Stop Adding to Your Roth Account

Transcript

Mike:

Welcome to another edition of Mike on Money. I’m Michael Reese, certified financial planner, founder of the prosperity planning system and CEO of Centennial Advisors, where it’s our job to help you enjoy financial prosperity,uas easy as possible, right? The easiest path to financial prosperity. So today we’re going to talk about the question of when you should not do a Roth conversion. And so this can be pretty exciting because if you watch us, you know, that I’m a huge fan of getting money into Roth IRAs, but there are some situations where you should not do a Roth conversion. And that’s what we’re going to talk about today. On the screen, we are looking at the 20, 21 federal income tax brackets,ufor both single married couples filing jointly, and I think heads of households, right? So,uI know anytime we talk about taxes, it gets a little bit crazy.

Mike:

For purposes of today’s discussion, I’m going to focus on this middle column, the married filing jointly. Now, if you’re single the same concepts apply, but they will apply for single individuals in that column. We often get the question like people come in all the time and they say this, I say, Mike, Mike, I know I need to be doing Roth conversions. My question is not, should I be doing conversions? My question is, how much should I do each year before we go any further? You know, when you say, I know I should be doing Roth conversions, ah, don’t not so fast. Maybe you should not be doing them, but generally speaking, generally, Roth conversions make a ton of sense for almost everybody, right? I mean, it’s not like everybody should do it. There’s no such thing as everyone should do something, especially when we’re talking about taxes, but she hadn’t really sure.

Mike:

I would agree with that. Every, you know, Roth conversions probably make sense, especially if you look at the long-term impact of holding money in IRAs and 401ks. And by the way, if you don’t know what a Roth conversion is, it’s where you’re moving money from an IRA. So you already have money in an IRA or 401k and you’re moving it or converting it to a Roth IRA. Now, why would you do that? Because in an IRA or 401k, the money’s growing tax deferred, but someday you got to pull that money out and pay tax. And those required distributions. Once you had 72, you’re forced to pull money out each year that could get ugly Roth IRAs. On the other hand, once you get the money in a Roth IRA, it’s tax free, it’s tax free forever. Tax-Free growth. Tax-Free distributions tax-free to your beneficiaries,

Mike:

But if you want to move money, that’s already in your IRA and you want to move it to a Roth IRA. Let’s say I’ve got a million dollars in my IRA and I want to move a hundred thousand dollars to a Roth IRA. Well, guess what? You got to pay tax. Now today I’m the a hundred thousand that you transitioned over. So the question is, should I pay tax today, Roth conversion? Or should I pay tax later on not doing a Roth conversion in order to answer those questions, we need to look at some tax tables. Oh, now tax stable. I know what you’re thinking. Like, no, Mike don’t do that to me. I hate taxes are complicated. I know. I know they are, but remember what am I, my job, my job is to make it easy on you. Right? So let’s go ahead and see what’s going on here.

Mike:

This middle column, married individuals filing jointly. Here’s what’s kind of interesting. Look at this for 2021. Look at this number right here, here. Let’s roll that up. Make it a little higher on the screen. 3 29, 8 50. That is how much taxable income a married couple can have in 2021 and pay 24% tax rate here or less less, because remember you’re only paying 24% on the amount that falls above 172, but below 3 29. So basically here’s the point. You can have up to $330,000, basically taxable income and pay 24% or less tax taxes have never been that cheap. Never. Now, by the way, you also have a standard deduction. That’s down here for married couple it’s $25,000. So if you add 25,000 to this 3 29, 3 30, basically, what does it say? Your AGI adjusted gross income. If you take the standard deduction, you can be like 3 55 and it’s 25, 20 4% tax or less.

Mike:

That’s awesome. That’s not good. That is awesome. By the way, if you like Donald Trump or hate Donald Trump either way, thank you, Donald Trump, because without him that wouldn’t have happened. If you are single, here’s your number 164,000 tax. We’ll call it one sixty five, your standard deductions about 12,000. So yeah, it on, you can have about 176,000 of income as a single taxpayer and be in 24% or less, if you are below these numbers, Roth conversions very likely make sense. I didn’t say did I very likely make sense if you’re below the, if you’re in the 24% bracket or below, and if you’re in the 24% bracket or below, it likely make sense to do conversions up to, but not exceeding that 24% number, but here’s the deal. What if you are in your sixties? Well, you got to think about Medicare premiums. If you do conversions up to, you know, these numbers, you might have problems paying extra on your Medicare.

Mike:

So you may not want to do that much. What if you’re younger than 60? Every time you do a conversion, you have to think about where are you going to get the money to pay the tax. If you’re over 59 and a half, you can just deduct it out of the new Roth IRA. But here, if you’re younger than 59 and a half, how are you going to pay the tax? That might be a constraint, but general rule of thumb, the window of conversions. If you are single up to tax bill up to the top of the 24% bracket is your general rule of thumb. That’s your window. So when should you not do a convert version? How about this? The other day, let’s scroll down a little bit more in these tax brackets. The other day I came across this couple, both of them working, both of them are executives. Their household income is like $550,000.

Mike:

And if they they’re planning on retiring in a few years and when they retire, they want their household income. They say, Hey, when we retire, we could live on 150 K easy. So right now they’re at 500. So where are they? Oh, 35%. They’re way down here. They’re in the 35% bracket. And by the way, with the new tax code coming out, their income’s really going to be at 39.7% tax and maybe even higher. But in a couple of years, I want to retire to what number one 50. Look at that that’s way down here in the 22% range right here. So does it make sense today for them to convert at a 35% rate way down here when they’re only going to pay a 22% rate later on, does that make sense? Pay 35 today to avoid paying 22 later on? The answer is no, that couple I told them no conversions right now.

Mike:

You’re just making too much money. By the way, as an aside, the new tax code, the what they want to do in Washington, DC, they want to say, look, if you’re a married couple, you’re making over four 50. And if you’re single, you’re making over 400, you’re not going to be able to do conversions at all is what they want. So if you’re way up here in these higher brackets converting today, when you’re going to be, you know, you’re going to be in lower brackets in the future, may not make sense. Now what’s interesting is sometimes it still makes sense, especially if you have a huge IRA, like if your 401k, your IRA is like three or $4 million, believe it or not, it might make sense to just convert the whole darn thing before the end of the year, even though you’re going to be in lower tax brackets later.

Mike:

And the reason for that is when they’re that big, what happens is yeah, you’re in these lower tax brackets for a while, but at some point when you hit age 72, your required minimum distributions are so large. They push you down here anyway. Everybody’s different. Now, remember, we’re talking about taxes here. Everybody’s different. Your situation is different from your neighbors. It’s different from your brothers and sisters. Everybody’s different. So don’t be taking this and saying, oh, Mike just said, if I’m not, if I’m less than 24%, I should fill that bracket up. That may not make sense for you. I’m telling you though, if you are below the 24% bracket, odds are good. That it makes sense to do conversions at some level. And don’t go above the 24% bracket. Probably if you are way up here in your income right now, heck I would even say, if you’re above three 30, if you’re in the 32% bracket or above for now, I probably would not do Roth conversions.

Mike:

I’d wait until I’m retired when I’m in maybe a lower bracket potentially. But here’s reality. This is where you need to sit down with someone that does tax planning, not preparation. Tax prep is just filling out your tax return tax planning. You need to sit down with someone who is, who has the capability to help you map out what your future looks like from a tax perspective. You know, if you keep doing what you’re doing now, where does that take you from a tax perspective? And then right, then you can start playing with Roth conversions and saying, well, what if I do this? What if I do that? How does that impact the total tax that you pay over time? You need that type of analysis to make the really smart decisions here. But there you go, general rule. I’m giving you general rules of thumb. Doesn’t mean they’re going to apply to you. Taxes are a little complicated. Everybody’s different. Let’s make sure you’re making the right choices. All right. That’s our message. Today. If you have any questions, feel free to leave questions in the comments below. If you like this, give us a thumbs up. Subscribe, share this with your friends. That’s our episode this week, we will see you next time.

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