Don't Believe This Roth Conversion Myth! (Bad Logic)

Timestamps:
0:00 All Too Common Conversion Myth
0:25 What is this Myth?
2:47 Comparing a Roth Conversion to Withdrawal
3:44 Why is the Taxable Account the Preferred Method?
7:22 Roth Conversion Case Study (No Taxable Account)

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Always remember, "You Don't Need More Money; You Need a Better Plan"

[QuigleyMarc]

My portfolio doesn’t just cater to dividend stocks. I hold $VFIAX (S&P 500 index fund) in my Roth IRA and $VTI (Total Stock Market ETF) in my taxable brokerage account. Two of my largest holdings. The individual dividend stock positions all complement the index holdings.

[markbernhardt]

Very important to consider this especially when the stock market crashes. A roth conversion at the bottom has a massive benefit in the long run.

[PragmaticPragmatic]

I retired 18 months ago. Have been doing Roth conversions since then, maximizing the 22% bracket. Yes it is hard writing that tax check each year (for the conversion and the taxes on the conversion) but it should pay-off once I start collecting SS in 5 years and 60% of my IRA has been converted to Roth.

[chumbawumba]

This is so true! Glad you did this video. As example, I have done several Roth conversions starting in 2022 and continuing thru 2024 and will do same in 2025, filling up the 22% bucket. In each case (including 2022) I have made more in growth within these conversion accounts than the conversion tax liability was in the year of the conversion. In all of the years, I was able to pay the tax liability from the Roth account (always making the Roth conversion in January of the year, and always paying the tax liability in December from the Roth account "principal"). Basically, in these cases, the Roth conversion paid for the tax liability itself. I ended each year with (at least) the same balance in each Roth account as I converted in January. Of course, this is highly influenced on how the Roth account is invested.

[jeanjasinczuk]

A point that is missing from most Roth conversion video or talks, including that video, is at what age is the breaking even point of a Roth conversion? Roth conversion are based on optimizing the total value of the accounts during the whole retirement. While this looks like a great goal, it might also mean not doing things one want to do early in retirement to get more money much later, when one cannot enjoy it. In other words, is the retiree the real beneficiary of the Roth conversion, or are his heirs the mains beneficiaries? There no single answer, it depends... But at least everyone should be aware of that.

[jamesleonard]

Couple of items people forget on conversions. If you lower your income enough, you can eliminate the taxes on your SS, which would really speed up your break even time line. Your income also affects your healthcare cost, bigtime prior to age 65 and even after 65 it can affect how much you pay for Medicare. I just did a large conversion this year, which is going to save me 24K a year on healthcare for the next 9 years till I turn 65, because the ACA premiums are based on income.

[IfranReinfeld]

I'm 54 and my wife and I are VERY worried about our future, gas and food prices rising daily. We have had our savings dwindle with the cost of living into the stratosphere, and we are finding it impossible to replace them. We can get by, but can't seem to get ahead. My condolences to anyone retiring in this crisis, 30 years nonstop just for a crooked system to take all you worked for.

[mikespangler]

It all depends on the tax rate you are in now, the rate you will be in if you do the conversion, and the future tax rate you expect to pay if you leave the money in the IRA until RMDs start. If you define those three numbers you can figure out the best path.

[delawariand]

I have watched so many roth conversion videos and this is the only one that actually explains how to determine if the strategy actually works. Its about comparing the tax rate at withdrawals and at conversion.

[NeilCarlsonNM]

Paying the conversion tax out of a taxable account effectively shifts dollars from the taxable account to the Roth account where it can grow tax free (with the amount shifted equal to the tax). I view this as a kind of "backdoor" way of making a Roth contribution when I no longer have earned income to make an actual contribution.

[tdkendall]

Thanks. My sit exactly. For a IRA > 1M you need a VERY large taxable account to pay the large tax bill. Who has that kind of money on the side? I dont.

[leemcfarland]

Been retired 6 years since I turned 55. Been doing small conversions and paying taxes from the Roth every year. Wish I did much larger conversions. Want to get most of it converted by 63 to avoid higher medicare premiums and the torpedo tax.

[paulschaaf]

The main reason I'm probably going to convert is to avoid RMDs. I want control over how much I take out. I don't want to be forced to take out more than that.

[jamesallen]

These discussions tend to just compare tax rates of a person at the time of Roth conversion vs tax percent that would be paid when the RMD would otherwise come due... but there is far less discussed about the benefit that all remaining compounding of earnings becomes tax free once the money goes into the Roth account, which seems possibly the bigger benefit. The longer the converted money is in the Roth account, the more beneficial this strategy will become, since the money may actually multiply in value. So for example, if you pay tax on $20K when you convert to Roth, vs at retirement when you need the money or take an RMD, it may be paying tax on $40K, $60K or ? depending on time and growth rate. Even taking the money out and putting it in a taxable account may have some benefit, because you will pay full earned income rates on all before tax IRA funds as an RMD (or anytime out of the IRA).... but if you take the $20K out and pay the 22%, 24%, etc tax on the $20K today, then remaining earnings are Long Term Capital gains, and if those funds grow to $60K in the taxable account, but most people will pay 15% on the additional $40K of earnings, rather than 22%, 24% (or whatever) earned income rate bracket you are at - of course again this depends somewhat on your relative tax brackets when you convert or when you use the money. If your retirement income is low enough, this strategy will not be as beneficial. But I think this point is that pre-tax IRA investments are probably over-sold as a sole retirement investing strategy. It would generally be better to have a mix of investment types - taxable, pre-tax and Roth, and possibly tap a mix of all 3 types each year as a retiree, with the ability to adjust the percent of each that you take out, to somewhat control tax rates if you truly want to minimize over-all lifetime tax paid... of course no method can be made 100% perfect because we can't forecast every possibility of our future (longevity, earnings rates, medical/unusual expenses, future tax rates), but I believe this would produce over-all better results (lower lifetime tax paid). Also, controlling what types of assets you put in each type of investment would help - don't just put the same risk balance of stocks, bonds, and cash in each investment type - lean toward bonds in pre-tax IRA/401K (whose interest/dividend income earnings will be paid as earned income rates in any case), and stocks and more speculative, higher earning investments in Roth, and remaining investment types that make up your over-all preferred stock bond cash risk adjusted mix, in your standard taxable brokerage and bank accounts. So keep more of the capital gain investments in the Roth or standard brokerage accounts if possible because for most people they can take advantage of the tax at a lower 15%, rather than full earned income rates, (and any tax exempt investments, like muni bonds, in your taxable brokerage account for sure - otherwise your tax exempt earnings would be taxed), while if you have stock/capital gains funds in a pre-tax IRA/401K you're going to pay earned income rates on the capital gains when you finally withdraw the funds from the IRA/401K. That's my take. My apologies to those who know this already, but I know, I wish I had taken the time to figure this out earlier or that the brokerage advisor would have pointed this out in helping clients manage taxes more efficiently, to reduce lifetime tax cost. Note that for most people, it is not beneficial to put all of your investments into Roth (and gives less options during your working years), so that in retirement you only have Roth funds, because due to deductions and the tax brackets, it is generally going to be better to have a mix of fund sources to draw from so you take full advantage of filling the standard deduction and low 10% or 12% brackets, maybe higher. The goal should be to have a more consistent annual tax rate through your lifetime as possible, thru working and retirement years, which will reduce your lifetime tax payments, rather than trying to pay all tax during working years and have only Roth funds in retirement or paying none of your retirement taxes by using exclusively pre-tax IRA investments because either of these approaches will likely cause higher lifetime taxes, by pushing too much taxable income before or after retirement rather than smoothing it out thru your lifetime. Also note that if you have significant (deductible amounts of medical or nursing expenses) you may be able to off-set taxes for funds you take from your IRA to pay these bills - another reason for not having only tax free income in retirement. ---- Sorry I just got on a roll --- probably too much info But perhaps something here could also provide points to discuss with an investment / brokerage or tax advisor.

[danielhurst]

You have to be aware that if you try this under the age of 59.5 that the taxable amount counts as a distribution from your qualified account and you have to pay a 10% withdraw penalty of those funds. This catches the unaware all the time.

[sscalercourtney]

Everyone is different. I am in the 12% tax bracket in retirement. I'm richer in assets than income. I still have over 21 years to spread out the money I have to take RMD's. So at my late age, I could be wrong, but why take a Roth now at 22% or more tax rate rather than paying 12% a year on small RMD's? Now if I was young and just starting out, I can see a Roth making more sense. But 12% tax bracket over nearly 30 years isn't bad and converting to a Roth I lose the money back in taxes from my regular IRA and the growth of the taxes I'd pay doing an Roth. Losing the growth of the money you lose in paying Roth taxes is rarely mentioned.
I did plow the money I save in federal income taxes doing the maximum of regular IRA contributions when I could. That gave me an immediate 12% return, non-compounding, for the 30 years or so I did regular IRA contributions.
Again, I have a son, 28 who is doing a Roth. His situation is different from mine because of age.

[robannmateja]

You hit the nail on the head (for me) when you said that the value of the conversion is determined by the tax rate that you pay today, vs what you would pay in the future. Right now, MFJ, with both of us drawing a good social security benefits and pensions. But we have to plan for the day when RMDs become a reality, or sadly, one of us passes on. The IRMAA threshold for single filers is not very forgiving. Also, the tax brackets are less forgiving for single people. And who knows what will happen with taxes in the future.

[innocuous_name]

One other important thing that makes using a taxable account to pay is annual contribution limits. Once taken out, you can't get those years of contribution back and can't catch back up.

[ld]

Hi Eric. Great video and discussion on this topic that can be so confusing. Hopefully this will clear things up for your viewers, I suspect it will. Have a great weekend and keep up the useful content. Thanks Eric. Larry, Central Valley, Ca.

[tajdvl-advocate]

Paying from a taxable account can reduce marginal income tax from investment income in that account so that more can grow in a Roth account, tax free. But beware. If you are 63, the conversion will increase your MAGI for the conversion year and may put you into a higher Medicare part B bracket 2 years later. Also, remember the taxes owed on the conversion are calculated at your marginal tax bracket and the conversion push some of the conversion income into a higher tax bracket the year of the conversion. Also remember that total income for any given year is paid at your average tax rate and a marginal tax rate is always higher than an average tax rate.