Roth IRA Conversion Strategy: Timing, Taxes & Estate Planning Benefits

Today we’re going to be talking about Roth conversions, a strategy where investors may choose to pay tax early as a way to get more dollars into Roth accounts and reduce their future tax liabilities.

My name is Gina DiGirolamo. I’m here with Robert Steinberg, the founder and CEO of blue Chip partners. Robert, thanks for joining me today. Thanks for having me on, Gina. Absolutely. So as I mentioned, Robert, we’re talking about Roth conversions. Let’s just take a step back and zoom out. Why might someone want to accelerate the taxes that they owe?

Because they like the IRS, or at least perhaps a few people do. The way I view a Roth IRA is simply as an investment account. Protected by a force field which keeps the IRS out. So once the money is in a Roth IRA, capital gains appreciation are not subject to any more income tax. So the idea is to get more money in that force field sooner.

And that’s why they would want to pay the tax.

So the force fields analogy sounds great. But how do you actually get money into a Roth IRA?

There’s basically three ways you can get money into a Roth IRA. First is subject to income limitations, where you make a direct contribution to a Roth IRA. The second is through company 401 K plans. Most plans now allow for Roth type contributions. In those circumstances, you don’t get the tax deduction, but you immediately get your money into the Roth.

The third way, which really is the focus of our discussion today, is converting money that’s already in a traditional IRA to a Roth IRA.

So the first two ways that you talked about contributing to a Roth IRA are all about contributions. The third way is a strategy. So when we’re talking about a Roth conversion strategy, how does that actually work?

How does someone do it? Yeah.

Basically, with a Roth conversion, you’re raising your hand today and saying, I want to pay tax today, which is kind of backwards to how we’ve been trained, where I’ve always been trained.

Deferred tax, deferred tax, deferred tax. But in reality, what we’re trying to do is get as much money in that protected environment where all future growth is tax free. Absolutely.

And as you mentioned, this isn’t something that you necessarily want to make a decision on today and just do over and over again forever. We can’t just set it and forget it.

This is a strategic move that we have to think about the timing of very closely. So talk a little bit about that timing. When might someone want to do a Roth conversion. Yeah.

Not very very well put. Because you know Roth decisions are made each year. That kind of the sweet spot of where we normally see Roth conversions or the most Roth conversions has to do between the time somebody retires and when they’re taking their required minimum distributions.

Somebody retires at 65. They’re required. Minimum distributions may not be until 75. So there could be a ten year window where they’re going to be in a very low income tax bracket where it may make sense to consider conversions.

So investors probably haven’t been used to this last couple of years, but there are years when we have market downturns.

How might someone be strategic during that time and do Roth conversions when there’s some volatility in the market? Yeah. You know, very, very good question. Because we know we’ve kind of been spoiled lately and hopefully we continue to be spoiled. But the idea of when markets go down, we still have the same amount of shares of the individual companies we own.

We just choose to convert them at a lower price. So in essence, when we’re doing that conversion, we’re having to pay less tax but converting the same number of shares. So hopefully over time markets return they go back up. So we’ve been able to basically pay our taxes on sale.

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So taking just a half step back, we mentioned the timing might be right during the low income years early in retirement. The timing might be right to do Roth conversions during market volatility or a down a year of a downturn. And there’s a third way where it can become very important for estate planning purposes. Getting more dollars in a Roth IRA.

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So talk a little bit about that.

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Under current tax law, the way traditional IRAs work currently is, you have to take the full balance. If your child out within ten years of the death of the survivor of your parents. And so so oftentimes with these large IRA balances having to take money out over ten years can create a significant tax liability. The idea of getting those assets into a Roth before somebody passes allows for ten additional years of tax free compounding.

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So not only are you allowed to have that money in the force field while you’re alive, but your children are able to have it for ten additional years. So it’s simple. If you made 7%, that amount of money that passed when you died would double approximately to when they would have to take it out under current IRS rules.

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So this sounds like a great strategy. Maybe everyone should be doing it right, but there’s probably some reasons not to or where it doesn’t make sense. So why might someone not want to do this? Yeah.

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The first thing is, if you don’t have the cash outside of your Roth IRA to cover the taxes, then the strategy becomes much less attractive.

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So what we really need to do is you need to have some independent funds that are not in retirement accounts that you can use to pay the taxes. The other circumstance can be, depending on your current tax bracket versus your projected future tax bracket. So if you’re in a high bracket today and then you’re going to retire and be an extremely low bracket, you may not want to do a conversion until after retirement.

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this is something that has to be reviewed every single year. It’s not a strategy that you can set it and forget it and convert the same amount annually.

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It’s also important to not just note the tax rates but the Medicare premiums. So talk a little bit about how that might affect

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it. Yeah. This is one of the overlooked portions of doing a Roth conversion from our end and helping people. Sometimes we find that people may fixate a little bit too much on their Medicare premiums going up, but Medicare premiums are based on your overall income amounts.

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And as we do Roth conversions, we may move people and do a slightly higher Medicare premium amount. The the benefit of doing that may be thousands, hundreds of thousand dollars of additional money for heirs, but it is certainly something that needs to be looked at and communicated. So people are making informed decisions. But the idea is a lot of times it still makes sense to pay slightly more Medicare tax because of the long term benefit of the Roth conversions.

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You just you need to be aware of it.

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in exactly what you said.

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It’s important to work with a financial professional in order to weigh those options and make those decisions.

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Yes, because each each year is a different calculation. You never know what happens in a particular tax year. And so the idea of being able to model different scenarios and look at how they may impact the future of your financial net worth is critical to the whole Roth conversion strategy.

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to tie a bow on this. What is one thing for someone listening that they should focus on or take away from this,

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that when it comes to taxation of retirement accounts, you’re in control of the timing of when the tax occurs.

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So. So this whole Roth conversion discussion really, really revolves around the strategy of when does it make sense to pay the taxes. And oftentimes paying taxes early will result in much more money for you and your heirs.

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As we mentioned this is a strategy that needs to be reviewed again and again. It can be very customized to the individual person. So if it’s something that you want to see if it fits in your financial plan, reach out to our team at blue Chip partners. We’d be happy to help. And thank you so much for chatting with me today, Robert.

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Thanks for having me on, Gina, and thanks for watching. Can’t wait to chat again soon.