Impact of Portfolio Return on Your Roth Conversion Strategy (Surprising)

Timestamps:
0:00 How Much Does Growth Rate Affect Roth Conversions?
0:13 The Main Catalyst For Roth Conversions
1:19 Why You Will Have an Increasing RMD...
2:30 The Wide Dispersion of Portfolio Returns
4:02 Case Study: Benchmark Example
6:17 RMD Growth in a "Normal" Environment
7:57 RMD Growth in Higher/Lower Return Environments
8:40 Optimal Roth Conversion Strategy Based on Growth Rate
11:19 Additional Context: Does Portfolio Return Matter?

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

[RetrieverTrainingAlone]

Excellent! We are 5-years off from huge RMDs starting at age 73. We are using our inheritance to pay for Roth Conversions and our tax bracket increases from 12 to 22 percent in the next 5 years. Our parents all passed in their mid-90s and mom at 102, so we expect a long investment time.
Another advantage is tax free to heirs from Roth IRA.

[ralphparker]

Did you talk about the advantage of Roth in that you can manage which bracket you max out. For instance, Say I need to max out the 12% bracket just for normal living expenses. But a need for a new roof comes up and if I pulled that money from the regular account cap gain gets thrown into the 15% bracket for from the regular IRA, which gets taxed at 22%. But then having funds in a Roth, I can withdraw that and not have any additional tax consequences. And this was incrementally funded thru optimum Roth conversions for that 5 to 10 Year period when my tax rates were lower.

[randolphh]

Great video!

Your last chart brings up the most important point for those already retired.
Over converting causes you to lose money! Under converting cause you to pay more tax.

What many forget, is that with average portfolios, relying on an high annual ROR to come out ahead increases the risk of a conversion, which of course is done early. That causes your portfolio value to drop, in a poor return environment that would mean less gains over the subsequent years. The person that didn’t convert as much will have more gains that maythen be taxed at a lower rate than if they had been aggressive with the conversion.

For large portfolios with excess funds, this risk is not as consequential.

On the flip side if I have a just large enough portfolio, that ends up with a very good ROR, then yes I pay more in taxes, but I also have more money to pay them, so it won’t impact my cash flow. Cash flow always needs to be the first consideration, ultimate total taxes paid should be the second consideration.

[Paul-GrnHil]

First let me start by saying Roth conversions early in retirement while living off taxable accounts and before collecting social security is an absolute priority. As for the remaining IRA or rollover 401k accounts, they are going to be taxed no matter what, the only question is when. Whether an RMD or a voluntary Roth conversion, the taxes are the same.
I do not consider RMDs to be a tax problem if you consider the tax liability holistically. If your retirement accounts are generating RMDs in excess of your living need then you should be thinking about estate planning rather than just retirement income. The taxes you pay today at your retiree rate are likely to be less than the rate your heirs are going to pay when they have to distribute the inherited IRA during what is likely are their highest employment income years. BTW, if you have the “problem” that your RMD requires you to recognize income you don’t need for daily living, you can always fund your grandkid’s 529 accounts and avoid taxes on the account growth and even have the opportunity to convert the unused portion of their 529 for their starter Roth account.

[joycewright]

Last year when the market was down every time there was a huge drop I hurriedly did some Roth conversions. Now that the market is back up the profits in my Roth have more than covered what I paid in taxes.(taxes were not paid from the conversions)

[montesarache]

In 2024 the ordinary income cap for the 22% bracket is $201, 050 and for the 24% bracket is $383, 900. Those advocating going into the next tax bracket when doing Roth conversions should keep in mind that once your adjusted gross income hits 250K you become subject to the Net Investment Income Tax (NIIT) which is another 3.8% of the portion of your income over the 250K or on long term capital gains, whichever is smaller. So it is not just going from 22% to 24% but could be from 22% to 27.8%, which is not insignificant. Not enough folk bring this up in videos ( a pet peeve) and so this is just a friendly reminder.

Overall, it was great to see that our strategy meshes well with Safeguard's. Nice video! Thank you!

[ericgold]

Nice presentation! The main element I find missing is a consideration of locating fixed income in the pre-tax account and stocks in the Roth. This has the salutatory effect of mitigating the effect of the overall growth rate (GR).

I'm starting out with about $5M in my tIRA. I'll convert about $2M to Roth by RMD age. The tIRA balance will continue to grow, but at a GR lower than a 60:40 stocks to bonds allocation implies because the Bond fraction will be higher than 40% in the tIRA

[BillMaass]

If I am the client shown, I will opt to fill the 24% bracket in 2024-2025. Annual reassessment might convince me to only fill the 15% bracket in 2026-2028 if TCJA sunsets. Since investment returns will inevitably fluctuate, one needs to consider taking advantage of a down market if we see a repeat of some short term correction/crash that occurred in say 2008-2009, early 2020, or even 2022.

[PH-dmew]

One fact that never gets discussed is the step up value of stocks in the brokerage account for beneficiaries. So reinvesting those RMD's help the beneficiaries in the end, if you cannot convert those funds to a ROTH, all is not lost.

[lidarman]

I guess what I am missing here is what is the 25% tax bracket? Doesn't the next bracket after 24% go to 32%? And there also is no 28% bracket. However 25% and 28% were before 2018 but there was not a 24% bracket. I'm lost.

[edsteadham]

Retirement planning is simple. Step one, determine date of death. Step two, calculate portfolio return over several decades. Step three, determine tax policy today, tomorrow and decades into the future. Step four, account for unknown, unpredictable health care expenses. Step five. Place large bet on the next 10 Super Bowl, World Series, NBA champions and hit on all of them. Retirement solved!

[Bondbeer]

I would rather be in the 28% bracket during RMDs than pay 22% today. Why? Because I won’t pay 28% on all income. I will take advantage of the inflation adjustments to the standard deduction and lower tax brackets so the “average” tax rate will be less than 22% and that assumes the rates revert in 2026 which is not likely.

[jefflloyd]

Always good Eric - thanks. But what if the market tanks 40 % early in retirement, for a couple years, convert into a much higher tax bracket? A good 'hedge' against a downturn?
Cheers

[slimdawgwoof]

You are the GOAT!!!! Another great one!

[jamesmorris]

Your final point, is the most salient, to me; especially since I live in COMMIEfornia. I'm already in the 22% bracket, Federal, and 9.3% State..as a RETIREE, and I haven't even begun to to take 401K distributions, yet! The overwhelming majority of my retirement assets, are in traditional 401K, roughly 90%. It would be JUST MY LUCK..that I would spend a zillion dollars on roth-conversions..and then 1929 would happen, ALL OVER; AGAIN!

[Bondbeer]

What about negative returns? I would rather pay more tax later in retirement if the reason is growth was more than projected vs converting and paying tax today at my highest marginal tax rate and risk a market decline after paying tax on the higher balance. Remember the older you are the less risk of a declining market (since you have less years left for your money to cover).

[paulsackles]

Great work Eric. Your clearly passionate about this topic and with that brings so much clarity to the table; it’s complex for sure.

[Bondbeer]

I like your videos. Everything else being equal, I am ok paying more tax if the reason is growth is higher than expected.

[byronmill]

I've watched quite a few of your videos and and very impressed by the quality of the information and the visuals. Are the charts and graphs that you are showing in the various videos actually used with your clients to communicate the variables and the optionals strategies or are they only used here in the videos for illustration purposes?

[danms]

How should a person account for state income tax? Does the 22% federal tax bracket still make make sense or should that be lowered by the amount of state tax?