Costly Roth Conversion Mistakes and How to Avoid Them

[@gizmobowen]

This is the only financial advice video I've ever watched that has actually acknowledged all the unknowns and presented them in a way that is helpful. Thank you.

[@apnudi]

I've never seen someone dress to match literally everything in the room before. 💯 Nailed it!

[@Robert-di3kv]

It’s called camouflage

[@silver6054]

And as you get close to retirement, you need to consider IRMAA thresholds when doing Roth conversions

[@PH-md8xp]

If you have a low tax year soon after retiring, because you’re living on cash you had saved up. So, very little taxable income. You could do a 0% tax Roth conversion by keeping the amount you convert within the amount of the standard deduction, which for married filing jointly in 2023 is $27,700. It’s not a big amount but it would be tax free. That’s hard to beat. You could convert more, up to an additional $22,000 and stay within the 10% bracket, or up to $89,400 and stay within the 12%. Do that a few times and you could move significant amounts over to your Roth accounts and not have to worry about taxes again on those amounts.

[@over07ful]

And qualify for Obama care subsidies up to 1500 a month. I think.

[@anujgupta9293]

U need to consider that u will be getting social security and other income like rental income

[@jamesscroggins3486]

Another consideration is what your tax bracket was when you were making 401k contributions. I was in the 22% bracket, since nice retirement I have been in the 12%. So I have been making conversions up to the top of my 12% ceiling.

[@bigjohnson7415]

That makes the most sense.

[@user-mx4uv5gn4y]

James, In this video you mentioned make an excellent point about a different tax situation if a spouse dies. You mentioned that the surving spouse has a couple of years before their brackets change. However this is only true if there are still children at home - year of death file MFJ and next year Surviving Spouse. If no dependent children at home, you can file MFJ only for the year the other spouse died. For many(most?) considering Roth conversions would not have dependent children at home.

[@user-mx4uv5gn4y]

BTW, I love your videos - great content and presented in an understandable way. Just wanted to clarify that for many they will have less time to course correct following a spouse's death

[@DougASAP]

He is talking about Roth "Conversions" not Roth "Contributions". Roth Conversions are virtually unlimited after age 59.5. Roth Conversions can be a great thing to do after you stop working and before you begin Social Security and/or RMDs from traditional retirement accounts.

[@user-mx4uv5gn4y]

@@DougASAP Agree - I am doing conversions well after 59.5. My comment was about tax filing status on death of a spouse.

[@DougASAP]

@@user-mx4uv5gn4y Oops! Sorry, I replied to the incorrect comment! Have a good weekend!

[@Stashmo]

@@DougASAP Also unlimited at any age.

[@64buffer]

10:26 great video! Wanted to let you know that the on-screen text is wrong compared to your point in the video…you say “they’re NOW pushed into a higher tax bracket” but the on screen text says “they’re NOT” pushed into a higher tax bracket, which is the opposite of what you’re saying. Anyway, new subscriber, love your clear, well-thought-out videos!

[@rayzerot]

The most important thing in deciding Roth vs a Traditional account is your marginal tax rate now vs your *effective* tax rate in retirement (including widow tax and possible IRMA). It's not a 24% marginal rate now vs a 24% marginal rate in retirement decision

[@keithmachado-pp6fv]

Good comment. I used to think the same thing, marginal vs effective. The better comparison is to start with the marginal tax bracket, both before either the conversion or the RMD and then calculate the effective vs effective rate you pay on either the conversion or the RMD. Example, you have a large IRA and you are in the 12% marginal bracket today. If you convert $100k you will be in the 22% marginal bracket. Let’s say 20% is taxed at 12% and 80% is taxed at 22%. Your tax in total will be $20k or 20%. Let’s say your remaining $80k doubles to $160k tax free by the time RMDs would have kicked in. If instead you deferred and were in the 15% marginal bracket at year 1 of RMDs (higher marginal bracket post expiration of tax cuts and jobs act). Let’s say had you converted your RMD would have been $16k but by deferring an extra $100k that goes up to $20k. To do the apples to apples comparison you would look at the tax rate you paid on that last $4k. If it’s still in the 15% bracket you would come out ahead by deferring. Yes RMDs go up each year but so does the standard deduction and tax brackets for inflation.

[@keithmachado-pp6fv]

One correction that does not impact the conclusion. Your $100k if deferring also doubles to $200k so the “extra” RMD will be $8k not $4k. You still benefit by deferring if that $8k is all taxed at 15% in the example.

[@Shane-zn4hm]

You are the Best! Thank you so much for sharing your wealth of information in a clear and easy to understand manner! Nobody does it better.

[@NicoleL8600]

Very useful information and very well articulated, James. Thanks for being concise yet explaining things in way most people can comprehend.

[@marcorios6806]

What a great educational video and awesomely explained in a simple way so even a knucklehead like me understands the complicated topic. I'm going to watch this video over and over again. I subscribed to your channel now and thank you from Los Angeles CA!

[@chessdad182]

It seems hard to believe that they will not raise the tax rates.

[@bigjohnson7415]

Which "They?" You mean the Republicans that wrote the legislation to screw the middle class, while business and the wealthy who get to keep theirs? Those "They?" Just keep in mind that's what happened, while the Right was slapped themselves on the back for getting another one over on the masses! All while adding trillions more into the National Debt. I see more likely the lower and Middle Class rates will stay the same, but the high end go back up, like Obama did with Bush's Tax Cuts for the Rich.

[@keithmachado-pp6fv]

The danger in comparing marginal vs marginal rate is that the conversion is all paid up front vs deferring is paid on RMDs slowly over many years. Thus there is more of a chance that the conversion will push you into a higher bracket. Therefore the better comparison is effective vs effective rate ONLY looking at the average tax % on the conversion vs RMD. That means some assumptions on future tax rates, growth of your IRA and your other income which will vary depending on inflation (SS COLA) and your spending as well as your longevity (widow tax trap). You can do the best estimate of future but it’s not an exact science. What you know for sure is the tax you will pay to convert.

[@chezellis]

Another consideration until they change it is how ROTH IRA and ROTH 401k distributions do not have as big an effect on Medicare and IRMAA. This does fall under the "what is your actual taxable income from your sources". RMDs from traditional 401k and IRAs could cause a higher premium for Medicare.

[@steves3234]

I think peace of mind of removing taxes and risk of IRMAS and SSA tax torpedo justifies even a higher rate. Also removing RMD is a plus. I will pay the taxes with non fund money

[@anujgupta9293]

And the possibility of giving it to your kids , taxfree

[@johngill2853]

Great job I like the theory of tax insurance but with all insurance you have to weigh the price you pay for it. I see to many people on KZbin blindly choose Roth/ Roth conversions because they think taxes will go up

[@rdspam]

Commutative property of multiplication eludes so many people…

[@michaeldinardo6391]

Great info, thank you!

[@frankt1720]

Thanks for a great explanation James

[@dianemckim9535]

non-spouse inherited IRAs currently require the depletion of the IRA within 10 years of inheritance. please make a video concerning making Roth IRA conversions based on what happens to an inherited IRA if IRA owner dies before depleting his or her IRA.

[@MichaelToub]

Great Video!

[@send2dwight]

Good stuff, bro!

[@bretschultz7321]

Great video on Roth Conversions, Looking at the last 35 years the rates and brackets have gone down 34 out of 35 years. Even with the tax reduction going away does not mean they will not replace it with even a lower tax rate. And at 65 you get even higher deduction. But RMDs @ 75, are a problem, if you were living on the money and expected to say even take out over 120k @ todays rate would be in the 22% or less rate. Because of SS @ say 80K for 2 and then you have about 140k room to take out money at or below the 22% tax rate today. if this is say 15 or more year in the future it is much more likely based on the last 35 years that the brackets and rate will actually go down...Oh 140k would make the account about 3.5m to have to take out an RMD of that size. So I am still not convinced Roth Cons. make any since for 95% of people...If you have 60-70 to take out more than you need (saving in after tax account) to say the max of a bracket 22% living on maybe 75% of the withdraw, you can wait on SS and let it grow for safety to 70. This brings the IRA total down while both are more likely to be alive, bigger tax break and get the money out of an account that has restrictions on inheritance. Roths have a 5 year can't touch and inheritance restrictions. And to have them make any since they need time, more like 20 years to grow tax free...I just don't see the advantages. I know we are suppose to plain for 90. But the stats just don't support it...The likely hood of both partners living to 80 is less than 25%.

[@Stashmo]

Hmm, not sure your analysis holds up. National debt load will need to be addressed with higher tax rates. Roths are much better to inherit.

[@simev500]

The RMD can become a huge pothole even if it looks like a speed bump now with a 4-5 year road horizon ahead.

[@Sylvan_dB]

Even at the same tax bracket, it might be desirable to pay the tax from other funds. This has the net effect of adding more money to the tax free account than you had in the tax deferred. This can result in paying less taxes, even at the same rate, over time by reducing the taxable funds in favor of tax free.

[@michaelday8426]

What if you’re young, 30-40? Is there a way to evaluate how much if at all one should do conversions?

[@MrLopez746]

If you have investments in both an IRA and a brokerage account and plan on living frugally in retirement, are you better off withdrawing roughly $1200 a month from your IRA that would be tax-free due to standard deduction or converting the same amount into a Roth and living off your taxable investments?

[@phoenixnmhesq]

Does grow matter? I mean, if I have a $5000 IRA that I convert to Roth because I expect major growth does that matter? Isn’t paying 20% on 5000 now better than paying 20% on $30000 in the future

[@ddenuci]

If you pay 20% on $5000 today, you're immediately down to $4000. You paid $1000 to Uncle Sam. Say you expect the stock market to double in 10 years. With the $4000, your account will have increased to $8000. Had you not opted for the Roth, your $5000 will double to $10000. Now when you start withdrawing, if you're tax bracket stays at 20%, then you will not pay any taxes on the $8000 and your grand total for taxes paid is $1000. If you didn't do the Roth, you would pay $2000. In both cases, you are left with $8000 net. So, from a tax perspective, there are at least these two things to consider: 1) will the government have raised the tax rates by the time I begin withdrawing money and 2) will I be in a lower tax bracket than today?

[@raymondcasabonne9055]

What if you paid the taxes using other after tax accounts and transferred the whole amount into the Roth?

[@jdmd10]

Exactly. Although I enjoy James' teaching style, his example uses withholding from the Roth conversion to pay for the taxes which I believe to be the least desirable way to pay for Roth conversion taxes. I am in the midst of doing a yearly Roth conversion in order to eventually convert a large traditional IRA into a Roth and using mainly LT capital gains from successful investments to pay for the taxes. That way the whole Roth amount is converted, the LT gains won't raise my AGI and I pay 15% tax on the LT gains. Unless I am missing something, I believe this to be the best possible option in my scenario.

[@wdeemarwdeemar8739]

Future tax bracket forecasting is nice but IRMAA and Obamacare subsidies are just as important. Go Roth or go home.

[@michaelswami]

Thank you for this. The cap on IRA contributions complicates this calculation, doesn’t it? If the cap is $7500, and I’m in the 20% marginal bracket, I can contribute $9,000 of taxable income to the Roth, but only $7,500 to a traditional IRA, with a tax savings I can’t invest tax free. What am I missing.

[@firecopscott]

My understanding is that you are able to convert (move) savings from an IRA/401k to a Roth. You have to taxes on the amount moved as ordinary income rates the year(s) you convert. I am currently evaluating my best course of action as I retired last year.

[@DougASAP]

He is talking about Roth "Conversions" not Roth "Contributions". Roth Conversions are virtually unlimited after age 59.5. Roth Conversions can be a great thing to do after you stop working and before you begin Social Security and/or RMDs from traditional retirement accounts.

[@Stashmo]

@@DougASAP Yes, he was totally confused about conversions. But what is different at 59.5? Age is not a factor in Roth conversions.

[@stephenhegarty6179]

Just need the money to pay the taxes

[@davepov]

If you do an IRA to Roth conversion and you're 70, retired and getting SS, doesn't the fed gov just lump that Roth money in to your income for the year you do it and send your tax bracket up? The government wants to take as much money from the average wage earner as possible.