3 Biggest Fears of Roth Conversions

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Hey there, this is Craig Weir. Thanks for joining me back to the What's Next for Retirement podcast. I hope you're having a great week. And, uh, this was, uh, one of the podcasts that for sure if you are, happen to download it and listening. On a run or a drive or the gym, you're gonna want to probably come back and, uh, be able to play it on a device. So you can see this is gonna be riddled with a lot of information and um, a lot of numbers, you know, and I'm gonna try not to get too deep in the woods, but I'm talking about a subject that is unfortunately just all about the numbers. So I want to kind of deal with one of the biggest objections that I think a lot of people have or questions they have, and in fact sometimes even fears that they have about, uh, doing Roth conversions. And that is the notion that if they do a Roth conversion, they're gonna pay taxes. On the portion of the IRA that they do the conversion on and the dilution of their account and the amount of those taxes is gonna be a bad deal for them. And those that have a little bit of financial savvy like to talk about it as the time value of money aspect. So they're, the belief is that if I give up some of the taxes on the front end, I'm gonna have less money there in the future. And I'm about to demonstrate to you that it is not at all that case. It seems that way, but when you do, when you look at the big picture and the the entire picture, then for most everybody, it doesn't matter. The only person, the only people that this really doesn't apply to are people that. Don't have any heirs and you're gonna leave all your money to a charity, then this part probably isn't as applicable. But Roth conversions are still very much well worth it If you are what I call the IRA millionaire and you really wanna save taxes during your life. But the time value of money thing is a little bit skewed if all you're gonna do is leave your money to your air. So I'll just leave that there cuz that's, this is not about a charitable giving, uh, strategy at all. So what I'd like to do is I'll just, I'll show you a couple things that I think make a lot of sense. Um, a lot of people believe, you know, you shouldn't convert because you'll have more for retirement if you don't pay the taxes now. And it sounds really logical, but. Uh, it just won't stand up to the facts. This is where it's gonna get kind of detail ridden. I'll, I'll do the best I can to describe it for those of you guys listening in. Um, but for those of you that are watching, you've got on your screen, you got all the numbers in front of you, you can look at, so this whole pay hour, pay later thing, um, let's just analyze it. So let's say you had a hundred thousand dollars in your IRA that you could either convert or not convert. But you're concerned that if you convert it, you're gonna lose access to money and you're gonna have less money later. So let's take that a hundred thousand dollars and let's just kind of assume that you're gonna leave it there for 12 years and your average annual rate return is 6%. So I just, I'm using this really funky little, um, mathematical thing is called a rule of 72, right? So six times 12 is 72, and it works for any two numbers that equal 72. You can take the number of years. And divided into 72, and that tells you what rate of return you're getting. Or you can take the number of years. I mean, you can take 72 divide by. The 6%, and that tells you how many years it takes money to double. So kind of a little bonus tip there, right? So a hundred thousand dollars, 12 years from now at a 6% is about $200,000 on your statement. So every year you're gonna open up your statement, you're gonna see that thing growing. And remember, it's still in an ira. And so it's tax deferred and you get all the benefits of that. We got a, several people we talked to say to us, you know, I'm not gonna pay taxes until I absolutely have to, and I'm about to show you why that's really n not a good idea at all. It sounds good, but it doesn't work out. So if you owed, say a 25% was owed on the, uh, in taxes on that 200,000 whenever somebody pulled it out, either you through required distributions or your heirs through inheritance. Whatever you're looking at, the government's gonna get it, so they're gonna get their due, right? So a $200,000 statement value, it may look great, but I, I mean, I think we're all adults here. You know that part of that, uh, Is what you owe to the irs. So, um, let's use 25% and the numbers, it doesn't matter what the number is, the math still works, but we'll take 25% cuz it's easy for me to do the math and you to understand it. Like this. Take 25% off of 200,000, you're left with $150,000 of what I call real value, real net after tax value. All right, so let's look at the other side of the equation. Let's say you're gonna convert it instead. Well, when you convert money from that ira, you gotta pay taxes now. And that's, that's kind of the, the whole crux of the, of the argument. So now you take that a hundred thousand and you pay your 25% in taxes, and you got $75,000 in value. So now you start with 75,000. You got 12 years at 6%. Same rate of return, same timeframe, and what do you have? Huh? Shazam, for those of you watching this, you're seeing that that ending value is the same exact $150,000 of tax free value. So what happened there? Well, what happened is, and you can see on this screen in the the payment hour, pay me later situation. All you're really doing over time is you're building a greater deferred tax liability to the government. Your real net after tax number is different than what the value of your account is. And if we take that on this next screen and we compare that to the Roth after tax tax free value where it's already been taxed, you can see the amount that's really your money is the same year after year, after year after year. And so, Leaving the money in there doesn't really create more value for you. It just creates a greater contingent liability by the i r s. Well, and some people like to say, yeah, but I'll have greater income that I can pull out of that. Well, that's the whole problem with the money in the first place. You're also gonna have a much greater required minimum distribution that has to start coming out at 72 or three or 75, depending how old you are. So you're gonna have that to be able to deal with. What I'm interested, ladies and gentlemen, is how much is my money? Not how much am I holding of the IRS's, but how much is really my money? What's what belongs to Craig and you, you can see in this pay an hour pay later scenario where really the whole time value of money thing is almost a moot point. Um, we've done this with just a lot of clients. We've got a lot of, a lot of success stories of typical IRA millionaires, you know, whether they're single or married, or whether they're retired or just kind of making plans to retire. Some of them have saved a million plus in pretax money in 401K accounts and K accounts in, in. A lot of them have very little savings outside of their company retirement plan to be able to pay the taxes on. But some have, and you may be one of 'em, the large savings in addition to those IRAs or company plans. And I've got a couple of real quick cases I'm gonna show you, but. Most people have social security, they got some pensions, and the typical client is distributing very little of their IRA to live off of every year. And I'm not gonna show you the impact of charitable giving plans, but if you have a big charitable intent and you like to give and you, you know, that's part of your strategy, that can fit into this whole game plan as well. But what happens when you get it right is, uh, really an optimal. Game plan, the optimal strategy, and again, this is kind of heavy laden with numbers, but for those of you that are watching this, as opposed to listening to it, you can see I've shown you the difference between a good plan, a better plan, or the best plan. And this is a lady, uh, I call her Kate to protect her privacy. Sh a single lady came to us in her late sixties. She'd had, oh, about a million bucks, saved up her total required. M her projected required minimum distributions if she didn't do any Roth conversions at all, was gonna be about 2.2 million. If she just converted at her current tax bracket because she didn't wanna spend the money on on taxes because of the time value thing, or whatever reason she could come up with, she would save a little bit of money at her at her current tax bracket. Her RMDs will go down to 1.9883 million. But at the optimal strategy that we converted her over a short period of time, 4, 5, 6, 7 years, whatever the number was, she had no RMDs. She saved. Um, you can tell there she saved about $93,000 in Medicare premiums compared to just going to the top of her tax bracket. And her total tax avoidance went from. No tax avoidance in the no conversion to her in her current tax bracket, she would've avoided about 250,000 of taxes. But if she got to her optimal strategy, she was gonna save 1.4 million of taxes. So the time value of money factor is not nearly as significant as the amount of taxes that she's gonna pay. Now the time value money is important in that you wanna make sure you're making a good financial decision. And we'll talk about that in a minute. Here's Doug and Bev. They're married both in their late sixties. You can see that for them. They had, I think they had about 800, $900,000 saved up. Um, they're gonna lower their projected Medicare premiums by about $120,000, and their total tax avoidance was just short of $600,000. I'm saying all this, just to help you to understand that the time value of money issue is not a big issue. What is important is the amount of taxes and what that, the damage that's gonna do in other areas of your life. But it is important to get the best financial decision, not just a great tax decision. And what we like to do is create a, uh, a tax adjusted net worth calculation. And you'll, you know, we, we like to be able to compare a variety of different tax bracket conversions as well as things that aren't straight tax brackets, but, um, asymmetrical conversions along the way. What we're always looking for is how much do you have in your pocket at the end of the day, net of what you owe the irs. And if you wait, you lose. Uh, your required minimum distributions are gonna be two or three times the value of your IRA over your lifetime. You're gonna lose a year of tax-free growth that could have happened in a Roth instead of in your IRA to just build greater tax liability. Your Medicare Part B and D are likely gonna increase due to your RMDs later in your life if you wait. And there's something that I talk about a lot that I'm sure I didn't come up with it, but I don't know where I. Where I stole her from, uh, something called the Widows Trap. So you get started doing conversions, then you're married and all of a sudden one of the spouses is no longer in the picture. Now all of a sudden you got this trap. You are the remaining spouse is left with all the money and half the tax. Bracket bandwidth to make the conversions with the other is you're gonna lose another year of the remaining lower tax rates that were created by the tax cut job acts from 2017. So my suggestion is you get with it, get working on it. Uh, Get your Roth conversion game plan optimized as best you can. But don't worry about the time, value, money thing. It's really not as big a deal as what you might think it is. Now we, when we do work for clients, we provide the tax adjusted net worth. We also are in the process of integrating net present value calculations, and they both are pretty much consistent across the way. So I'm not saying it's not important to know the answer to that. But I'm showing you some really simple math that kind of cuts away all the confusion and makes it really simple. So I appreciate you joining me. I know it was a short podcast this time, but sometimes the short ones are the best ones, right? So hope you have a great day and uh, check out the show notes for. Links to where you can get additional information. We've got a bunch of free books and free information that we can plug into prior webinars that we did and new webinars coming up. So thanks a bunch. And if you haven't subscribed, smash the button, subscribe. So you'll be up to date when I come up with some new stuff. Thanks a bunch. Talk to you later.