Early Retirement - Financial Freedom (Investing, Tax Planning, Retirement Strategy, Personal Finance)

5 Situations When It Does NOT Make Sense To Implement Roth Conversions

• Ari Taublieb, CFP®, MBA • Season 1 • Episode 176

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Ever wondered why Roth conversions might just be the financial cauliflower you didn't know you needed? We're peeling back the layers of this tax planning strategy to show you how it could supercharge your retirement savings or possibly trip you up if it's not the right fit. Today, we're walking you through the pros and cons, armed with real-life examples like the time I advised a client to steer clear of conversions due to their health and retirement horizon. Think of it as a tailored suit – Roth conversions need to be customized to your financial physique, or they just won't look good on your bank account.

Feeling jittery about upcoming changes in tax brackets, or confused about when to convert your 401(k) to a Roth IRA? Grab a cup of coffee, and let's talk timing and tactics. We're not just talking theory; we dive into a case study of a forward-thinking couple who used a market downturn to their advantage with a Roth conversion, illustrating that with careful planning and a pinch of courage, you too can navigate the financial market waves and sail smoothly into retirement. Whether you're a seasoned investor or a newcomer to the retirement planning game, this episode is your invitation to become a part of the conversation and make decisions that resonate with your future financial well-being.

Create Your Custom Early Retirement Strategy Here

Get access to the same software I use for my clients and join the Early Retirement Academy here

Ari Taublieb, CFP ®, MBA is the Vice President of Root Financial Partners and a Fiduciary Financial Planner specializing in helping clients retire early with confidence.

Speaker 1:

A lot of you have saved and invested really well and you are still going to get killed by taxes. So if you don't know my dopey joke already, I'm all about being patriotic, just not to the point that you pay more in taxes than you need to. In today's video, I'm going to talk certainly about Roth conversions and why they can be so amazing, but also the five situations when you should not implement Roth conversions. That's right. I find a lot of advisors will talk about all the amazing things about tax planning or withdrawal strategies or investing but not say, hey, this is something that you do not have to worry about if this doesn't apply to you. So as I see it, a job of an advisor or a good poscaster should be to say, hey, here's a bunch of things that apply to you and you certainly might want to consider them, and here are things you might have been thinking about that I do not want you to worry about. That's what we call head trash. So in today's podcast, I'm really excited because I get to talk about Roth conversions a lot. If you don't know my cauliflower example, you're going to get to hear it again today and I'm going to tell you the five situations when you do not want to implement Roth conversions, because I always try to keep it fun and lighthearted and a joke and sometimes I'll keep it serious if I need to.

Speaker 1:

But I'm going to start with this joke where and it's a lighthearted one but a client came to me and they said hey, ari, you know I already did Roth conversions. They said it with a little bit of attitude and I'm cool with that if they're nice people. And I said I wish you did nothing. They go what do you mean? I did Roth conversions. I go yeah, you did, but you did too much where? Now I wish you did nothing at all. Now we have to fix the mistake of you over converting. And they go yeah, by sawing a YouTube video, it looked really cool. And I go on YouTube, it can look really cool. On podcasts, it can sound really good. Doesn't mean you should do it. It depends on your situation and more often than not, people don't screw it up.

Speaker 1:

When I see people implement these tax strategies but they either over do it a little bit and pay more than they need to in taxes or they don't do enough and they do it, but they left a lot of room on the table that they should have either converted more or just considered an additional strategy. So I'm gonna start with my real life example and then we're gonna hop into the fun. So one client came to me and said all right, you know what I think I've got this big RMD issue required minimum distributions. They're gonna kill me. I know I'm when I'm 73 or 75 or just something like that. When I hit some point later, I'm gonna get crushed, isn't that right? I go, that's right. Then they go.

Speaker 1:

You know what? Well, brackets are changing. So I know some brackets that we have right now. I think they're going away. Aren't they reverting to the old brackets, like even before? You know Trump, biden, like before any of those changes, like what's gonna happen? I said, yeah, you're right, they are gonna revert, meaning the previous tax law that was higher, that's coming back into play. So for those of you that don't know, right now the brackets are 10% and then 12%, then 22, then 24,. That's going away. So it's gonna become 10 and then 15 and then 25.

Speaker 1:

You might not think it's a big deal, but if you're debating an early retirement, the next one to three years are really important because it changes a lot of planning and they said, yep, totally get that. So I'm gonna have RMDs and I'm tax. Brackets are changing. We should do a lot of these conversions. I said that's true, we should. And they said, hey, make it really easy for me, tell me how much I should do. I said okay. So I made them as whole analysis. I said, hey, flip to the last page. What does it say you should do? They said, all right, it says zero. I go, that's right, I want you to do zero. They go. But you said big RMD issue. I go. Oh, it's gonna be huge, they said. But you said brackets are changing and I should do it before they jump up. I go, oh, they're gonna jump up. They go. Then why do you recommend zero?

Speaker 1:

Now, this particular client was not in the best health and I said, hey, I know that we need to do these conversions, but the benefits of an early retirement, how specific an early retirement is to your age, meaning you're not retiring at 63, where social security is gonna get turned on pretty soon, or 60, you know, whatever you're retiring, you're retiring at 58. We have plenty of time to do conversions. So I'd rather you go spend $35,000, take a fun trip with your mom. Well, you have her and your health, and we're gonna have plenty of time to do these conversions. So the premise here is I want you to be really strategic, but don't let the financial kind of answer wag the life dog and I see a lot of that where people sacrifice a ton of fun and lifestyle just to do Roth conversions. So what on earth is a Roth conversion? We're gonna talk about that and then I'm gonna tell you the five instances where you do not need to worry about this, where, if you're gonna hear this and go, hey, that's me. Then if you hear that, that means you might not need to worry about doing Roth conversions and I might save you literally hundreds of thousands of dollars in taxes. So you are going to get that very shortly.

Speaker 1:

I am going to start with a recent review, and this one comes from Harold. Harold says Ari, really enjoy financial planning, but you are giving me a new perspective, especially regarding health insurance and withdrawal rates. You're very welcome and I love doing the show. So, with that being said, I've got my five little instances situations, if you will, when not to do a Roth conversion. I'm going to give you all of the answers right now and then I'm going to go through each of them in more detail.

Speaker 1:

So, first of all, what is a Roth conversion? Very, very simple. I try to keep it fun. I know this stuff can get dry at times, but I want to make sure that you, first of all, are meeting with an advisor. Going this isn't like going to the dentist, like I'm getting some real guidance and I'm not falling asleep and I'm excited for our meetings.

Speaker 1:

Most people it's like hey, I like this stuff, but my spouse doesn't, so how do you get her involved? And I'll, I know I promise I'm going to talk about Roth conversions and all this stuff, but when these thoughts come into my head, I just want to share them and some of them are fun. So, one, one person, real quick. I promise guys that they came to me and they said all right, I really love this stuff, the conversions, the planning, but my wife could care less. So, like, how do you keep like someone who doesn't like finances involved in these meetings? I go, you don't talk about Roth conversions, you do it like this. You go. Let's assume, spouse, I forced you to spend $100,000 this year beyond what you're already spending. But if you don't spend it, it goes to your least favorite political party. Now what would you do? That's when they start talking. So you got to keep it fun and stuff like that.

Speaker 1:

So to my point here what is a Roth conversion? I talk about it in the sense of cauliflower. Some people love cauliflower so this wouldn't resonate with you. But if you go yeah hey, I get the joke here. Cauliflower, the way I frame it is you can say I'm going to retire early and I'm not going to eat any cauliflower. That's right. All steak, all pasta, all the good stuff for the rest of my life.

Speaker 1:

And then all of a sudden, 75 comes and you're forced to eat so many vegetables you don't want to eat it ever again and the government's like too bad, those are required minimum distributions. You are forced to pay taxes and so you can delay and delay and delay and not eat any vegetables and in the future you're going to be forced to eat so much that you're going to be so sick of them and they're not going to care. You're going to be forced to pay required minimum distributions. You're going to be taxed at your highest marginal bracket. So if you have a pension and social security and rental income or a really healthy portfolio. You're just going to get annihilated. Okay, I'm not saying that to scare you. What I'm saying is next year it's kind of the last year before brackets change where you can do a lot of cool planning stuff. You can still do them in future years. They're just less effective.

Speaker 1:

So what I want you to do is consider eating a little bit of cauliflower, not saying you don't you have to eat a ton, but eat a little bit, because if you're willing to eat a little bit or pay a little bit in taxes, you are not going to be forced to eat all cauliflower or a large portion of cauliflower in the future. It's pretty simple. So what you can do is move money from an IRA, a pre-tax account or a 401k into a Roth IRA, and so you get to determine how much you want to move. You are intentionally going yes, I am more than happy to pay taxes, knowing I will never pay taxes on these dollars ever again. Now, those are the very basic kind of loose fun examples on conversions.

Speaker 1:

What I want to tell you is when not to do this Now. Number one is if you know you will be in a lower tax bracket in the future, do not do Roth conversions. Meaning if here we are paying 33% taxes plus and a lot of you, excuse me, are paying north of that, you're paying 40%, you're paying 50% taxes, all in depending on fed and state where you live. The truth is, you're getting crushed and what you want to do is you want to certainly limit that by doing some pre-tax deductions 401k, 403b, all that good stuff. You want to limit how much you have to pay in taxes. Now some of you are in let's call it, 22, 24% bracket, all in.

Speaker 1:

Right now Maybe you're still working, maybe there's part time income, maybe you're going. You know what? I've got a really healthy income. Today I'm getting crushed. But in the future I'm going to retire early and I'll have a chance where my income is like nothing or very little. Well, if you're even going to have a chance where your income is going to be very, very low, that's when it makes sense to do some strategic tax planning. But if you are never going to have an RMD issue, meaning you are forever, let's assume you have all Roth or all brokerage or whatever no pre-tax accounts In the future. There's no pension, no rental income. You just have a really healthy portfolio.

Speaker 1:

And you're wondering should I do Roth conversions? Well, in the future, if your income is going to be lower, don't go pay 20% in taxes today just to save paying 10% in taxes later. That doesn't make any sense Sometimes you just need to hear it that way. What some people are doing is they're paying Roth conversions, but they really shouldn't, meaning there's going to be an opportunity where, yes, they're going to be in a lower tax bracket and if they're going to be jumped into a higher bracket later let's assume, hypothetically, you're 50 years old, you're in a high tax bracket, north of 40%, and then all of a sudden you retire.

Speaker 1:

There's five years where, from 50 to 55, you can pay really low taxes and then maybe a pension starts at 55. Okay, well, during those years where your income's really low, you might want to do Roth conversions, because from 55 to 62, let's assume there's a pension and now you have a pension and Social Security, it's turned on at 62, and then let's assume, assuming you want to elect then, and then let's assume Roth conversion or RMDs should I say, start 10 years after? Let's assume really 13 years at 75,. Well, now you're going to continue to get crushed. And so the premise here is if you've got some varying windows of time where yep, I'm going to retire, my income will be low, but I've got a few years, okay, that's when it can make sense to a conversion. It does not make sense to if you're going to be in a lower bracket in the future, forever.

Speaker 1:

That's number one. Number two if RMDs are never going to be an issue, you don't need to worry about Roth conversions. Meaning what's going to happen is, if you have $100,000, the government's going to force you to take out 3.8% of your portfolio to start. So 3,800 bucks. You're going to have to take that out and you might go well, that sucks, I go. No, you got a deduction for it up front. Now you're just paying taxes. That's okay, you're paying taxes on it and it's not going to be excessive.

Speaker 1:

Meaning, I imagine let's assume you're living on $80,000 a year. Well, if you're living on $80,000 a year and you're forced to take $30,000, that's not kind of forcing you to take out more than you need. I am talking about if you have, let's just assume, $10 million in an IRA. It doesn't have to be $10,000, but let's assume it's $2 million. If it's $2 million in an IRA and you're forced to take out. Oh, I don't know. Let's just say 5%, you go, okay, I'm not so sure I need that amount of money in excess of what I'm already spending. Now, most of you would go well, what's the big deal? $50,000, I want to spend $80,000, I go, you're right, it's not a big deal. But what's going to happen is it's going to keep growing and all of a sudden you're going to be forced to take out 6%, 7%, 8% out of a $4 million portfolio. And then you might go alright, I don't need $300,000, like I've already got Social Security and pension and rental income and I've got other stuff going on. Like I don't need that. And I go, you're right, I know that the government doesn't care and they're going to force you to pay taxes on it. So if you're not worried about RMDs, meaning if RMDs are not going to be excessive for you, then Roth conversions might not be applicable and you might not need to worry about anything I'm saying at all.

Speaker 1:

Additionally, if you do a lot of charitable giving, you can do what are called QCDs Qualified Charitable Distributions. I know you're thinking alright, that was Portuguese. But what this means is what you can do is intentionally, as opposed to paying this big RMD what I. If charitable giving is important to you, you can say you know what I'm going to be strategic here. I'm going to not sell this stock and then pay taxes and then give it to my church. I'm going to just move money from my IRA that I got a deduction for up front and give it to my church, so that I don't have to take the money out, pay taxes and then give it to my church. I want to be tax efficient here, and so what you can do is, starting at 70 and a half, you can actually take funds and start to do charitable giving and that can count as fulfilling your distribution from the government. So that's a really cool way. And there's more planning involved in this, such as donor advised funds, which I have separate videos on, but qualified charitable distributions in general.

Speaker 1:

If charitable giving and a lot of it is of importance to you, there's a lot of tax planning where Roth conversions can be really helpful in addition to it, or you might not need to do it at all. So those are the three reasons so far. If you're gonna be in a lower tax bracket forever in the future, don't do it. If RMDs are not gonna be an issue in the future, don't do it. If you're gonna do a lot of charitable giving in the future, you might not need to do it. Or pair it with a conversion. Do the really kind of pro tip stuff. If you don't have a long life expectancy, I mean if you're not really worried because your health isn't the best spot you might not need to do Roth conversions. Because if we're not planning to get to that point where RMDs are gonna hit you which is very sad but sometimes very real to talk about you might not need to do it. And then, finally, if you are not open to being proactive, don't do it.

Speaker 1:

So I'm gonna give you a final example here to just summarize today's video podcast, which is let's assume you bought Apple stock at $1 and it went up to $5. Awesome. And let's assume that's all in your IRA. When you take that money out of your IRA, it's as if you just made more money. It's called ordinary income tax. It's like you're going to work. Now let's assume it keeps growing. So you bought it at one. In your IRA it grows to five and it keeps growing. So now it's worth 10. That's awesome. Now it's worth $10. If you want to take that money out. You just pay ordinary income taxes.

Speaker 1:

Now let's assume markets go down and now that Apple stock isn't worth 10, it's worth two. Oh my gosh, alright, which one's that 80%? What do I do? Most people sit on their hands and go yeah, I'm gonna wait for Apple to recover. It's a strong company. I've seen markets go down, I'll be okay. What most people don't do and this is where, if you're not open to implementing these strategies, roth conversions might not be good for you. If you are, it can be really powerful, which is you can go wait a second. So I bought Apple stock at one and went to five. Then it went to 10. Now it's worth two. What if we did a Roth conversion at $2? So now Apple stock, all you're going to do is move it that you bought. You bought it at one, went to five, went to 10. Now it's worth two. Move that two from your IRA to your Roth IRA, you do a little conversion, you pay a little bit in taxes and then guess what happens when that $2 of Apple stock grows back to 10? That's all tax-free growth. So from the two all the way to the 10, you now get to reap all of those benefits tax-free.

Speaker 1:

So a real life example. Clients came to me and they were late 50s about 58, 57, and they wanted to retire early. They didn't know if they could make it happen. And this was right before COVID. And they were like all right, we make this happen, I go. You know what? It's gonna be tight, but if you're open to implementing dynamic strategies and you really hate what you're doing and you're not open to part-time income, here's kind of where you stand. What are your thoughts? And they're like, hey, I'm not so sure I go. Hey, let's talk more about this. Ran more stress testing, more what-if scenarios, started to get more confident. But still, even if markets go down, you want to make sure you don't have to go back to work just because of what markets have done.

Speaker 1:

So what we did is we implemented for them some strategic Roth conversions, but not right away. We said, hey, what if you know, when markets go down? We kind of really put our kind of pedal to the metal there. And here's the reason for it. They go yep, I'm ready. If markets go down, I'm not gonna go sell everything. I'm open to being dynamic.

Speaker 1:

So markets went down 30% when COVID occurred and all of that kind of big downturn. We didn't convert it right at the bottom, because we don't do market timing you never know when the bottom is. But when markets were down about 20 to 25%, we implemented a lot of strategic Roth conversions. Now what does that mean? What that means is we moved a lot of the money. So they had about one and a half million dollars and now they were in the range of kind of one, one, one, two, one. So a big, very scary downturn.

Speaker 1:

And now what we did is we did a Roth conversion at that point and so we moved the money from their pre-tax accounts to their Roth. As the growth came back and as to where they are right now, sitting in the 1.7 to 1.8 range, there's five, six hundred thousand dollars. That's tax-free growth, taking their withdrawal rate from what was originally around four to four point four percent to now about three point six to three point eight percent. Their withdrawal rate actually Decreased even though they stopped working and now they're in a better spot to spend even more money pretty special stuff here. So Roth conversions can be amazing if you're open to being dynamic and going.

Speaker 1:

Yep, markets went down. I'm not gonna freak out, I'm simply gonna move this money so that when the markets do recover all of that, I'm not paying taxes on all that growth. So this is not strict market timing. We don't subscribe to that. What we want to make sure is you have the income you need in retirement and that you're open to doing what we call our NB's no brainers where it's hey, this is a no brainer, let's absolutely implement this and be ready. It doesn't mean we're gonna implement it tomorrow. It means, hey, let's be ready. So if we're traveling or doing fun stuff, that we know the strategies in place to take care of these things. So these were the five situations where you do not want to do Roth conversions, but also you can see the real benefit of them.

Speaker 1:

So I've got tons of different videos and podcasts on this. My final request is if this made you think 1% differently about your retirement or an early retirement Taxplaining, whatever it is, please do, of course, drop a comment If you are on YouTube or leave a review on iTunes really fun for me to see or just shoot me an email. My email is directly Ari at root, financial partners with an s on the endcom. I love hearing from all of you guys and if you want to work with us on a custom strategy. It's what we love to do, so, of course, reach out to us in the description of this episode. Thanks, guys, love you.

Speaker 1:

Thank you for listening to another episode of the early retirement show. If you have a question that you want answered in a future episode, you can always go to my website, early retirement podcast Com. That's early retirement podcast Com, and you can go ahead and submit a question that I'll look to answer in a future episode. Thank you all for listening. Please do rate it, review it and share it with someone who you think would benefit from this information. If there's anyone out there that you know, I certainly appreciate it and I will see you all each week. Hey guys, it's me again. Please be smart about this. Nothing in this podcast should be construed as financial, tax or legal advice. Consult with your tax preparer or financial advisor before taking any action. This podcast is for informational purposes only.