make a lot of money aren't going to get as much of that deduction as possible, but like everything the government does, it doesn't quite work out the way that it's intended to. Because in theory, in headlines, it's like, okay, five people who make $500,000 or more.
Shouldn't get this deduction. I'm all on board with that except for I have a whole lot of people who have a whole lot of money in their retirement accounts and who the, the required minimum distributions are gonna force them to take out hundreds of thousands of dollars from that account because it's grown and because they have social security and they have a pension and they don't really need to live off of that money.
Right. Or they're very frugal because that's how they got all that money Right. Was by being frugal. Right. And now they're not. Spending it. And so they have a huge amount saved up that they want to give to their kids and their grandkids, or they want to save up to live off of in retirement and make sure to pay for their, you know, long-term care needs or their, you know, um, their needs as they get older.
And the government's gonna take most of that money. Right? And not only that, but it's gonna double tax 'em. And so it, when we talk about Roth conversions and we talk about RMDs and we talk about all these expenses that we have in retirement. All of a sudden we start looking like these upper class, these one percenters that we never were in our entire lives.
Right? And we really aren't. It's just that because of the cork of how the tax system works, we end up looking like them on paper for a short period of time. As the IRS slowly drains our retirement account before our eyes.
Freddie: Wow, we're talking about Roth conversions and the SALT deduction, uh, cap. And I'm just wondering with that you just mentioned, uh, the Roth conversions do the long-term benefits of the Roth conversions outweigh the short-term loss of these deductions Leibel.
Leibel: That's the math you gotta do, right? Like, you know, we're constantly having to do this math and it's something that they, the answer today may not be the answer that will be tomorrow. But you gotta do the math. You gotta see where am I today financially, what happens if I don't do any Roth conversions?
And then what happens if I do Roth conversions? Do I do it slowly? Do I do a very. Aggressively, um, how does that impact my taxes over the short term, over the long term? And then you gotta throw a wrench in there, right? Because it's not just about the theoretical. Uh, how much money am I gonna pay in taxes, but it's then what is my spouse gonna have, right?
Hmm. Who are my survivors, right? Uh, what taxes are they gonna pay because my spouse is gonna lose out on that marriage. Filing jointly SA tax status, right? And what is that going to do to their tax situations? Is that gonna jack up their taxes and maybe I, it's worth paying it at the higher merit filing jointly rate, or is it, you know, do we need to use some other mechanisms, right, to reduce that tax burden?
And so. It ends up really being a game of calculus. So there's no binary answer of yes, it should, you should do Roth conversions. No, you shouldn't. It's, you know, what makes sense for your situation? What will get you the outcome that you're looking for the most, right? Whether that is to protect your spouse whether that's to make sure that you're have the money for those later years in life so you can live in comfort.
Or maybe you're not worried about that and it's how do you make sure that your kids, you grandkids. Or the, the organizations you want to receive your money have the most amount of money possible rather than the government.
Freddie: Interesting. So in a couple of minutes we have left. I was, I was wondering, can you share some strategies Leibel that retirees can use to get through this calculus and balance Roth conversions with the SALT deduction gap?
Leibel: Yeah. Yeah. So, so all of this always comes down to right basic math that you need to do. And it and really, even before you do the math, it's the basic questions you gotta ask yourself, right? Is, am I gonna be in a higher tax bracket now? Versus in the future, right? And look into your crystal ball and figure that out.
And there's some basic assumptions that you gotta make, but you know what those assumptions are, right? Am I gonna be dead in 10 years or not? Is my spouse gonna be in a higher tax bracket or not? Are those concerns that I have? Will my required minimum distributions increase my taxable income in the future?
And if they do, right, what do I need to do to reduce that taxable income? And the way you go about answering those questions is really the hard part, right? Because it's, if you're retired right, or you're just separated from work, that's gonna be a period of time between that separation and when you take social security, where you get to control more of your income those early years until RMDs kick in.
Again, you can control your income. So how much of that income of that tax bracket are you gonna use up for doing Roth conversions, if you should even do Roth conversions? And again, the only way that you're gonna be able to answer those questions is by doing the math. We've got some basic calculators on our website that can help you piece it together.
We've got an RMD calculator, we've got a Roth conversion calculator. Uh, but at the end of the day, right, doing that kind of calculus, looking at your personal situation, looking at. What are the things that you want to have happen with your money? That is what we do every single day at yields for you.
And it is not, it is not just a simple like, you know, plug it into an Excel spreadsheet and get an a, an answer. It is understanding how all the different. Factors affect you and the outcomes that you want to achieve and what will get you there with the highest probability of success and then making an informed decision.
And that's what we do. We have a free retirement tax bond analysis that we do for people. Mm-hmm. Go to yields for you.com, put that book appointment fill out a, you know, answer some basic questions that'll kick off that process, and we're more than happy to do this and help guide you through that decision making process.
Freddie: He's Leibeled Sternbach and Leibeled. We gotta leave it right there, but I don't wanna leave without giving you the website. It's yields the number four, the letter u.com. So that's yields for you.com. And as you've heard, Roth conversions and the SALT deduction cap can create a tricky tax trade off for retirees.
And by planning carefully doing the math, this Leibel said you can balance short-term deductions. Long term retirement tax benefits and working with an advisor like Leibel Sternbach ensures you that you'll be making the best decision for your situation. This is Leibel on Fire. I'm Freddy Bell, and we'll see you next time right here.
