Impact of Portfolio Return on Your Roth Conversion Strategy (Surprising)

[@RetrieverTrainingAlone]

Excellent! We are 5-years off from huge RMDs starting at age 73. We are using our inheritance to pay for Roth Conversions and our tax bracket increases from 12 to 22 percent in the next 5 years. Our parents all passed in their mid-90s and mom at 102, so we expect a long investment time. Another advantage is tax free to heirs from Roth IRA.

[@randolphh8005]

Great video! Your last chart brings up the most important point for those already retired. Over converting causes you to lose money! Under converting cause you to pay more tax. What many forget, is that with average portfolios, relying on an high annual ROR to come out ahead increases the risk of a conversion, which of course is done early. That causes your portfolio value to drop, in a poor return environment that would mean less gains over the subsequent years. The person that didn’t convert as much will have more gains that maythen be taxed at a lower rate than if they had been aggressive with the conversion. For large portfolios with excess funds, this risk is not as consequential. On the flip side if I have a just large enough portfolio, that ends up with a very good ROR, then yes I pay more in taxes, but I also have more money to pay them, so it won’t impact my cash flow. Cash flow always needs to be the first consideration, ultimate total taxes paid should be the second consideration.

[@ralphparker]

Did you talk about the advantage of Roth in that you can manage which bracket you max out. For instance, Say I need to max out the 12% bracket just for normal living expenses. But a need for a new roof comes up and if I pulled that money from the regular account cap gain gets thrown into the 15% bracket for from the regular IRA, which gets taxed at 22%. But then having funds in a Roth, I can withdraw that and not have any additional tax consequences. And this was incrementally funded thru optimum Roth conversions for that 5 to 10 Year period when my tax rates were lower.

[@missouri6014]

Excellent episode Thank you

[@joycewright5386]

Last year when the market was down every time there was a huge drop I hurriedly did some Roth conversions. Now that the market is back up the profits in my Roth have more than covered what I paid in taxes.(taxes were not paid from the conversions)

[@Bondbeer]

Paying the tax outside of the withdrawal provides the best answer. With that said, the gain would have also occurred if you invested the money used to pay the tax so that is not as important as what tax % you paid to convert vs would need to pay down the road if you didn’t convert. I don’t know your fact pattern to judge whether converting will save you money but it sounds like you are happy with the outcome and that is all that counts.

[@mike73ng]

That works unless you are still in high income years.

[@montesarache5993]

In 2024 the ordinary income cap for the 22% bracket is $201,050 and for the 24% bracket is $383,900. Those advocating going into the next tax bracket when doing Roth conversions should keep in mind that once your adjusted gross income hits 250K you become subject to the Net Investment Income Tax (NIIT) which is another 3.8% of the portion of your income over the 250K or on long term capital gains, whichever is smaller. So it is not just going from 22% to 24% but could be from 22% to 27.8%, which is not insignificant. Not enough folk bring this up in videos ( a pet peeve) and so this is just a friendly reminder. Overall, it was great to see that our strategy meshes well with Safeguard's. Nice video! Thank you!

[@johnboyle7376]

Very good point. To clarify, the $250k is for people filing MFJ. It’s $200k for single filers.

[@anujgupta9293]

The other thing they never talk is, your state income tax and city tax . Let's say at present your state tax is 8 percent , but in retirement, u move to no state income tax state . That will make conversion less useful

[@PH-md8xp]

Lots of gotchas to watch out for in retirement.

[@Random-ld6wg]

that is the exact situation i am in. i live on and pay taxes out of my taxable brokerage in early retirement so even getting the money to pay for the conversions also generates capital gains. for 2023 i converted 195K and with my MAGI at 286K. the 36K of capital gains had an extra $1368 of taxes. If i converted up to 24% bracket above 250K, all my capital gains will have the extra 3.8% NIIT. this also pushes more of my actual living expenses from my capital gains into our states top 5.9% bracket although we do get a 40% deduction on LTCGs but not on dividends. my solution for now is to tap the investments with less gains vs the multibaggers if i get tempted to go up 24% for the remainder of '24 and for '25. that jump from 22% to 25% and 24% to 28% as the trump tax cuts most likely expire in 2026 is tempting me to go up to the 24%. your portion of conversions above 250K though is considered income and not capital gains so any conversion above 250K IS NOT subject to the NIIT. correct me if i am wrong as that is what i infer from your " doing Roth conversions should keep in mind that once your adjusted gross income hits 250K you become subject to the Net Investment Income Tax (NIIT) which is another 3.8% of the portion of your income over the 250K OR on long term capital gains"

[@montesarache5993]

@@Random-ld6wg, Thank you for your thoughtful analysis and for sharing a real-life experience. We are not a CPA nor a fiduciary so would never advise anyone other than to suggest that they speak with a professional. Your sharing your experience is very valuable and is much appreciated. The IRS code IRC Section 1411(c)(5) agrees what you have written. Our somewhat poorly worded point was that going over 250K will trigger the NIIT and this part is often omitted. We should have been clearer on that. Thank you!

[@rdspam]

Good stuff.

[@slimdawgwoof]

You are the GOAT!!!! Another great one!

[@ericgold3840]

Nice presentation! The main element I find missing is a consideration of locating fixed income in the pre-tax account and stocks in the Roth. This has the salutatory effect of mitigating the effect of the overall growth rate (GR). I'm starting out with about $5M in my tIRA. I'll convert about $2M to Roth by RMD age. The tIRA balance will continue to grow, but at a GR lower than a 60:40 stocks to bonds allocation implies because the Bond fraction will be higher than 40% in the tIRA

[@PH-dm8ew]

One fact that never gets discussed is the step up value of stocks in the brokerage account for beneficiaries. So reinvesting those RMD's help the beneficiaries in the end, if you cannot convert those funds to a ROTH, all is not lost.

[@Paul-GrnHil]

I totally agree. I hope to leave 529s to my grandkids, Roths to my heirs and hopefully little left in my IRAs. RMDs are the least of my concerns.

[@Random-ld6wg]

he wasn't recommending converting everything just enough to keep rmds manageable. the 500k left after conversion will still be subject to rmds but hopefully be manageable. the way i look at it is if after mitigating the rmd tax hit with conversions yrs before and you still end up with substantial rmds, then just count yourself lucky that your portfolio grew even more and pay the tax,.

[@Bondbeer]

Exactly. You can also harvest losses in a brokerage account and invest in assets such as MLPs that cause issues if held in an IRA. As for heirs, access to the accounts and ease of transfer is much easier with a brokerage account if you have a POD assigned. I inherited a Roth and had to fill out paperwork including getting medallion signatures so I could transfer everything to an inherited IRA. Now every time I want to make a withdrawal I have to mail in a form. You cannot add funds to an inherited Roth, you need to Track the 10 years to deplete the account or face a penalty and you need to report your withdrawals correctly on your tax returns (although there is no tax owed).

[@Bondbeer]

I left out one more point. If you inherit a Roth you are dependent on the choices made by the original account owner. The inherited Roth I received has limited investment choices and an annual fee.

[@rdspam]

@@Bondbeer Make a trustee-to-trustee transfer somewhere else.

[@jefflloyd394]

Always good Eric - thanks. But what if the market tanks 40 % early in retirement, for a couple years, convert into a much higher tax bracket? A good 'hedge' against a downturn? Cheers

[@Paul-GrnHil]

First let me start by saying Roth conversions early in retirement while living off taxable accounts and before collecting social security is an absolute priority. As for the remaining IRA or rollover 401k accounts, they are going to be taxed no matter what, the only question is when. Whether an RMD or a voluntary Roth conversion, the taxes are the same. I do not consider RMDs to be a tax problem if you consider the tax liability holistically. If your retirement accounts are generating RMDs in excess of your living need then you should be thinking about estate planning rather than just retirement income. The taxes you pay today at your retiree rate are likely to be less than the rate your heirs are going to pay when they have to distribute the inherited IRA during what is likely are their highest employment income years. BTW, if you have the “problem” that your RMD requires you to recognize income you don’t need for daily living, you can always fund your grandkid’s 529 accounts and avoid taxes on the account growth and even have the opportunity to convert the unused portion of their 529 for their starter Roth account.

[@BillMaass]

If I am the client shown, I will opt to fill the 24% bracket in 2024-2025. Annual reassessment might convince me to only fill the 15% bracket in 2026-2028 if TCJA sunsets. Since investment returns will inevitably fluctuate, one needs to consider taking advantage of a down market if we see a repeat of some short term correction/crash that occurred in say 2008-2009, early 2020, or even 2022.

[@BillMaass]

@@_-Karl-_ The example says they have $1.5 million in tax deferred. They aren’t collecting SS for another 5 years. Filling the 24% bracket means they can convert over $400k in both 2024 and 2025. Depending on their rate of return, that should drop them under $1.0 million by 2026. I stated that after annual reassessment I might drop down to the 15% bracket. This was a direct comparison to the example shown where the first five year target was 22% in the first two years and then 25% the next three. The current 24% bracket is much wider than the lower brackets. Do the math and you will see that I can convert much more using the 24% bracket and having the ability to drop to the 15% before collecting SS than converting thru the 22% and just about being forced to convert into the 25% those last 3 years before collecting SS. You will notice that Eric’s example shows him dropping conversions to the 15% bracket after 5 years. Being more aggressive by using the TCJA’s 24% bracket gives me the chance to scale back to 15% earlier if I want. Remember, 24% is less than 25%. I personally would sleep better filling those 24% brackets initially even if I am triggering IRMAA for one year with the 2025 conversion.

[@byronmill]

I've watched quite a few of your videos and and very impressed by the quality of the information and the visuals. Are the charts and graphs that you are showing in the various videos actually used with your clients to communicate the variables and the optionals strategies or are they only used here in the videos for illustration purposes?

[@SafeguardWealthManagement]

Thank you! We do use the same charts and graphs in our day to day with clients as well.

[@byronmill]

@@SafeguardWealthManagement and you use the clients data to generate unique charts and graphs for their situation?

[@SafeguardWealthManagement]

@@byronmill Yes!

[@byronmill]

@@SafeguardWealthManagementI've been to your website and reviewed your services and pricing structure. It doesn't mention the minimum portfolio balance required which it seems most fiduciary financial advisors do have. What are your portfolio requirements if you have them?

[@lidarman2]

I guess what I am missing here is what is the 25% tax bracket? Doesn't the next bracket after 24% go to 32%? And there also is no 28% bracket. However 25% and 28% were before 2018 but there was not a 24% bracket. I'm lost.

[@Bondbeer]

I would rather be in the 28% bracket during RMDs than pay 22% today. Why? Because I won’t pay 28% on all income. I will take advantage of the inflation adjustments to the standard deduction and lower tax brackets so the “average” tax rate will be less than 22% and that assumes the rates revert in 2026 which is not likely.

[@rdspam]

You’re paying 28% on the portion in the 28% bucket. Why not pay 22% today to lower your marginal rate later to the top of the 22% bucket? Multiplication is transitive. The discussions are always about the final amount at the highest marginal rate, not an average rate. In the graphic, you’re shaving off the top green segment(s), replacing them with blue (lower rate) segments. And these are all with inflation adjusted rates, deductions, etc. If they weren’t, the breakpoint between marginal rates would be the same every year. In the graphs, they are not.

[@Bondbeer]

There are 3 issues ignored by the Roth conversion advocates. 1. Market Risk. If you are 60 today, a major market decline after you have decreased your gross net worth by converting and paying tax will have a much bigger negative effect than if you defer and suffer a market decline while taking RMDs. The reason is you will have fewer years to fund when deferring. 2. Inflation risk. If inflation is high, the standard deduction, tax brackets and IRMAA surcharge limits will all adjust, thus it will take more income via RMDs to push you into higher brackets. 3. You may not need a Roth if you have more tax free income than you ever will need that will already pass to your heirs tax free (paid off real estate, cash value life insurance, brokerage account with step up in basis). In that case just withdrawal and spending or adding to the brokerage account will have the same result as Roth with the added benefits of being able to take advantage of losses annually against ordinary income, invest in assets such as MLPs and collectibles and include a pay on death (POD) clause so your heirs don’t need to transfer everything to a new inherited IRA and empty the account in 10 years.

[@baolichang6019]

@@Bondbeeryes, if you have all your money in tax efficient vehicle, you don’t need Roth conversion. It’s for people with large portion of their money stored in IRA or 401k. They will need to get some money out of tax deferred. The video also advocates multi year conversion. It’s even better to convert in a bear market if you have some cash or equivalent to pay for tax, since eventually the market will recover and the money in the account will grow tax free for you and your heirs.

[@Bondbeer]

Thanks for the reply. I am not anti Roth conversion per se but I disagree with many of the financial gurus spouting Roth for all (not this video as he is very good). The reality is if you are 55 years old today your first RMD is 20 years away. Year 1 RMD on $1m is $40k which after 20 years of inflation adjustments is less than the standard deduction. Anyone with less than $1m in tax deferred accounts is unlikely to see a benefit from converting. As far as converting after a down market, that myth is wrong with the exception of converting the entire account at one time which is not recommended for most people. As far as partial conversions there is no benefit and you can make the argument the opposite is true that there is less reason to convert. The purpose of converting is to end up with more after tax net worth by paying a lower % tax today vs if you defer. A major component is typically reducing future RMDs. When we have a market decline the result is similar to what would happen had we converted to Roth, a lower balance and lower RMDs. Therefore Roth conversions at this point will have less value than prior to the decline, or said another way you can convert less to get to the same result. For some situations a Roth conversion may no longer be needed if it was a close decision prior to the decline. Here is the math. You have an $800k balance and it drops to $600k. You convert $200k and pay 25% tax and your balance of $150k doubles to $300k tax free. Had you not converted your $200k doubles to $400k which is the same $300k after tax if still in the 25% tax bracket. Had the account risen to $1m instead of declining and you converted the same $200k with the same fact pattern the result would be the same as would the result if you converted prior to the market decline. Yes your balance and RMDs are lower in the example where the market has declined but that difference is caused by the market decline not the conversion. The only thing a market decline will do is potentially get the future tax bracket lower, boosting the argument for deferring. I can think of one situation where it works. If the market decline causes losses in your brokerage account which you can take advantage of for tax purposes and use those funds to pay the tax on the conversion.

[@paulsackles1329]

Great work Eric. Your clearly passionate about this topic and with that brings so much clarity to the table; it’s complex for sure.

[@edsteadham4085]

Retirement planning is simple. Step one, determine date of death. Step two, calculate portfolio return over several decades. Step three, determine tax policy today, tomorrow and decades into the future. Step four, account for unknown, unpredictable health care expenses. Step five. Place large bet on the next 10 Super Bowl, World Series, NBA champions and hit on all of them. Retirement solved!

[@Bondbeer]

I like your videos. Everything else being equal, I am ok paying more tax if the reason is growth is higher than expected.

[@PH-md8xp]

Great analysis and discussion.

[@lukemaxon]

Excellent video - Thank you!

[@jamesmorris913]

Your final point, is the most salient, to me; especially since I live in COMMIEfornia. I'm already in the 22% bracket, Federal, and 9.3% State..as a RETIREE, and I haven't even begun to to take 401K distributions, yet! The overwhelming majority of my retirement assets, are in traditional 401K, roughly 90%. It would be JUST MY LUCK..that I would spend a zillion dollars on roth-conversions..and then 1929 would happen, ALL OVER; AGAIN!

[@Bondbeer]

What about negative returns? I would rather pay more tax later in retirement if the reason is growth was more than projected vs converting and paying tax today at my highest marginal tax rate and risk a market decline after paying tax on the higher balance. Remember the older you are the less risk of a declining market (since you have less years left for your money to cover).

[@danms1232]

How should a person account for state income tax? Does the 22% federal tax bracket still make make sense or should that be lowered by the amount of state tax?

[@danms1232]

Thank you. I live in Minnesota.

[@ld5714]

Another great discussion on this important topic Eric. Thank you for this excellent video. Larry, Central Valley, Ca.

[@paulbeaumont2714]

What is the tax impact for paying back Social Security for overpayment? Do you need to file an addendum on last year’s taxes or dues this impact this year’s taxes?

[@OffgridApartment]

All this gets extra interesting if you plan to exit the w2 at or around 40. Converting enough early to keep your deferred accounts from growing over 35 years to be hit with RMDs is a big consideration IMO, but also, you can be very selective in choosing how much and when to convert. Pairing tax loss harvesting and conversions in the same year as a big draw down creates benefits on benefits later on. If nothing else you get to exclude $3000 more in income every year on top of standard deductions which should hopefully keep you out of super hot water long term.

[@mere_cat]

Hooo! You look like you got some sun. Hot over there in Wisconsin?!?

[@SafeguardWealthManagement]

Getting there... Been a rainy summer thus far!

[@jerrylabat550]

It fascinates me that you fixate on filling tax brackets. Since tax rates are progressive you should fixate on effective tax rate, so in your example where you declared 3 of the return rates should fill the 22% bracket you would have seen significant tax savings by optimizing to a flat effective tax rate over their lifetime (I.E. one of them might have optimized to 14%, another 17%, and another to 20%). None of these optimizations would have exactly filled a tax bracket.

[@BillMaass]

Tax planners fixate on what matters like marginal tax brackets along with other special rules such as taxation of SS, LTCG/Qualified Dividends, IRMAA, etc. Calculating an effective tax rate is totally irrelevant to tax planners. You should watch Safeguard’s excellent video of 3 weeks ago showing useful tax planning graphs contrasted to the useless graph of effective tax rates.

[@jerrylabat550]

@@BillMaass I hope you realize that if you are talking about filling the 22% tax bracket, you have conceded you are taxing SS at 85%, capital gains are at 15%. All of your special considerations are wiped out except the discussion on IRMAA. Which brings my point into focus, if someone has enough tax deferred income to consider filling the 22% bracket they should focus entirely on minimizing their effective tax rate across their lifetme. So planners should have laser focus on this versus marginal tax brackets once you move past filling the 12/15% brackets. This becomes particularly important when one spouse passes, and the real tax torpedo hits when they switch to single tax rates.

[@BillMaass]

@@jerrylabat550 Not at all. Roth Conversions are best performed in tax years prior to claiming SS. As for LTCG, most taxpayers don’t have a taxable account with significant unrealized gains. If they do, then they can time the Roth Conversion to be smaller in a year they recognize a large gain. Proper planning takes all of those tax rules into account. An effective tax rate is simply a ratio of total taxes paid to total income and is calculated after the fact.

[@jerrylabat550]

@@BillMaass Look at the difference between planning for $1M and $2M - at $1M you could convert filling 12/15% prior to taking SS, and then do the rest with RMDs. That will still have a fairly big tax hit when one spouse dies, but we don't know our expiration dates ahead of time. Now switch to $2M, if you don't go over the 12/15% bracket you likely don't even reduce the principal. So it makes sense to start focusing on effective tax rate so that you get away from having an effective tax rate of about 10% on $100K so that you can have the privileged of paying an effective tax rate of 25%+ on $250K as a single. If you targeted taking $150-$175K total per year (including RMDs) for the rest of your life you likely have a 15-18% effective tax rate which could easily save $250-500k in taxes over 30 years. Obviously you have to adjust based on market conditions, tax law changes, etc. but when you look at the lifetime tax savings by optimizing the effective tax rate to a flat line you get to the point I was trying to make.

[@BillMaass]

@@jerrylabat550 My point is that good tax planners don’t bother calculating an effective tax rate. It is meaningless. Beyond that, you seem to assume that tax rules won’t change in the future and both spouses will die at about the same time. I don’t want to take that risk. In this example, I recommend converting into the 22-24% brackets while taxes are on sale. I refuse to kick the can down the road by paying less in taxes now and leaving a surviving spouse or heirs with a larger tax liability in the future.