Roth Conversions Age Limit: When Is Too Late? | Listener Question
Paul Winkler: And welcome to The Investor Coaching Show, Paul Winkler talking about this money thing.
You Can Ask Paul Questions
You know, if you’ve got questions for the show, I was like, Hey, why don’t we do this? It’s fun for me to go through the news and talk about things that I find interesting. And I typically can anticipate a lot of questions that people have just because you see the same stuff people asking about currencies. I know that people are going to talk about currencies, virtual currencies. They’re going to talk about tax changes. They may be talking about overvaluation in the market. So I thought, you know what, sometimes you get people asking questions or wondering about things that didn’t necessarily anticipate so I thought we’d do this thing where we have question and answer type thing.
So what we did is we went and put a section on the website. You get to it by going to paulwinkler.com/question. You can enter a question and we got inundated, which is great. Thank you so much. It’s so much fun to get all these questions and see what is on everybody’s mind. It’s just really fun to do that. And hopefully, it’ll help you as well. So I’m going to go through some of these questions on a regular basis. And one came in, Jill was asking about doing a Roth conversion. Is it a good idea to do a Roth conversion for a 73-year-old?
Is a Roth Conversion a Good Idea?
Well her kids will be in a higher tax bracket than she is, and have to use all of the required minimum distributions to cover expenses and would have to withdraw from the retirement. 401(k)s approximately a million dollars to pay taxes on the conversions. Now, this can be a really detailed question, and I’m going to go through what I can without knowing the entire situation. And there’s a lot of this that requires planning. But number one, 73, you’re already doing required minimum distributions and a big thing that you’ll do with Roth conversions. Many times as you look for years where you have a lower tax bracket than you might have in the future.
You know, so for example, you might have a year that you’re out of work and you don’t have any income. So, well, that’s a good year. If you have some money sitting on the side that you can live on to go in and take some of the money out of your IRAs or pre-tax accounts and convert them to Roths because of the fact that you’ll be paying taxes at next to nothing because you have some income you can earn because of standard deductions that the tax rate zero, and then you have some at 10 and some at 12. And, and for that, for a particular scenario where you’re just literally, they don’t have anything going on tax-wise, it can be really good because you get the money out and then you never pay taxes on it.
Again, you pay taxes on it at a zero, 10% rate, or maybe a 5% average rate or something like that. Or go up to 12 and, and sometimes I’ll do that. And I’ve been known to do conversions where somebody is in a 22% just simply because I look at the scenario and go, wow. You know, based on what’s going on in their financial life, there’s going to be a lot of income down the road and that income’s going to drive them into a higher bracket likely. And you never know because the government could change tax laws. I mean, that’s one of the things that you just don’t really know, but you look around and you go, Hey, you know what? There is a lot of spending going on Washington. You know, they may be looking for other sources, revenue, but you know, people think automatically income taxes.
You know, when you think about they’re going to be raising taxes to raise revenue, well, there is a lot of other stuff that they can do. I almost don’t want to give any ideas, but there are things that man, it would be awful taking way charitable deductions for some people. There was always actually helping a financial advisor last night and he emailed me. He goes, man, I got this thing. I’ve got coming up. I got a meeting. And, and I don’t know why, I didn’t think talking to you before, but you know, I just, I want to know what your opinion on it was. This lady has five stocks and is literally sitting on five stocks with a ton of built-up gains.
What to Do with Built-Up Gains
I mean, unbelievably built-up gains. And you know what, she’s older what would you do? And I said, well she could lose all of it. Number one the prices on the stock, she held were super, super high compared to book value, not overpriced, but you know, because you don’t know when a stock is overpriced, there’s just no way to know. You know, there are sometimes telltale signs that make it look like it. This thing is not necessarily a bargain on the table, waiting for somebody to pick it up. But you know, stock prices, it’s hard to tell when something’s going to drop.
You know? So you just don’t know. But back to what happened in this particular situation is he had all of these gains. What do I do? And I said, well the situation is you could have capital gains tax, that whole thing where you get a step up in basis where you don’t have to pay taxes on gains after a person passes. And if you inherit their stock, that could go away. I mean, that’s another place that they could raise taxes. They could raise taxes on in there. You know, there’s talk about just raising regular rates, just on people in higher income ranges. You could actually raise the capital gains tax rate itself. That’s something that’s being talked about. You could take away you have a situation where they go and say, well these people that own rental property, they’re able to appreciate it.
Well, why should you be able to depreciate an appreciating asset? Now let’s go take that away. So all kinds of things like that could go on. So knowing whether tax rates are going to go up, it’s hard to know because there are so many different areas that can be changed in order to we could go and lower the income tax rates and do an assumption tax having nationals sales tax or something like that and sell it under the idea that there are a lot of people out there that are doing contracting work that are hiding their income. And they’re actually hurting themselves because they’re not declaring income and paying social security taxes on it. And therefore they don’t get the social security benefits yet.
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Required Minimum Distribution
You know what I mean? There are a lot of things that can happen Jill, when it comes to that. So number one what, what are we looking at as far as converting a Roth after the age that you started your required minimum distribution. Well, when you do this, you have to do your required minimum distribution and you have to take the distribution for the conversion on top of that. Yeah. Well, so not only do you not avoid that tax because you know, some of you might be, let’s say 65 years old, let’s say, let’s go back to that and you might go and say, well, I’m going to have to pull money out of my IRA when I reach 70.
And that’s going to create a lot of taxable income that I can avoid and I can do qualified, charitable distribution and save some that’s you have the check made out directly to the charity and then you don’t have to go and do you can actually get your charitable deduction back. It’s kind of a way to get your charitable deduction back because if you’re doing a standard deduction, you lose that. But you know, here’s the situation I’m going to have to pull the money out at age 72. And boy, what if I could just go and voluntarily pull some money out at age 65, pay a little bit of taxes now live off of my savings account or my non-qualified, my taxable brokerage account, or maybe reverse mortgage money or whatever.
I mean, you can pull think of different sources of income or if you’re living off work income, that’s taxable too. So that may actually defeat the purpose. So this is, I’m giving an example. If you’re not working at age 65, they’re going to be ideal ways to have literally be in a super, super low tax, next to nothing because you’re living on money that’s already been taxed. You know, if I’m living off of money that was in my savings account. Well, my money and my savings account were already taxed. You know, if it’s not an IRA, hopefully it’s not an IRA. You don’t want to put your IRA in a savings account. In very many situations, there are some exceptions, but you don’t typically want to do that because you have no protection against inflation whatsoever.
But if it’s a non-qualified, meaning after-tax savings account, that can make sense. You know, so you can live off of that. Well, what’s, the tax rate was zero. So I can go in, if I’m married, filing jointly, take $25,000. If I have no other income, any place else, and the 0% tax rate on my IRA, stick it in a Roth, and then it’ll never be taxed. And then when I get to the point where I’m taking required distributions, that’s my account is that much smaller. My taxable IRA is that much smaller. And therefore I can reduce taxes that way. So that’s not the situation here that you’re already taking, required distribution that you see. So that is not necessarily going to be terribly helpful.
What If the Kids Are in a Higher Tax Bracket?
And Jill, you’re making a good point. You say, well, my kids are in a higher tax bracket than I am. And they inherited it may be an issue, but here’s what you got to actually calculate because the tax law changed on that too used to be that you can, this is another way that the government kind of sneaks taxes in on us. If you think about it used to be that you could stretch as they called it, your IRA out over the kid’s life expectancy so you’re you get a kid 40 years old, 50 years old that inherits your IRA. And you know, the distribution amount may be 3% or something like that so it’s very, very low and they stretched it out over their life expectancy.
Now it works a little different than what, it, it works a little different from what it does for you, with your required distributions in that it’s your life expectancy is recalculated every single year. And you know, what happens is it goes up more gradually with kids when they inherited it. They would. They look at your life expectancy and say, well, it’s 30 years. So they take your account value divided by three by 30, and then you get about three little bit over three is your distribution. And then they divide it by 29, the next year. And by 28 and 27 and each year that you’re alive, they divide it by a smaller number.
They take one year away and eventually it gets down to one, right? So you have to distribute the entire account, but now they say, Oh, no, we’re going to do it over 10 years. You know? And there are some limited exceptions if you’ve got a child inheriting the account and you know, they can delay those distributions a little bit, but for the most part, you’re looking at going, Oh my goodness. You know, and that, if my kids inherited, not only could they be in a higher tax bracket because of the fact that it’s got to be pulled out all in a 10-year-period for most of them. All right.
Taxes and Tax Rates
So that is a that’s one of those things, you look at it and go, okay, so what’s my tax rate. If I pull it out now converted to a Roth and you know, what’s the tax rate. If I actually go and give it to what, what’s, they’re going to tax rate. If I give it to the kids after I pass away, you know? So those, one of those things that you have to look at, so you know, the RMDs and, and you’re talking about paying those taxes on the conversion of the Roth IRA from your required minimum distributions. Well, that’s taxable too. So you’re it defeats the purpose where you do tend to pay taxes on Roth IRA conversions, which is kind of a fun way of doing it is you go, well, I’m going to convert a hundred thousand dollars of my IRA to a Roth IRA, let’s say, and let’s say that I figured out my tax rate’s going to be, I’m going to have to pay 10% of the value of it in taxes.
Let’s just use that as a nice round number. So I’m going to pay $10,000 in taxes. And then what I do is I go, well, I take the whole a hundred thousand, I put it into the IRA. And then I take the 10,000 that has to be paid in taxes. And I go, well, okay, I’m going to pay that tax with money. That’s in my savings account. Well, if you think about it, what have I done instead of taking a hundred thousand in my IRA, pulling it out, pay taxes, $10,000, putting $90,000 into my Roth, and then paying the $10,000 to the government. I pay a hundred into the Roth. I put a hundred in there and all of the hundred goes in. And then what happens is the $10 that has to be owed in taxes, gets paid from a non-qualified account.
And it’s kinda like a way of sneaking extra money into a Roth IRA. You see? So that’s how that works. So to be really super, super definitive, I’d want to do planning in this particular instance and just see what the tax situation is and what the possible future things are that are going on in your financial situation, Jill. But I appreciate the question, good stuff right there. And maybe that helped a couple other people out along the way because as you see, I’m going to get in a lot more detail on things you may not necessarily think about. And it may be, as you’re listening to these questions, being answered, it answers a question that actually is directly affecting you.
Taxable Income
The other thing you have to think about regarding this is conversions to Roths and doing these types of transitions creates taxable income, but it also creates what’s called a tax torpedo in some circumstances, and in English, what that means is that tax repeater is where you have some kind of a tax that just creeps up because of something else you did. You know? So it’s commonly with distributions, from IRAs, where it triggers taxation of social security, where it wasn’t being taxed before, because basically, they take your provisional income, you have your income plus half your social security, and then they determine, okay, do you have to now pay taxes on what was formerly a tax-free benefit, which is social security for some people, for many people.
So last I looked, it was like 70% of people get social security and they don’t pay taxes on it. And then you got 15% of people they’re going to pay taxes, no matter what they do. And the other 15% can actually do things to control some of the taxations. You know, those numbers are probably slightly higher now, but then, then when I saw the statistic a couple of years ago, but anyway, so that’s one of the things you have to think about. And then you also have to think about, well, Medicare premium taxes that Medicare taxes and the premiums and things like that. So surcharges on other things so you have to look at how this income actually affects other things. Okay. Thanks for the question, Jill.
And this is The Investor Coaching Show. I’m Paul Winkler talking about the world of money and investing.
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