Should You Stop Roth Conversions at the 22% Tax Bracket?

0:00If you're concerned that higher tax rates in the future could take a bigger bite out of your retirement than you ever expected, now may be the time for a second opinion. At davidmagnite.com, you can schedule a complimentary strategy session with a power of zero advisor who's been traded, vetted, and qualified personally by me. These are advisors who understand how to help you build more tax-efficient retirement income and move you as close to the 0% tax bracket as possible. Visit davidmagnite.com to schedule your complimentary strategy session today. Now, enjoy the podcast. This is why I've always advocated what I call the rip the bandaid off approach to Roth conversions. I'd rather endure several painful tax years while I still have some control over the timing and the amount of the tax, then preserve my IRA simply because I'm afraid of Irma, only to have that IRA continue compounding until RMDs eventually force the money onto my tax return, whether I want it there or not. A tax freight train is bearing down on your retirement.

1:00To protect yourself, you'll have to harness the power of zero. I recently did a video where I talked about why I believe the 24% tax bracket is the sweet spot in the current tax code for Roth conversions. And I got some pushback from a viewer who laid out a pretty detailed case for why he believes it makes sense to stop at the 22% bracket. So I want to dispense some time responding to his comment because unlike a lot of comments you see on YouTube, he's actually done the math and understands the importance of calculating the all-in costs of a Roth conversion before setting it in motion. Here's what he said. Hey, good reason to stop at 22% or the Ancillary Cost Association with going to 24%. Using round numbers of a $200,000 conversion to the top of the 24% bracket will cost me a whopping 33% more tax versus 22%. That includes 24% fed, 6% state, 4.62% tier, 3.

2:01Ermiser charge, 1.9% for NIT on $100,000 of investment income, and 0.72% for phase out of the remaining senior bonus deduction for a total of 37.24%, compared to 28% and the 22% bracket. Now, I really appreciate this comment because these are exactly the kinds of things you should be considering when you're trying to figure out how much you should convert in any particular year. Where I disagree with him is the conclusion he draws from it because what he's really doing is optimizing his tax bill in the year of the conversion, whereas what I'm trying to do with a Roth conversion strategy is optimize your tax bill over the balance of your lifetime. I'm trying to increase it likely that your retirement estate will last as long as you do. And those two different goals can lead you in two entirely different directions. Here's an example. Close your married and you've accumulated $2 million in your IRA and let's assume that over time that portfolio averages an 8% return. Obviously, you're not going to get 8% every year, but for purposes of illustrating the

3:02problem, that means the account is growing by about $160,000 per year. Now let's assume that you need $100,000 after tax every year just to maintain your lifestyle. You're going to have to take substantially more than $100,000 out of that IRA and order to net $100,000 after federal and state taxes, which means a meaningful portion of your lower tax brackets is already being consumed before you've converted a single dollar. So maybe depending on your exact circumstances, you have $70,000 or $80,000 of room left in the 22% bracket for a Roth conversion. Well, think about what that means. If your IRA is growing by $160,000 per year and you're converting $80,000 per year, you're not actually shrinking the tax deferred portion of your portfolio. In fact, you're not even keeping pace with the growth. You're executing a Roth conversion strategy year after year while the amount of money exposed to future taxation continues to grow and compound over time. And that's one of my biggest problems with the idea that you should categorically stop

4:02at 22%. Depending on the size of your IRA, the amount you're spending every year, your expected rate of return and how many years you have before R&Ds begin, you may simply not have enough space in the 22% bracket to get any meaningful amount of converting done. If we believe there's a reason we'll likely have the tax rates will be higher in the future than they are today. And based on the trajectory of the national debt, that's a safe assumption, then staying religiously within the 22% bracket could result. And you arrive in at R&D age with an IRA that's just as large as it was when you started if not larger. In other words, you haven't really moved the money off the train tracks. The tax freight train is still bearing down on a considerable portion of your retirement savings. Now, let's talk about some of the additional costs he mentions because I don't want to dismiss them. He includes another 1.9% for the net investment income tax because he apparently has about $100,000 of investment income that becomes exposed to the NIIT as his income rises. That's certainly something he should take into consideration, but it's important to understand

5:04that a Roth conversion itself is not subject to the net investment income tax. What can happen is that the conversion increases your modified adjusted gross income enough that other investment income capital gains, dividends, interest rental income, and so forth becomes subject to the 3.8% NIIT. So in his particular situation, that could absolutely be a cost associated with doing the conversion, but I wouldn't extrapolate that to the typical retiree I encounter because most of the people I deal with don't have $100,000 per year of taxable investment income coming out of a brokerage account. The lion's share of their retirement savings tends to be sitting in IRAs and 401Ks, and they're generally taking distributions from those accounts to support their lifestyle. So if the NIIT applies to you, absolutely included in your calculation, but I don't think it's a particularly compelling reason for most people to avoid the 24% bracket. Then we have Irma, and this is probably the strongest part of his argument because Irma is a very real cost of doing large Roth conversions.

6:06If you're dramatically increase your modified adjusted gross income through Roth conversions, you can absolutely push yourself into a higher Medicare premium tier two years down the road, and depending on how aggressively you're converting, that can amount to thousands of dollars of additional Medicare premiums. The question, however, is whether avoiding those additional premiums today ultimately saves you money over the balance of your retirement? If I can spend several thousand dollars more on Medicare premiums for a couple of years, while I'm aggressively converting my IRA, but in the process, I dramatically reduce my future RMDs, reduce the taxation of my social security, reduce the likelihood that I'll be subject to Irma later in retirement and get myself into a position where I'm living primarily out of tax-free accounts, then paying Irma temporarily may actually be the less expensive option. This is why I've always advocated what I call the RIP the Band-Aid Off approach to Roth conversions. I'd rather endure several painful tax years while I still have some control over the timing and the amount of the tax, then preserve my IRA simply because I'm afraid of Irma,

7:09only to have that IRA continue compounding until RMDs eventually force the money onto my tax return, whether I want it there or not. Then he brings up the phase out of the new senior bonus deduction, and once again, that's a legitimate consideration. If your Roth conversions cause you to lose some or all of that deduction, that's an additional marginal cost to converting. But the senior bonus deduction is currently scheduled to disappear after 2028, whereas the consequences of leaving a large amount of money in an IRA could follow you for the next 20 or 30 years. So I'm certainly going to include the loss of that deduction in my calculation through 2028, but I'm not going to allow a temporary tax deduction to dictate a Roth conversion strategy that has implications for my entire retirement. This brings me to what I think is the biggest problem with the entire argument, which is that we spend all this time calculating what it costs to convert the money today without asking the equally important question of what it's going to cost if we don't convert it. If you're telling me that you're true all in marginal cost of converting a dollar today is 37%, and you can demonstrate that you'll be able to withdraw that same dollar later

8:11at 28%, and they agree with you, you probably shouldn't convert that dollar. But that's not usually the choice we're making. The choice may be between paying a somewhat painful tax rate today, or allowing that money to compound inside the IRA for another 10 or 15 years, at which point you're dealing with larger RMDs, potentially higher tax rates, more taxation of social security, potentially more Irma, and eventually the death of one of the spouses. And that last one is incredibly important because once one spouse dies, the surviving spouse can have essentially the same IRA and a very similar amount of income, but now they're navigating the much narrower tax brackets of a single filer. If we recognize that the surviving spouse may eventually be forced into the single tax brackets for 10 or more years, like both of my grandmothers were, then it may make enormous sense to deliberately take advantage of the 24% married, finally, jointly bracket while both spouses are still alive. We could even get into the cost of having your children inherit what's left of your IRAs at their highest marginal tax brackets at a point in the future when tax rates could

9:12be double what they are today. But I'll leave that for another video. So I don't really disagree with this viewer's math as much as I disagree with what the math is trying to accomplish. He's asking, what's my marginal cost of converting the next dollar this year? That's a great question, but it isn't the only question we should be asking. We also have to ask what happens to that dollar if we leave it in the IRA, how much it could grow between now and the time RMDs begin, what tax bracket will be in when we're eventually forced to withdraw it, what happens to the surviving spouse after the first spouse dies. And perhaps most importantly, whether we believe that tax rates even 10 years from now could be dramatically higher than they are today due to our country's catastrophic debt trajectory. Because the goal of Roth conversion planning isn't to win this year's tax return. The goal is to position yourself so that over the balance of your retirement and potentially over the balance of your spouse's retirement as well, you pay the least amount of tax possible. And if you're sitting on a $2 million IRA that's growing by $160,000 per year on average,

10:14while you're only converting $80,000 because you're determined never to rise into the 24% bracket, I think you have to ask yourself a very simple question. Are you actually solving the problem or are you just postponing it? Because saving money on taxes today isn't much of a victory if doing so ultimately causes you to pay even more over the balance of a 30 year retirement. Folks, my mission is to put 1 million Americans on the road to the 0% tax bracket. If you'd like help implementing a balanced comprehensive approach to tax free retirement, head over to davidmc9.com and click connect with an advisor. I'll connect you with a Power of Zero Advisor has been trained, vetted and qualified personally by me. And if you're a financial professional, and wants to bring these strategies to your own clients, head over to power of zero.com to learn more about becoming a Power of Zero Advisor. And finally, be sure to check out my newest USA Today best selling book, The Secret Order of Millionaires, Available on Amazon and wherever books are sold. For both copies of any of my books, visit davidmc9books.com. All right folks, that's the show for today. I look forward to chatting with you same time next week.