What Retirees Need to Know about Roth Conversions

[INTRODUCTION]

[00:00:11] Dean Barber: Welcome to The Guided Retirement Show. I’m Dean Barber, Managing Director at Modern Wealth Management. Wouldn’t it be great if you got to keep every dollar you made? What if you never had to give $1 to Uncle Sam? Think about how different your life would be. Unfortunately, as long as we live in the United States, as long as we have money or earn money, taxes are going to be a fact of our lives. But there’s also a fact out there that with a very complex tax code, over 76,000 pages, that if you understand the rules of the tax code, you can reduce your tax bill and it’s well within the confines of the law. Joining us today on The Guided Retirement Show is a repeat guest.

It’s JoAnn Huber. She’s a CPA, also a Certified Financial Planner® and a partner here at Modern Wealth Management. JoAnn and I are going to dive in deep today and we’re going to talk about more tax reduction strategies. Please enjoy.

[INTERVIEW]

[00:01:08] Dean Barber: So, back on The Guided Retirement Show here now we have JoAnn Huber, CPA, Certified Financial Planner®. In Season 1, JoAnn, you and I have two episodes, Episode 1 and 2, talking about a Roth IRA or a Roth 401(k) versus a traditional IRA and a traditional 401(k). And in those two particular episodes, we spent about an hour-and-a-half talking about the difference between those. And there’s no possible way that even in a format like this on The Guided Retirement Show that we can cover all of the nuances that affect every single person that chooses to listen to this podcast.

Suffice it to say, it’s a complicated decision. And when we were ending the last episode that we did in Season 1, we promised our listeners that we would come back and talk about, continue to talk about Roth IRAs, but talk about Roth IRAs instead of making a contribution to a Roth IRA or a contribution to a Roth 401(k), we wanted to talk about Roth conversions.

And so, there’s a number of reasons why a person may want to do a Roth conversion. There’s also a number of reasons where a person may not want to do a Roth conversion. So, let’s try to cover some of the basics of the Roth conversion first, and then let’s talk about who would want to do a Roth conversion, why it would make sense, and who might not want to do a Roth conversion.

[00:02:41] JoAnn Huber: And there’s a lot to talk about in those things so let’s get going.

[00:02:44] Dean Barber: Alright. So, let’s first define the Roth conversion. I’ll do that and you see if I mess it up as a non-CPA.

[00:02:51] JoAnn Huber: I bet you can do it.

[00:02:52] Dean Barber: So, a Roth conversion is simply the act of taking money from a traditional IRA and moving it from a traditional IRA over to a Roth IRA. Now, there is taxes due when you move the money from the traditional to the Roth. And so, what essentially happens is you’re making the decision that I’m going to take some money out of that traditional now, I’m going to pay the taxes on that piece, I’m going to move it over to the Roth IRA. And then as long as I hold that Roth IRA for at least five years, and I’ve attained the age of 59 ½, then all of my income from that Roth IRA in the future is going to be tax-free.

[00:03:37] JoAnn Huber: I think you did a great job defining it, Dean.

[00:03:39] Dean Barber: So, the question always becomes, okay, so people think, okay, if I’m going to do a Roth conversion, that means I have to convert all my money from a traditional IRA over to a Roth but we almost never recommend that people do that, right?

[00:03:51] JoAnn Huber: Right. Lots of times we’ll look at what we call bracket management and let me explain what that means is everybody is in a tax bracket. There’s the 10%, the 12%, 22%, 24% and it keeps going up. Alot of times, we’ll look and say, “Does somebody have room in their current tax bracket?” So, for example, if you’re in the 12% tax bracket, can we convert a little bit to take advantage of that 12% tax bracket and not jump up that extra 10% to the 22% bracket? We do a lot of small sequential Roth conversions over a period of years to pay the least amount of tax we can but yet still take advantage of that conversion.

[00:04:24] Dean Barber: Okay. So, people might be wondering, why would you do that? Why would you choose to go ahead and pay some taxes now because we have no idea when the money is going to come out. We don’t know what the tax rates are going to be at that point in time. In order to make a decision to do a Roth conversion and pay some tax now for the benefit of tax-free income in the future, and by the way, a tax-free inheritance for children and grandchildren, you have to actually look forward. You have to do some really solid financial planning and understand the scope of your overall situation to know what is your future tax rate going to look like?

[00:05:09] JoAnn Huber: And that’s the most important thing we look at is what is your current tax rate and what’s going to be your future tax rate? And if you’re going to be in a lower tax rate in the future, there’s no reason or very few reasons you’d want to do a Roth conversion now. But if you’re going to be in a higher tax bracket, you want to pay it now. So, really what we’re looking at on a Roth conversion is when can you pay the least amount of tax possible on that income?

[00:05:32] Dean Barber: Alright. So, a lot of people will think about doing that Roth conversion at pretty much any point in their life. You and I have a favorite time for people to do Roth conversions. The number one favorite time for people to do Roth conversions for me is once a person has retired and they no longer have earned income, they don’t have that W2 income anymore.

So, we then as financial planners and CPAs working together can help to lay out the sources of income that we want people to take out for a second, and third, and so on and how much of each, so that we can then do conversions at a low tax rate, and then have that money grow tax-free from now on. So, during retirement, which a lot of people don’t think of doing Roth conversions during retirement can really be one of the best times.

[00:06:25] JoAnn Huber: I agree with you. It’s one of the ideal times to do it, especially for somebody who is older. Another time and we’ll come back to that is maybe if they’re really young and have left a job. But we’ll come back to that. Let’s talk about the older person. You’ve retired. You don’t have those required minimum distributions because they don’t start until age 70 ½.

You haven’t started Social Security. So, it’s possible to have a really low tax bracket and maybe you’re even in zero, but zero is not necessarily a good thing. Because if you’re going to go up to the 24% bracket later, do you really want to pay zero now instead of 24% later? Or if we do a Roth conversion, can we maybe keep you at 12% for a really long time? Maybe extend that out by 10, 15 years just by doing a series of conversions and paying it at a lower rate.

[00:07:15] Dean Barber: Right. And the reason why we think this is really critical is because we know that as long as you live in the United States, as long as you have money or make money, the taxes will be a fact of your life. So, the idea of a Roth conversion centers around the understanding that taxes will be a fact of life for as long as you’re alive, and as long as you have money and make money.

So, the question becomes, how do we pay as little tax as possible over a lifetime, not in a given year? And sometimes, JoAnn, people can’t get past this idea that if I do a Roth conversion now that means I’m going to pay taxes on that piece now and so that’s going to put me behind the eight ball. So, they want to do some sort of a breakeven analysis using, you know, for lack of anything else to utilize a breakeven analysis using an Excel spreadsheet that basically says, “Well, if I pay these taxes today, how long is it going to take me in order to break even on that?” But do you think that that’s a good way to look at a Roth conversion analysis?

[00:08:21] JoAnn Huber: I don’t, because let’s look at what happens with Social Security. Most people don’t realize that Social Security is subject to income tax based on your provisional income. So, it is possible that none of your Social Security is taxable, but up to 85% of it can be taxable.

[00:08:35] Dean Barber: What’s that have to do with the Roth conversion?

[00:08:36] JoAnn Huber: Well, because if we don’t do the Roth conversion, we’re going to have our required minimum distributions. And if we haven’t done Roth conversions that required minimum distribution will be higher once you hit age 70 ½, which may cause more of your Social Security to be subject to income tax.

[00:08:51] Dean Barber: Okay. Well, before we go too far, explain the required minimum distribution.

[00:08:55] JoAnn Huber: So, the IRS has said that once you hit 70 ½, you have to start taking money out of your qualified retirement plans. That would be a 401(k), a 403(b), an IRA. Anything that’s tax-deferred once you hit 70 ½ unless you hit a couple of the exceptions, you have to start taking money out. And that’s why it’s called, you know, Ed Slott refers to it as the Retirement Savings Time Bomb, because you have a partner in that account that you’re going to have to pay the tax at some point and 70 ½ is when they’ve said, “We’re tired of waiting, you’re going to start taking distributions and paying tax.”

[00:09:30] Dean Barber: Okay. So, if you think about that in conjunction with Social Security, because that’s where you are going on that, you have to start taking Social Security at age 70, right?

[00:09:40] JoAnn Huber: Well, I guess you don’t have to, but it stops growing.

[00:09:42] Dean Barber: Well, but if you don’t take it at age 70, I mean, you’re dumb.

[00:09:44] JoAnn Huber: You’re leaving money on the table. Right. So effectively, yes, you have to start at age 70.

[00:09:49] Dean Barber: Yeah. So, you know that Social Security at the very least will kick in at age 70 and you know you have to start taking money out of your IRAs, 401(k)s, 403(b)s, etcetera. And so, what JoAnn’s talking about on that provisional income piece is that when Social Security was originally enacted, it was designed to be a tax-free source of income.

And what people don’t know is that today, Social Security by itself is a tax-free source of income. But you can have to pay taxes on your Social Security if you disqualify yourself. And you disqualify yourself by having too much of what JoAnn talked about earlier, which is provisional income, which is a complex calculation that’s used to determine how much if any of your Social Security is becoming taxable. And as JoAnn said earlier, up to 85% of your Social Security can become taxable. So, let’s just say, JoAnn, that somebody was doing that Roth conversion, say from age 62 when they retired to age 70 and allowed their required minimum distributions to be down to a point where say only 50% of their Social Security was taxable from age 70 on.

Versus if they didn’t do the conversion then 85% of their Social Security would become taxable. And that’s why you say that the Excel spreadsheet can’t catch that because it doesn’t take it. So then, in other words, you’re not just paying taxes on $1 of a required minimum distribution from that traditional IRA or 401(k). It’s also causing another $0.85 of your Social Security to become taxable. So, it’s increasing the effective tax rate by almost two times.

[00:11:22] JoAnn Huber: Right. Well, and then we can add on it also might cause some of your capital gains to be subject to tax. And that increases it even more. So, there’s all of these little pieces that play together that just by having a larger required minimum distribution can really increase the amount of tax you’re paying, because you’re not just paying tax on that required minimum distribution. You might be paying tax on capital gains or qualified dividends, plus more of your Social Security.

[00:11:48] Dean Barber: Alright. So, as you can tell what we’re talking about here, it gets pretty darn complicated to make a decision whether you should do a Roth conversion or whether you shouldn’t do a Roth conversion, and I want to remind you that we talked about actual IRA or 401(k) contributions to comparing a contribution to a traditional 401(k) or IRA versus a Roth 401(k) or IRA. That’s all in Episode 1 and 2 of Season 1 of The Guided Retirement Show. And if you didn’t listen to that, I encourage you to go back and listen to that because that talks about getting money in. Now, what we’re talking about is once you’ve got money in the traditional part of your 401(k), do you want to roll that over to an IRA and therefore start doing some Roth conversions?

And I think one of the things that has to happen in order to make a determination of if you should do that or not, I mentioned earlier, a good solid financial plan. And that good solid financial plan has to assume a budget that you have, the spending that you want to do, and then look at all of the different sources of income that you have and take that out not just over the next year or two, but you need to take that out to age 85, age 90 and look at where those different sources of income are going to come from. You have to make some assumptions on rate of return and understand how much money is going to be in each different type of tax bucket, whether it’s a taxable tax-deferred or tax-free bucket, and then understand what is that doing to my taxes?

How much money am I losing each year to Uncle Sam? And look at that over a period of say you start those Roth conversions right after retirement, you retire at 60 or 62, you may have a 25 or a 30-year period that you’re going to look at that over. And a lot of times, JoAnn, you’re seeing that if people do the right conversion amounts, the total lifetime of taxes can be significantly less, 100,000, 200,000 or more.

[00:13:50] JoAnn Huber: That’s so true. And you talked about having the money in the different buckets and having that tax diversification is key to being able to plan where you’re going to get your money during retirement, but a lot of times people will have saved so much in their 401(k) because we’re told over and over if you read things and listen on the press that you’re going to be in a lower tax bracket once you hit retirement.

But what we’re finding out is that’s not necessarily true. So, the people who have done that and put so much money in their tax-deferred account, that 401(k), now they hit retirement and everything that comes out has to be subject to tax but Roth conversions is a way that we can change that a little bit and say, “Okay. We are at that point right now, but I have some flexibility. Let’s do that Roth conversion to create some tax-free income.”

[00:14:34] Dean Barber: So, that’s obviously something that people want to consider, but it’s not something – it’s kind of one of those things you watch some stunt things on TV and they say don’t do this at home. Don’t try this on your own. This is one of those things where I encourage people not to try to do this on their own without the help of a good CPA. In most cases, it can’t be just a CPA. It’s got to be a CPA who is either also a Certified Financial Planner® that’s laid out that long-term plan or it’s got to be a CPA that is working in conjunction with that Certified Financial Planner® that that has already laid out that long-term plan. And then the CPA can look at and say, “Does this make any sense? Or does it not?”

[00:15:23] JoAnn Huber: Well, that financial plan is the foundation of everything we do from a tax plan. Because the most important thing is, what is it that you want your money to do for you for the rest of your life? And the only way we know that is through that financial plan. So, we can come up with a great tax plan where you don’t pay anything, but you’re going to have a really boring, miserable life, because you don’t have any money to do anything.

And that’s not what we’re looking at when we’re talking about tax planning. It’s we’re looking and saying, “What do I need to do today to save the most money so I have more money that I can go and spend and do the things that I want or give to charity or leave for your family?” You know, what it is but really it’s focusing on you and that foundation comes from the financial plan.

[00:16:03] Dean Barber: Alright. So, let’s talk, JoAnn, about other reasons why kind of people get into these traps. And I want to go to the comment that you made earlier where we get told time and time again, as we start work, start putting money into 401(k) plans to put your money in here, get the tax deduction today, let it grow tax-deferred because you’re going to be in a lower tax bracket in retirement.

Well, we could take that at face value and just believe it, right, which is what the majority of people have done. Or we could actually do some calculations and see what the reality is. The other problem that has come in that I think has exacerbated that particular issue is that it’s another notion from Wall Street, where they come up with their 4% rule. And the 4% rule basically is saying that if you take the value of your account, multiply it by 4%, that’s how much income you can safely take out of your 401(k) or your IRA, or any investment that you have, and not have to worry about running out of money in retirement.

So, what has that done? That’s caused a lot of people to maybe work longer than what they needed to, to save more money inside of their 401(k) than what they needed to, not understanding that in the very first year of that required minimum distribution, it’s 3.65% withdraw and it doesn’t take very long before those distributions coming out of that IRA or 401(k) are going to exceed 4%, because they’re required, and getting up in the 6% and the 7% and 8% and the 9% withdrawal rates. And so, you and I worked on a scenario a couple of years ago, which just comes to mind today, where we had a couple who had done a fantastic job of saving.

They were following this 4% rule. They weren’t really taking into consideration the pension and the 401(k). They’re thinking, I mean, they had a narrow chain of thought. “This is what I’m going to need. This is how much money I need to have saved.”

[00:18:05] Dean Barber: And they worked all the way until the age of I think it was 68 or 69. And when we looked at it, we realized and showed them that the required minimum distributions that were going to come out of their IRA plans was going to cause them to have to pay more taxes each year than what their actual living budget was.

[00:18:27] JoAnn Huber: And that’s common. We see that over and over again. And that’s where we have to look and say, “Okay. What do we need to do to make it so we can change that situation?” And it’s not bad to have more money than you need. I mean, it beats the alternative.

[00:18:40] Dean Barber: No, but the problem…

[00:18:41] JoAnn Huber: But the problem is, is they’re paying so much more tax than they need to on that.

[00:18:44] Dean Barber: Right. And so, the comment that the lady of the couple, she said, “Why in the hell did we work so long and work so hard and sacrifice so much to put all this money into this retirement account and now all the sudden, we’re sending the government more each year than what my husband and I are even living on?” Right? And oh my god, that’s something that nobody wants to do.

[00:19:13] JoAnn Huber: But it happens over and over again.

[00:19:15] Dean Barber: It happens a lot. And that’s why you say that financial plan is the foundation of determining it because some people may say, “Well, yeah, if I know that I’ve got enough and I could retire, that doesn’t matter. I don’t want to do that because I enjoy my job,” right? Okay. So, start giving some money away to your kids. Help them out.

Take them on vacations. Do some things that are going to give you a great quality of life. But a lot of people, they get into this thing and they start looking at the numbers on their investment statements and saying, “I got this much money. I have this much money. Oh my god, I can’t wait until they get the next million.” Not understanding that in the end, they’re going to wind up giving a huge amount of that money away not to a favorite charity, not to kids, not to grandkids but to our least favorite uncle, and that’s Uncle Sam.

[00:20:03] JoAnn Huber: And that is why it’s so important when they’re looking at their account balances to realize that if it’s a tax-deferred account, it’s not all yours. And you’ve got to be looking at that. And that you can’t wait until you’re retired to be doing that. You’ve got to be looking, where do you need to be saving, but if you have retired, now we have to look and say, “What do we do now to stop that?” So, that couple that we worked with, if they would have listened and said, you know, we kept saying you have enough to retire, but they didn’t feel comfortable. And so, a lot of times people need permission I think to retire and say, “You really are going to be okay.”

And the reason sometimes you actually hurt yourself like these people did because they’re paying so much more in taxes, and they missed out on the opportunity to live life.

[00:20:47] Dean Barber: Well, exactly right. And so, they lived well below their means. They didn’t do vacations and didn’t eat out. They were just so consumed with saving enough money that they wound up in this scenario where their tax bill after retirement was, literally, they were paying more in taxes than they were receiving in Social Security benefits, which is ridiculous.

[00:21:14] JoAnn Huber: It is because they worked and saved so hard to pay taxes.

[00:21:20] Dean Barber: Yeah. I don’t think that’s the scenario everybody wants to be in. So, that’s why we think that examining the possibility of doing a Roth conversion for everybody is critical. Let’s draw another scenario out there, JoAnn. Let’s say that someone’s working, they’re in their mid-50s, and this happens all the time, and they get laid off from their job.

And so, they find themselves in a year where their income is drastically lower than what it was before. Maybe they’re six months or nine months or a year without a job. A lot of people in that particular scenario the thought doesn’t even come into their mind that, oh my gosh, this is an opportunity where my income is really low, I should think about or analyze the possibility of converting some of my money that’s in my 401(k) or my IRA over to a Roth, because I’ve got no other taxable income this year. I could do this at a really, really, really low rate.

That’s an opportunity that’s there but people in that time of their life or in their mindset, it’s like, “Oh my God, I’ve got to scrimp and save and do everything that I possibly can in order to make sure that everything’s okay because I don’t know when I’m going to get that next job.” And there’s all these things that get in the way of actually doing a good thorough analysis.

[00:22:36] JoAnn Huber: Right. There’s a lot of fear because they don’t know where that next paycheck is coming from and will I run out of money? But the thing is, is that money in that tax-deferred account, they’re probably, well, hopefully, they’re not going to need to touch it that they have their emergency savings. And so, it’s a great opportunity to convert at a really low rate.

And then it still has a lot of years to grow tax-free and that’s where the Roth, the sooner you can get it in, which is why we spent the first podcast in Season 1 talking so much about the 401(k) traditional versus the Roth is the sooner you get it in, the longer it has to grow tax-free. But if that situation doesn’t make sense for you, then the Roth conversions and the sooner we can get it converted, the longer you have for that compound growth to happen.

[00:23:15] Dean Barber: That’s exactly right. But I don’t want people to think that so I should always contribute to the Roth portion, right?

[00:23:20] JoAnn Huber: Definitely not.

[00:23:21] Dean Barber: All right. So, there’s a scenario where, I mean, we talked about this a little bit in Season 1, but I think it bears repeating and me going a little bit deeper here. So, let’s say that we’ve got someone that’s 55 years old, they plan on retiring at age 60. Chances are that person, that couple are in their peak earning years. They’re probably making more money at that point in their lives than they’ve ever made before. And it may be that they’re making far more at that point in their life than what they’re going to need to live on in retirement. So, for a person in that scenario to put money into the Roth portion of their 401(k) and pay taxes on the money before it goes in, maybe exactly the wrong thing to do.

[00:24:05] JoAnn Huber: Right. And that’s what’s so important to make sure it’s what’s best for you that it’s going to be your individual situation because if you’re in that really high tax bracket and you’re going to be lower later, we don’t want to be putting it in there.

[00:24:17] Dean Barber: So, share right now what’s the brackets there for a married couple. Where am I at? And what are my income levels on these tax brackets? So, we can give a specific example.

[00:24:26] JoAnn Huber: You know, the 12% bracket goes up to $78,950.

[00:24:31] Dean Barber: Right, but I’m in my peak earning years. I’m making a lot more than that.

[00:24:32] JoAnn Huber: And so, the peak, the 22% goes up to 168,400 and then the 24% goes up to 321,450. So, a lot of people are in that range where they’re in that 24% bracket right now or maybe if they’re above that 321, they’re going to go up to the 32% which goes up to $408,200.

[00:24:56] Dean Barber: Okay. So, let’s go with that 24% bracket and the income limit on that is what?

[00:25:05] JoAnn Huber: 321,450.

[00:25:08] Dean Barber: Alright. So, let’s just say and then the one below that’s 200 and…

[00:25:12] JoAnn Huber: 168,400.

[00:25:13] Dean Barber: So, between 168 and that 320, round numbers, you’re losing 24% of every dollar you make. Okay? So, what that means is if you choose to make a contribution to a Roth 401(k), you first lose 24% of that money before it goes into the Roth portion of the 401(k). Now, if you’re in a state, where there are state income taxes, you also lose the state income tax on that, too. So, if you’re on a state at 6%, you add that to the 24%, now all of a sudden, you’re losing 30% of that money before it gets into the Roth 401(k). So, that person’s in their peak earning years. Now, let’s assume, JoAnn, that that person wants to retire and once they’ve retired, they’ve determined that they can live on $10,000 net of taxes each month, $120,000. What’s my tax break going to be then?

[00:26:08] JoAnn Huber: Well, it’s possible that they might be down in that 12% bracket or they might be in that 22% just a little bit.

[00:26:15] Dean Barber: Right. So, most of the money could be in 12%, right? So, think through this with me. If I can put into the traditional 401(k) at that point, when I’m in my peak earning years.

[00:26:28] JoAnn Huber: You get 24%.

[00:26:30] Dean Barber: I save the tax on the 24%. I save the tax on the 6%. That’s my state taxes. And then when I retire and I’m spending less, I can control those taxes for a good number of years and maybe then I can take it out of the traditional and convert it to a Roth at a 12% tax rate. So, then all of a sudden, what I did there was I got money into the Roth IRA at half the tax rate, and then making the contribution to my Roth 401(k).

[00:27:00] JoAnn Huber: And that’s the magic of tax planning is looking at when can you do it most tax efficiently and how is that going to impact you for the long term.

[00:27:08] Dean Barber: Right. We all know that there’s no better tax rate than zero and that’s the tax rate on the Roth IRA. The question is that knowing that you have to pay taxes on the money before it gets into the Roth, when should you be putting money into Roth? When should you be converting from traditional to Roth so that you come out a winner?

[00:27:28] JoAnn Huber: Right. And sometimes I have people come in and they’re really disappointed when I say, “You know what, I don’t think a Roth conversion makes sense for you this year.” And they look at me like, “Well, you guys talk so much about a Roth.” Well, in their situation, it might not make sense. So, what are some of those situations? Well, maybe they’re on a higher tax bracket this year. Maybe they inherited some money and had to take some money out of an annuity or out of a beneficiary IRA that caused them to be in a higher tax bracket.

[00:27:57] Dean Barber: Maybe they sold some stock and had a big capital gain, right?

[00:28:00] JoAnn Huber: Right. Well, another situation that we run into is say that they’ve started their Social Security. And they’re not yet paying tax on 85% of it. If we do a Roth conversion, it might cause them to pay tax on the full 85% of their Social Security. So, instead of doing a conversion at 12%, we’re really doing it at close to 30% or 40%.

[00:28:20] Dean Barber: Well, and even if you’re at 12%, right, if you’re 12% tax rate on the conversion, but it’s causing 85% of your Social Security to become taxable, now, for every dollar that you convert, you’re going to pay taxes on $0.85 of your Social Security. So, it’s almost like you’re going to have a double taxation on whatever that 85% of your Social Security is.

[00:28:39] JoAnn Huber: And so that’s why we have to really look at the whole picture and say, “What does it really costing you to do that conversion?” And one thing that a lot of people don’t realize is you can continue to do Roth conversions after age 70 ½. You just have to take your required minimum distribution first.

[00:28:52] Dean Barber: Right. And I think that what people need to be doing so you mentioned earlier, we’re going to circle back to this is, is that the financial plan is the foundation for all tax planning. Let’s say that you’re 10 years out from retirement. Maybe you’re 15 years out from retirement. Don’t just get a plan that’s going to get you to retirement.

You need a plan that is going to make assumptions all the way through retirement because as early as 10 to 15 years before retirement, you should already be calculating and understanding what tax planning opportunities, what Roth conversion opportunities, when Social Security should be claimed during retirement. That planning needs to take place way, way, way before you actually retire.

[00:29:35] JoAnn Huber: Right. So, I think it’s important whenever you’re putting money into an account of any sort that you know what’s going to be the tax implications getting that money out. So, when you’re making that 401(k) contribution, what’s it going to cost you from a tax standpoint getting it out?

[00:29:48] Dean Barber: You know, a lot of what we’re talking about could make somebody’s head hurt.

[00:29:51] JoAnn Huber: Yes.

[00:29:52] Dean Barber: Right? Because there’s so many different rules and so many different applications to this. And the thing is that there’s no book written that explains how to do all this. And the reason that there’s no book written that explains how to do it is because every single person listening to our podcast is in a totally different financial situation. So, really what has to happen in order for somebody to make the right decisions is they’ve got to somehow telepathically gain all of the knowledge that you and I have as professionals, and then know how to apply that knowledge to their own personal situation or you’re going to have to go hire somebody to help you make these decisions.

And you have to understand nobody in the financial services industry work for free. The question becomes, can that person add enough value so that the fee that you’re paying them actually makes sense and you wind up ahead?

[00:30:47] JoAnn Huber: Well, and I think so often, I’ll have somebody ask me a question, “Well, I have a really easy question for you. You know, should I do a Roth conversion?” And if we don’t have that financial plan, I really don’t know the answer.

[00:30:58] Dean Barber: You can’t answer. That’s not an easy question.

[00:30:59] JoAnn Huber: And so, even though it seems really simple, it’s not because there’s so many things we have to look at and make sure we’re taking into account. So, I might give you an answer that I have a chance 50/50 of it being the right answer but it’s not just should I do a conversion that’s important. It’s also how much should you convert? And to me, that’s maybe even a more important question.

[00:31:20] Dean Barber: And it used to be, JoAnn, that people had an opportunity to undo a Roth conversion. They called it a recharacterization. So, if you converted an amount that was higher, and it caused some additional tax problems you had until October 15 of the following year to actually undo that and say, “Ah, I didn’t really intend to do that.” Today, once you do that conversion, you can’t undo it.

[00:31:45] JoAnn Huber: You know, we were really sad as tax repairers to see that go away because it did give us some flexibility. And we could guesstimate, but now we can’t guess. We need to be right.

[00:31:53] Dean Barber: Right. And so, a lot of the Roth conversion work and the analysis and the final decision won’t come down for anybody until November, December of the year that we want them to do that conversion because we have to know what interests, what dividends, what capital gains, what other things took place within their financial life throughout the year is going to look like before we actually suggest an amount for a person to do a Roth conversion on.

[00:32:22] JoAnn Huber: Right. And so, we do have to look at that whole picture. And it’s so important that you’re communicating everything with us so we don’t miss something. Did you start your Social Security and forget to tell us that you were doing it? Because that would make a big difference in the amount that you can convert. So, it’s important that you’re communicating and we have an up-to-date financial plan, so we’re looking at everything that’s correct and then we’re making the best decision.

[00:32:46] Dean Barber: I like it. I would say I’m a proud US citizen, and I don’t mind paying the taxes that I have to pay but I know because I’ve been in the financial planning business for 32 years that the tax code is written to favor the taxpayer but if you don’t understand the tax code and how to utilize the rules that are in the tax code, that’s when you wind up paying too much in taxes.

And many people make the mistake of thinking that they can gather all their documents up together, bring them into you as a CPA or any CPA that they work with and say, “Here’s what I did last year, what can you do to help me?” Well, by that time, there’s really not a lot that can be done. You’re pretty much trying to do damage control. What you should be doing is you should be having a good enough relationship with your financial planner and your CPA to say, “This is what I’m thinking about. Help me make sure that I make the right decision so that I don’t pay one more dollar in taxes than I absolutely have to.”

[00:33:44] JoAnn Huber: Right. And I think that’s important to point out is that we’re talking about tax minimization, not tax avoidance. So, everything we’re talking about is legal and playing by those rules. But most people because the tax code is so long, I think it’s over 700,000 words or maybe more.

[00:34:00] Dean Barber: 76,000 pages.

[00:34:01] JoAnn Huber: So, it’s so long and cumbersome, that there’s no way that people are going to know everything about it. And that’s why it’s important to work with professionals to guide you and say this is really what you should be doing so you have more money to do what you want to.

[00:34:16] Dean Barber: Okay, let’s take a quick break. This is The Guided Retirement Show. I’m Dean Barber. We’ll be right back.

[ANNOUNCEMENT]

[00:34:22] Female: At some point in everyone’s life, you have to go to school because let’s face it, a good education is important and just because you’re nearing retirement age or you’re already there, it doesn’t mean the learning stops. One of the easiest ways to learn about retirement is at Modern Wealth Management’s Education Center. There, you’ll find things to read, to watch, and to listen to about important retirement topics.

So, go to BarberFinancialGroup.com. Click on the menu dropdown. It’s in the upper right-hand corner and select Education Center. There you can download and read our Social Security checklist, watch Dean Barber’s latest video on the current state of the markets, or listen to an audio recording about tax reduction strategies and so much more. There’s no cost. Just sign up for access at BarberFinancialGroup.com. It’s as simple as that. Besides, there’s no tests, no textbooks, and I promise, not to move your seat even if you talk too much. There’s so much to learn about retirement. Just go to BarberFinancialGroup.com. Click on the menu drop down and select Education Center.

[00:35:38] JoAnn Huber: Well, that financial plan is the foundation of everything we do from a tax plan, because the most important thing is what is it that you want your money to do for you for the rest of your life?

[INTERVIEW]

[00:36:09] Dean Barber: Welcome back. I’m Dean Barber, Managing Director at Modern Wealth Management and this is The Guided Retirement Show. You actually do a thing, JoAnn, that’s like a long-term tax map, if you will, that with the professional software and programs that you have, you can look out forward multiple years and say, “How are the decisions that we’re making today affecting our long-term tax liabilities? And what can we do now to mitigate that long term tax liability and reduce it?”

[00:36:41] JoAnn Huber: And that’s really the only way to do tax planning. A lot of people would like to say it’s tax planning if I get your taxes down to zero this year. That’s really not what tax planning is about. It’s about that forward-looking long-term projection. So, over your lifetime, you’re paying the least amount of taxes not necessarily paying zero today.

[00:36:59] Dean Barber: Right. And we’ve run into that. I mean, I’ll never forget. It’s been 10 or 11 years ago where a gentleman came in and he slides his tax return across the desk and he says, “How can you do any better than this?” And he paid zero taxes that year. I said, “From a perspective of paying zero taxes in a given year, that’s a great thing but what are you living on?”

He says, “Well, I’m living on money that I have in savings that’s already been taxed.” And I said, “Super.” So, there’s no taxes due on that. You’re not getting Social Security yet. That’s why you have zero tax liability. I said, “But don’t you have any money in IRAs or 401(k)?” He says, “Yeah, I got a couple million dollars.” I said, “So, when your CPA explained to you that during that year, you could have taken almost $40,000 out of that IRA or 401(k) and paid zero taxes on that, was there a reason you didn’t do it?” He says, “Well, we never talked about that.”

I said, “Well, surely when your CPA explained to you that you could have taken about $90,000 out of that IRA, moved it over to a Roth IRA and paid an effective rate of about 10% on that $90,000 and then it was going to be tax-free forever, was there a reason you didn’t do that?” He said, “We never talked about that either.” I said, “Why not?” He said, “Because my CPA doesn’t know that I have money in that 401(k) and IRA.

I was just basically giving my CPA the data that I was doing. I had figured out that if I lived on this, I could pay zero taxes.” Then I said, “Congratulations. What you’ve done is you’ve just missed three years’ worth of opportunities to either get money out of that IRA or 401(k) with no taxes or to be able to convert a very large amount of that over that period of time at an effective rate of 10%.” And by the way, when your required minimum distribution start at that point in time, we projected he would be up over a 30% tax bracket.

[00:38:51] JoAnn Huber: Yeah. And so, who did he hurt? Himself and his family because they could have paid less tax had they just been working with somebody that had the whole picture. And that’s why that financial plan is so important so we know what are we really talking about.

[00:39:08] Dean Barber: No, that’s it. I mean, because if you’re not looking forward, then it’s really hard to give any – you can give tax advice based on what somebody is telling you. But if you don’t have the full picture and you haven’t done the forward-looking projections, it’s virtually impossible. And that’s why we said earlier that I don’t believe and JoAnn doesn’t believe that using an Excel spreadsheet to do a breakeven analysis to determine if you should do a Roth conversion will work. In fact, I think that you could actually harm yourself by looking in that’s a very narrow view.

[00:39:39] JoAnn Huber: You’re just in a vacuum and looking at it. If you’re in the same tax bracket and you assume the same rate of growth on it, it’s not going to make a difference if you do the Roth or the traditional, if you do those calculators, but we know as we talked about earlier, you have Social Security that impacts, you have capital gains, and the timing of when you take the money out. So, there are different things that impact that because you can control your taxes once you hit retirement. It’s really hard when you’re working, besides making decisions, do I contribute to the 401(k), traditional or the Roth, those kinds of things, but they’re minor compared to what somebody can do once they hit retirement.

[00:40:14] Dean Barber: Right. We always have said that you have more control over how much taxes you pay once you hit retirement than you ever did while you were working. But it doesn’t start. The biggest mistake I think most people make, JoAnn, is they think, “Well, I’m still working. I need that financial planner once I retire, so I’m going to go see them six months before I retire or I’m going to start interviewing financial planners a year before I retire so that I know once I retire, that money comes out of my 401(k) what am I going to do?”

That’s too late in a lot of cases because you’ve missed a ton of opportunities leading up to that, which is why we always say, “Hey, get a good relationship built with a good financial planning firm that works hand in hand with CPAs,” that hopefully, they’re in the same office like we are, JoAnn, where people can, you know, we can sit down together and collaborate on some events, but get there 5 to 10 years before you actually plan to retire because there’s so many decisions that you’re going to make in that five to 10 years leading up to retirement that are going to impact the amount of taxes that you’re going to pay after retirement.

[00:41:18] JoAnn Huber: That’s so true. And it’s important to make sure that you’re planning. You got to plan that route of where you’re going to get to retirement and that’s not the end. That’s just the beginning, I think, and then you have to know where am I going to take that money once I hit retirement. But if you haven’t done the planning in those 5 to 10 years leading up to retirement, you’re probably not going to have the flexibility to make much of a decision once you do hit retirement.

[00:41:43] Dean Barber: Right. And I get a lot of people are so busy working at that point in their life and they’ve got their blinders on and they’re just saving as much as possible. And so, they simply don’t take the time to do it. But the crazy thing is that I will see people that will spend more time planning a vacation than they’ll take planning their retirement, which I consider to be the longest vacation you’re ever going to take. Right?

[00:42:11] JoAnn Huber: For a lot of people, if they have done a good job saving, then it can be that retirement or they can be doing whatever it is that adds joy to their life.

[00:42:18] Dean Barber: Right. So, what we’re talking about here, and the reason this is called The Guided Retirement Show is because we believe you need a guide. Okay. So, I’m going to go back to the vacation for an example. I do a lot of fishing, right? I love being out on the water and fishing. It’s peaceful for me. I enjoy it. And I know how to fish. I’ve fished for years and years and years.

But I made a decision that I was going to take my two sons and we were going to go fishing in Brazil on the Amazon River. And we were going to fish for giant peacock bass. All right now, I could have said, “Look, I’ve fished almost my entire life. I know what to do and how to fish. I don’t need to hire a guide to fish on any body of water.”

However, I would be an absolute fool to think that I could go down to Brazil, rent a boat and have any success at giant peacock bass fishing in a country that I don’t know in an area that I don’t know on water that I don’t know.

I’m going to have a much better experience if I hire a seasoned guide that has guided hundreds and hundreds of people to have the experience of a lifetime. That’s no different than somebody thinking that I’m going to go into retirement and I don’t need a guide in order to guide me through all the nuances that surround my retirement. I can do this on my own, read things, and buy a tax return in a box.

I can read a prospectus of a mutual fund and make investment decisions. That’s not what we’re talking about. Because a lot of people if they apply themselves, can do that but you’re going to miss I promise you so many opportunities that it’s going to cost you one heck of a lot more to try to do it on your own than it’s going to be to hire a guide to take you through that.

[00:44:08] JoAnn Huber: Well, and I think it’s those missed opportunities that usually are the biggest cost that causes people to pay more taxes.

[00:44:14] Dean Barber: Most people, maybe.

[00:44:15] JoAnn Huber: It’s not the math mistakes on the tax return. It’s the opportunities that they missed.

[00:44:18] Dean Barber: And they could be totally ignorant to the fact that they’ve missed those opportunities. Because if they miss the opportunities, they didn’t know they existed so they’re living in the state of bliss. Okay, fine. But once they understand, “Oh, I missed that. I missed that. I missed that. Oh, my God, how much money I just cost myself.”

[00:44:32] JoAnn Huber: Right. And then another issue that we deal with a lot of times that people that are married assume that they’re going to be married throughout retirement. And that’s not usually…

[00:44:41] Dean Barber: Tell me when you’re going to die and I’ll tell you how long you’re going to be married.

[00:44:44] JoAnn Huber: Right. And the reason that that matters is the single tax brackets are about half of what the married filing joint is. And so, that single taxpayer…

[00:44:54] Dean Barber: The income levels.

[00:44:55] JoAnn Huber: The income levels, right.

[00:44:56] Dean Barber: Are about a half to hit the same tax brackets. So, that single taxpayer, let’s say that you’re a couple, JoAnn, and let’s just give some numbers. Let’s say you’re a couple that you’re living on $150,000 a year in retirement. Now, one person dies. Do you only need 75,000 to live?

[00:45:13] JoAnn Huber: Not usually.

[00:45:14] Dean Barber: Probably not. Right. Your lifestyle is probably there. You’re maybe not going to eat as much. There’s going to be some things that’s going to be a little different but what if your required minimum distributions are still forcing you to take out that $150,000 a year? What’s the difference in the tax rate for a single person at 150 versus a married couple?

[00:45:29] JoAnn Huber: Right. So, the 150,000, you’re going to be in the 22% bracket as a married filing joint, but you’re going to go up to the 24% for the single taxpayer. But what that doesn’t take into account is those are the marginal tax rates so you might say, “Well, 2% doesn’t make that much of a difference.”

[00:45:45] Dean Barber: It’s the effective rate, right?

[00:45:46] JoAnn Huber: It’s the effective rate that really makes a difference because you’re going to pay at that 24% a lot sooner than you would have been.

[00:45:54] Dean Barber: Right. So, the thing is that what you want to do, again, this is again, making decisions as to whether you do a Roth conversion or whether you don’t do a Roth conversion. If a lot of times we want to know what’s the health like of each spouse and what’s longevity like in their family history, right? Because if we’ve got someone who’s not well and let’s say that their life expectancy may only be 7 to 10 years and you got another person that’s super healthy and their family history says we’re going to live into our 90s, well, now we got to create a tax plan that’s going to be more for a single individual, as opposed to a married couple because the reality is that at some point in time, in the not too distant future, you’re going to have a single taxpayer.

[00:46:40] JoAnn Huber: And that’s what so many people don’t look at. And so, we have that in that forward-looking tax plan. We’re looking at that and saying, “Okay, what does happen if somebody dies earlier than average life expectancy? And what do we need to be doing?” So, a lot of times when we’re talking about a Roth conversion, we might have somebody say, “Well, I don’t really care about leaving my kids tax-free assets. I worked hard for this. If they get anything, that’s great. But when you say, “Well, what about your spouse?” And all of a sudden, that’s a whole different answer.

[00:47:07] Dean Barber: Absolutely. So, there can be a number of reasons why a person might want to make a contribution to the Roth 401(k) or Roth IRA. There can be a number of reasons why a person might want to do a conversion from a traditional IRA to a Roth IRA. They may even want to, in a given year, do a conversion of some of what’s in their 401(k) to the Roth portion of the 401(k). And there’s some company plans that actually allow that to happen. The bottom line is, though, that making the decision of whether you should convert from traditional to Roth should not ever be done in a simple breakeven analysis format using an Excel spreadsheet.

It needs to be done in the context of a well thought out and a professionally crafted financial plan that not just takes you to retirement, but it takes you through retirement and even looking at generational planning.

And so, I encourage you that if you’re going to think about doing Roth conversions or if you want to actually minimize the amount of taxes that you pay over your lifetime, and get that relationship going with a firm that specializes, first of all, in financial planning, in retirement, that also has CPAs working side by side with that financial planner. You’ll notice a huge difference in what your actual spendable money is. We always say, it’s not how much you make, it’s how much you get to keep that counts. And it’s not just money taken away by a bad investment that can hurt your retirement. It’s too much going out to taxes when it doesn’t need to be going out to taxes that can hurt your retirement, JoAnn.

[00:48:42] JoAnn Huber: And a lot of times that is the biggest wealth eroding factor, our taxes. And the thing is, is you can control your taxes and, yes, it takes work and it takes effort but that’s what you can do if you work with professionals that guide you through that process.

[00:48:57] Dean Barber: Alright. So, we hope you’ve enjoyed this episode here of The Guided Retirement Show as we talk about Roth conversions. Number of reasons to do, some reasons not to do the Roth conversions. Join next time, next episode of The Guided Retirement Show that I have you on. I want to talk about how to reduce your taxes post 70 ½. And that’s when the required minimum distribution starts. There’s a lot of regulations and rules that are written around the required minimum distribution and there are a lot of things that most of you have at your disposal that you can utilize to still reduce your tax bill even though you’ve hit that age 70 ½ required minimum distribution.

So, you won’t want to miss the episode where JoAnn and I talked about required minimum distributions and how to pay as little taxes as possible even after those required minimum distributions start.

[00:49:49] JoAnn Huber: Look forward to having that discussion with you.

[00:49:51] Dean Barber: Thanks for being here.

[00:49:52] JoAnn Huber: Thanks.

[CLOSING]

[00:49:53] Dean Barber: That was JoAnn Huber, CPA and Certified Financial Planner®, also a partner here at Modern Wealth Management. Get to the show notes, get a copy of our tax reduction strategies guide. Better yet, start a conversation with the financial planners and CPAs here at Modern Wealth Management. Take control of your own future by getting that forward-looking tax strategy in place and stop overpaying your taxes, stop missing opportunities that are right in front of you every single year. Keep more of that hard-earned money for yourself.

Find the show notes, links to resources, and show transcription at GuidedRetirementShow.com/18. That’s GuidedRetirementShow.com/18. Make sure that you subscribe to The Guided Retirement Show. Share this with all of your friends. And check us out on YouTube where you can watch The Guided Retirement Show as opposed to just listening. Thanks for being here.

[END]

Investment advisory service is offered through Modern Wealth Management, an SEC-registered investment advisor.