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At the end of the day, the most successful strategies are the ones that you consistently implement. And if every time a Roth conversion comes up, you have this pit in your stomach and you wish that it would just go away, then maybe this isn't the right strategy for you.
Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm talking about Roth conversions. But instead of talking about why they're so great and why you should rush out to implement them, I'm leaning on one of the sharpest CPAs that I know, Stephen Jarvis, to help us talk through the five reasons why you might not do them. Because while Roth conversions can make a giant dent in your retirement tax bill, there are some important, often overlooked things that might make you pause. And I'm going to talk about that today.
And taking those things into consideration can be a good place to start when considering this tax strategy. So if you're ready to learn why you might take a pass on Roth conversions, today's episode is for you. For the links and resources mentioned today, just head over to youstaywealthy.com forward slash 145.
Let's start with the basics. So in plain English, what is a Roth conversion? And why is this strategy so popular with those that are in retirement or even getting close to retirement?
A Roth conversion is moving money from pre-tax to after-tax is usually the simplest way to think about it. Most people are more familiar with what we like to call traditional IRA, which is I got to put money in an account before I paid taxes on it. But the IRS is only so patient. And so eventually they're going to come back and say, why don't you go ahead and give us some piece of that pie so that we can have our share.
Roth, on the other hand, once dollars are in a Roth account, they're after tax, the money you put in as well as any growth stays tax-free. And so I think that's what's so exciting about it and why it gets so many headlines is it's one of the few opportunities that any of us have to generate truly tax-free income. I often hear from podcast listeners and new clients that after going through a retirement analysis that,
knowing what they know now about the tax problems in retirement and having to pay this giant tax bill on these large traditional IRAs or traditional 401ks, I often hear that they wish that they would have contributed more to Roth IRAs and Roth 401ks throughout their working career. So I'm just kind of curious,
if you've heard this before, and what your thoughts are on Roth versus traditional while you're in the working world. And maybe what you might say to someone who's already retired and just like kicking themselves for not putting more money in a Roth during their career. Yeah. So a couple of great questions in there for people who are kicking themselves about what they didn't do before. I would try to focus on the positives and say, Hey, we got a lot of money set aside.
especially if they're on track for their retirement, even if they've got to pay a little bit more tax than they wanted to. But let's focus on what we did accomplish because Roth or traditional, what's most important is taking consistent action. I can go through numbers for days of what the optimal percentage of Roth versus traditional is, but really the best plan is the one you're going to follow through on. I wouldn't beat myself up too much if there's somebody listening who's already at a point where they're past their earning years.
For people earlier in their careers, earlier in their earning years, I like to think about Roth in two ways because you can find endless articles and philosophizing about which one is better numerically.
But having Roth dollars isn't just about tax savings. It's about tax flexibility. And so one of the things I like to talk to people about as I work with taxpayers is say, you know what? Taxes really can only do three things. They can go up, they can stay the same, or they can go down. If they go up or stay the same, we're better off for having Roth.
are you at all worried that taxes might go down? And most people are not worried about that one. And so I try to keep this aspect of flexibility of removing the IRS's ability to change the game on us later by increasing tax rates or changing thresholds on us.
I love that. So in many cases, aggressive Roth conversions in a retirees gap year. So gap years being that date you retire till age 70 or 72 when income starts to kick in again from those RMDs and social security. Aggressive Roth conversions in your gap years in some cases can lead to millions of dollars in taxes saved over 70%.
somebody's lifetime. You gave us a nice little simple breakdown of what a Roth conversion is. And by doing this appropriately over a period of time during the right time can result in some large savings. They can be really powerful tax planning tools, but as you've previously highlighted, they're not a universal solution for everyone. In fact, there are some really good reasons, five to be exact, why you might not do a Roth conversion. And that's really what I want to talk through today for the rest of this conversation.
Let's start with number one, which you highlighted, which is shadow taxes. Shadow taxes being one of the reasons why you might not do a Roth conversion in 2022. So if you wouldn't mind, maybe share what is a shadow tax and why might this stop someone from doing a Roth conversion this year? So the reason I led with shadow taxes, as I talked about reasons that maybe you shouldn't do a Roth conversion is
is that Roth captures a lot of headlines like we've talked about because this idea of having tax-free money is really exciting. So it's really easy to write these almost click-baity articles about, hey, do Roth conversions because you're in this tax bracket and later you might be in this tax bracket and so we should go ahead and pay the taxes now. Which
which that is certainly part of the consideration. But what gets missed is things outside of just our income tax rate. Because when we look at our taxes, there are certain line items on our tax return that have other impacts beyond just, am I in the 22% bracket or the 24% bracket?
A big one here is Medicare premiums. We like to call Irma that the IRS uses your tax return to say, hey, are you in an income bracket where you are going to have to pay a higher premium for Medicare? And unlike our tax rate system where each dollar gets applied a certain tax rate. And so it's this progressive sliding scale.
For Medicare, it's these cliff brackets that if you get $1 into the next bracket, you have to pay that full extra premium. And so this can get missed in this evaluation. And so we get to the end of the year and suddenly we're paying a lot more, not directly an income tax, but we have a lot more expenses than we expected because we tripped some of these other shadow taxes.
And nobody likes surprises with their tax bill or with extra insurance premiums. But to be fair, in some cases, it could make sense to pay an extra few thousand dollars, let's say in shadow taxes, to potentially save hundreds of thousands of dollars in the future by doing Roth conversions, which is why we want to be really careful about looking at tax planning in a vacuum and just looking at what the impact is in one single year, which is a trap that I think many people, including some CPAs,
kind of fall into. So any thoughts on, sure, it might send you over one of these cliffs and you might have a higher Medicare premium this year or for a few years, but by doing that, you might be able to save a lot more money over your lifetime. Yeah. I really like the analogy or I guess the saying of let's not let the tax tail wag.
Our financial decision dog, or however you want to phrase that. Taxes are an important passenger on the bus when we're making financial decisions, but they are never the driver. And that's true as we go through all five of these reasons of maybe why not to do a Roth conversion. These aren't automatic, absolutely don't do it. It's things we need to make sure we consider. And Medicare premiums or any other shadow tax definitely fits in that.
Let's go in with clear expectations and making a really informed decision. And there are going to be times where we say, you know what? It's still worth it to make that Roth conversion, even though we're going to push ourselves into a higher premium. It's going to be in part because of tax savings and in part because of tax flexibility. Totally agree. So shadow taxes, number one reason why you might not do a Roth conversion this year. Again, we don't want to get caught off guard. We want to make that informed decision. A couple of the bigger shadow taxes you mentioned, Irma,
the Medicare income related monthly adjustment amount and the premium tax credit. So keep an eye on those. And if you do consider a Roth conversion, just keep those in mind. Number two is there is no undo button. So talk to us about that, the permanent nature of a Roth conversion and why that might make someone pause.
So taxes are inherently an estimate. Anything we're projecting for the future is going to be an estimate until we get to a point in time where the year's over and we can look back and say, here's definitely what happened. What's tough with Roth conversions is that we have to do them before the end of the calendar year. And sometimes we're still only mostly sure what our final income is going to be.
which this definitely has impacts as we talk about those shadow taxes. We talked about the Medicare cliff brackets. If we misjudge where we were going to end out and we thought, oh, we're just under a bracket, but then we get to January or February, we're preparing our taxes and we realize, oh no, we were just over that one.
There's things like that that can affect what the actual outcome is. But once we get past December 31st, once we've made that Roth conversion, we can't go back and undo it. There are other things with retirement accounts. Like, for example, you can take a distribution from your IRA and you technically have 60 days to potentially roll back into a tax qualified account. We don't have that option when we're doing Roth.
It's really a reminder to make sure we've thought through all of these pieces, that we're really confident in our decision, that we're making the best choice based on the information we have before we move forward.
I'm glad you brought up the 60-day rollover. I think sometimes when retirement savers see rollover in the name, 60-day rollover, they assume it has something to do with a 401k rollover. But that 60-day IRA rollover really means that you can take money out of your IRA. And if you put it back in within 60 days, then there's no consequence for it. You have 60 calendar days to put it back in. So some people view that as a short-term loan. I'm going to take some money out of my IRA, use it for something, but I'll put it back within 60 days.
You mentioned maybe using it as an alternative to a Roth conversion where I'm not really sure if I want to do a Roth conversion this year, but I'm in a low tax bracket. So I want to get some money out of my traditional IRA before the end of the year. So maybe in December, I'll go ahead and take a chunk of money out. I'll get through the holidays and know that I have 60 days to put it back in if I change my mind.
Do I have that right? You have anything else to add there? You're exactly right. You have this kind of window to make the decision because the important thing is that the money has come out of the IRA before December 31st, especially waiting right till the end of the year to do that. That gives us almost 60 days into the next year to get those final numbers and really see where things end to say, okay, does it make sense to just go ahead and convert that to Roth or do I put it back in the tax qualified account and we'll revisit it again next year? Now let's highlight-
One downside to the 60-day rollover, again, you're in a low tax bracket.
you're not sure about a Roth conversion. So you go ahead and just take a withdrawal from your traditional IRA. Again, low tax bracket. So that's great. The downside is, is that money is now in a taxable account of some shape or form. If you did a Roth conversion, that money would go into a Roth account and be sheltered from taxes. So it can continue to grow tax-free over the next year, five years, 10 years, 30 years. And that's really powerful. And so if you do just take it straight out of the traditional IRA, again, you don't have that tax deferral anymore.
Yeah, you want to be really careful anytime you're implementing these different tax planning strategies that you keep your ducks in a row, that you're paying attention to dates, whether you're working with a professional or you're doing this yourself, that you have some sort of reminder built in place so you don't accidentally get past that 60 day window. You can't ask for an extra 15 days. It's a pretty hard 60 day cutoff.
Okay. So to recap, the number two reason why you might pause and not do a Roth conversion this year is that it's permanent and there's no undo button. And so as an alternative, you might consider just taking money straight out of your traditional IRA. Again, you lose some tax advantages there, but you have some more flexibility.
The number three reason is that the taxpayer doesn't have the cash flow to cover the tax bill. And this is really an important one and one that always generates a lot of questions. Talk to us about this. Talk to us about how taxes are paid on a Roth conversion and why the money being converted, you can't use a piece of that conversion amount to pay the tax bill.
Well, you can use a piece of the conversion or you can use a piece of the distribution from your IRA. That wouldn't be my first recommendation. So for just easy numbers here, let's say that you have $50,000 in a traditional IRA that you would like to convert. And we'll just assume 20% taxes again, so I can do easy math here.
So we have $50,000 distribution. One alternative could be that we take $50,000 out of our IRA. We owe 20% taxes. And so we just take $10,000 out of the distribution and pay the taxes. So we end up with $40,000 we can put in our Roth. You can definitely do that. If you're under the age of 59 and a half, you're going to pay a penalty on the amount you use to pay the taxes because you're not over the IRS's age for that.
But really, the important part here is that you only end up with $40,000 in your Roth account, only $40,000 that can grow tax free. If instead you can pay the taxes out of some other taxable account out of your bank account, out of taxable investments, something that you've already paid taxes on.
Now, we can, instead of only ending up with $40,000 in the Roth account, we pay the $10,000 in taxes from another source, and we end up with the full $50,000 in the Roth. And now we've got more in this bucket of tax-free growth.
That's a better way to frame it. I guess, yeah, I look at it from the angle of the first step in a Roth conversion analysis is to determine what the opportunity is. So if the opportunity this year is a $50,000 Roth conversion, well, you wouldn't want to pay the taxes from that conversion amount because it's going to reduce the amount that you end up
converting. So in your example, the opportunity was 50,000, but you only ended up with 40,000 because you had to use some of it to pay the tax bill. So we want to be mindful of that, which is why we typically recommend that the taxes are paid from a
another account from another bucket of investments or cash that's outside of the IRA. Any ideas on how some people might go about coming up with cash to pay that tax bill if maybe they weren't prepared for it? Or maybe if they have 12 months to prepare for that Roth conversion tax bill, what are some ideas that they can go about coming up with that money? Yeah. As I work with taxpayers on this, I really like to take
a long-term approach. This is seldom something we do once and then we forget about. Usually we're making a plan. You talked about someone doing this in their gap year. So that kind of implies this is a multi-year approach. And so if we're planning ahead for this, there's a lot of different things we can do. If we are still working, we can go ahead and increase our withholdings from our earnings to go ahead and set some of that aside to cover that
increased expected tax bill, this can come out of savings or other investment accounts. The further ahead we plan, the easier it's going to be to fit this into whatever our cash flow needs are. Similar to these other reasons we've talked about to potentially not do a Roth conversion, for me, this isn't an automatic deal breaker of if you have to pay the taxes out of the distribution, then
under no circumstances should you do it. But ideally, we're paying the taxes from somewhere else. I'm going to be thinking a lot harder about whether this makes sense if the only option for the taxpayer is to pay it out of the distribution. I love that you highlighted that. We need to think ahead on these things and we need to really plan ahead. That's
That's why I always stress that cash management becomes really, really important, not just in retirement, but ahead of retirement. Those three, four or five years ahead of retirement, if Roth conversions are on your radar and there appears to be an opportunity, you need to start to think about setting some cash aside for those anticipated tax bills. So you're not scrambling at the last minute to figure out how you're going to pay this tax bill.
So cash management becomes really important. I love what you said about, well, increasing your withholdings. In some cases, when there's truly an opportunity for Roth conversions, it might mean to stop contributing to your 401k, let's say for those last couple of years, and instead divert that money to cash, cash that can be used to help you get money out of your retirement accounts at a lower rate.
So just some things to think about. I love thinking about this long-term. I love thinking ahead. Roth conversions, we can't just do at the very last minute here because they do have sometimes sizable tax implications. But to summarize, the third reason why you might not consider doing a Roth conversion this year or any year is that you may not have the cash to pay the tax bill. So we move on to number four here. The number four reason, which is one of my favorites actually, is that you just simply don't want to do it.
As listeners and clients of mine have heard me say countless times, there is the textbook answer, and then there's your answer to just about everything in life and especially financial planning. And I always say that as long as your answer doesn't put your retirement in jeopardy, I am here to support it. So talk us through your thoughts here on why just not wanting to do a Roth conversion is maybe a good reason to skip it and what
what could be maybe a lucrative tax planning strategy. I mean, you're spot on with how you work with clients on it. I love that approach. The reason I always include this is because, again, we've mentioned it, but there's lots of really catchy headlines around Roth. And so sometimes people can feel pressured into it. At times, even if you work with a financial professional, you might feel like this is something that's being pushed on you. At the end of the day, the most successful strategies are the ones that you consistently implement. And if every time a Roth conversion comes up, you have this pit in your stomach and you're
you wish that it would just go away, then maybe this isn't the right strategy for you. I like how you phrase that of as long as it's not going to hurt your overall retirement plan. If I'm working with somebody and they're just right on the edge of being comfortable in retirement, and this is going to make a huge difference, I might come back to this conversation more often.
But if a taxpayer is in good shape and they're just for whatever reason, sometimes I run into taxpayers who just are adamant that I'm not going to pay taxes any sooner than I have to. It's almost this like moral belief on their part that they're going to just delay taxes as long as they can. Great. As long as they're on track for retirement, that's not a hill I'm going to die on.
I love what you said too. One of the pushbacks we get sometimes when we show the opportunity for a Roth conversion, sometimes the client thinks that we're suggesting that they have to do that full amount. And so I always stress them and say, look, our job is to just show you the opportunity. Now let's have a conversation. Although you might be able to do a $100,000 Roth conversion and there's a clear...
a clear opportunity for it, it doesn't mean you have to do it. Maybe you decide to only do $50,000 Roth conversion this year, or maybe you decide not to do one at all. So I think it's important to highlight just because that opportunity exists doesn't mean you have to pursue 100% of it. Yeah, I completely agree. Any other thoughts on those
those taxpayers that just don't want to do Roth conversions or any other exercises that they might go through mentally or with their financial planner or even with their spouses, they think you're like, do we really want to do this or not? I think the most powerful thing is getting really clear on what your retirement tax bill looks like if you do nothing, which this is clearly going to be an estimate, but we already know that even if Congress doesn't do anything, tax rates are going to go up in 2026 when the Tax Cut and Jobs Act expires.
The power of Roth conversions is all about relative income. If we're in a few years where we're not going to have as much income before required minimum distributions hit or something like that, I don't like getting lost in the software of, hey, this is the exact dollar amount to the penny that you need to convert. But giving yourself, if you're a DIYer, working with a financial advisor to get a clearer picture of,
Here's the hundreds of thousands of dollars, if not millions of dollars, the IRS is going to ask you to pay in taxes over the course of your retirement. And then looking at, hey, if we just make these little adjustments, here's how we can sand the rough edges off of that.
What I find is that taxes are complicated. They kind of feel like a black box to a lot of people. And so just talking about it in general terms doesn't always get the power of it across. But if we can say, you know what, if we do nothing, you're going to pay $500,000 in taxes over the course of your retirement. But if we make these few changes in the next couple of years, here's where we start knocking tens of thousands of dollars off of that. Amen.
Another way to frame this too is often what I say is that, look, if you don't do anything, if you're not proactive about this, you're going to pay your taxes on the IRS's terms. If you take control and you are proactive and you implement these tax planning strategies, you can start to pay taxes on your terms when it's most opportune for you. So by taking control, again, you take the control away from the IRS and you pay it on your terms. Now there's some guardrails and you're confined to some certain limits there, but I do like this idea of giving the
the retirement saver control over when they want to pay those taxes rather than waiting for the IRS to come knocking on their door and start collecting all this money at potentially an inopportune time. I also like our mutual friend, Michael Schlansky has this question that he asks his clients. And even if you don't work with the financial advisor, it's still a question that you could ask yourself or ask your spouse, which is,
how much are you comfortable in paying taxes right now? And as he said, it changes the conversation a little bit and just changes your thinking. And you can kind of back into the Roth conversion opportunity by just saying, well, how much am I comfortable paying right now? And what does that mean for a Roth conversion in this given year? Rather than saying, here's the opportunity, do you want to pay the tax bill?
That's a great point because if the software tells us that the optimal amount is $50,000, but I'm working with a client who says, I'm going to feel good if we do $10,000, great, $10,000 is the right answer. To recap, the number four reason why you might not do a Roth conversion this year is that you just simply don't want to do it. And that's okay. Again, there's the textbook answer and then there's your answer. And as long as your answer doesn't put your retirement in jeopardy, both Steven and I are here to support it.
Bringing us home here, the last reason, the number five reason why you might not do a Roth conversion this year is lifetime planning of wealth. If you expect to have significant wealth at the end of life and one of your big goals is to leave that money to charity, you suggest that you might skip a Roth conversion. Can you maybe talk to us about why this is?
The big power behind Roth conversions, like you've mentioned, Taylor, is paying taxes on your terms instead of the IRS's terms. But if your legacy plan is to leave significant amounts of money to charity, then those taxes actually will never get paid because of how these charitable organizations are set up and because of this opportunity we have to support great causes we care about.
And so, again, we don't want to get lost in the headlines of, hey, Roth conversion is the only way to have tax planning. It's a great tool, but there's going to be situations where it doesn't fit. And if you're in that situation where you expect to have a lot of wealth at the end of your life and you're going to leave it to charitable organizations, well, then let's just kind of be a little bit more patient and say, can we just avoid paying that tax altogether because of what we're going to leave to charity? Another way to think about it, too, is that by
by not doing the Roth conversion, if that is your goal, you're able to essentially give more money to those organizations. So by pursuing those Roth conversions and you paying the tax bill and taking the tax hit, you may lessen the impact that your donations make and that the amount of money that those organizations
organizations receive. So you can think about it from that end as well. Definitely. All right. So those are the five reasons why you might not do a Roth conversion this year. Again, to recap, number one is shadow taxes. Number two is that it's permanent. There's no undo button. Number three is that you might not have the cash flow or the cash save to cover that tax bill. Number four is you just don't want to do it. One of my favorites. And
Number five is charitable giving is really important. And you've got a lot of money at end of life, and that'd be the final reason not to consider it. Steven, any final thoughts on Roth conversions, any major pitfalls to watch out for, or anything that's often overlooked that listeners might take into consideration today? The one other piece I'll throw out is let's not forget about state taxes. Often when we talk about tax planning, we focus on the federal side because many states follow the same general rules.
But especially if there's any chance you could move during retirement, whether from a high income state tax location to a low income state tax or vice versa, the power in this tool is that relative income. And so especially if you work with a financial planner, make sure you're sharing what your goals, what your dreams are. There could be really important factors in either direction of do a Roth conversion or wait, depending on where you're earning your wealth versus where you're
are going to be spending it in retirement. So I think that's the only one we didn't really touch on. Yeah, great point. Thank you for sharing that. Well, Stephen, thank you very much for joining me today, sharing your expertise. Really quick before we let you go, where can people find you? How can they learn more about you? How can they consume more of the information that you're putting out there? Taylor, I really appreciate you letting me come on the podcast and all the good you're doing sharing this information with taxpayers. I have a consumer-facing podcast that I co-host with a great financial advisor, Benjamin Brandt. It's called the Retirement Tax Podcast.
I'm also really active on LinkedIn. While I work a lot with financial advisors, all of my content really is going to be great. Whether you're a DIY taxpayer yourself or you work with a financial advisor, you can follow me in either of those places. Awesome. And we'll link to everything in the show notes for everyone to find. Stephen, thanks again for joining me. Really appreciated the conversation today and hope to have you back on the show again soon. Yeah. Thanks, Taylor. Happy tax planning.
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