Roth IRA conversions can provide significant tax benefits by allowing tax-free growth and withdrawals, making them a crucial strategy for long-term financial planning and legacy wealth transfer.
In this week’s special episode of Retire in Texas, PAX Co-Founders Darryl Lyons and Joseph Schuetze dive into the critical topic of Roth IRA conversions. They discuss the benefits of tax-free growth and withdrawals with Roth IRAs compared to traditional IRAs, highlighting the importance of strategic planning for retirement. Learn why Roth conversions are advantageous, the optimal timing for conversions, and how financial advisors and CPAs collaborate to maximize tax efficiency.
Show highlights include:
*A breakdown of Roth IRAs vs. Traditional RIAs, citing advantages and disadvantages of both.
*Why CPAs play a crucial role in validating tax strategies for Roth conversions, ensuring comprehensive tax planning.
*The ideal time for a Roth Conversion is right now, taking advantage of tax-free growth; and other opportune times include market downturns or lower tax brackets.
*Why Roth conversions are generally advantageous for most clients (around 90%), promoting long-term financial planning and tax efficiency.
If you enjoyed today’s episode, make sure to leave a comment and share the show with a friend!
Transcript:
Darryl: Hey, thanks for tuning in to Retire in Texas. This is Darryl Lyons, CEO and co-founder of PAX Financial Group and as always, I want to remind you that this information is general in nature only. It’s not intended to provide specific investment, tax or legal advice. Visit PaxFinancialGroup.com for more information.
And then also, I want to remind you when you go to the website and you go to the upper right-hand side, there’s a ‘Connect Now’ button. So do that if you haven’t met with one of our advisors just to see if it’s a good fit. So, they’ll reach out to you to be a 15-minute consult. It won’t cost you anything, but it’s just a way to see if we’re a good fit, if you need help there.
And today is a special day because I get to talk with the co-founder of PAX Financial Group. Joseph Schuetze. Welcome.
Joseph: Thanks, Darryl.
Darryl: I don’t think you’ve been here.
Joseph: No. Finally. Yeah. No. I’m excited.
Darryl: Yeah. I can’t believe it.
We don’t do a lot of interviews, but I wanted to interview Joseph because he’s been doing some incredible work in the Roth IRA space, specifically in the conversions and we did a show before with Roger Stucky, one of our advisors and partners here. And I actually got a lot of good feedback. And so, this idea of Roth conversions, I thought we could do kind of a take two, because Joseph does a lot of them and he’s an expert in this space.
So, I thought I would just share his expertise with the world. So, we’re going to dive in. Today’s topic is going to be Roth conversions. You definitely, absolutely 100% need to know how this game works. It’s very important for your long-term tax strategy, so be sure to stay tuned to this. But let’s kind of lay the landscape and make sure everybody’s on the same page. Joseph, what is the difference between a Roth IRA and then the traditional IRA?
Joseph: Yeah good. So traditional IRA, as Roger stated a couple months ago, is a tax beneficial account that allows you to put money in and get a tax deduction, which means any money that you put in there, you’re not paying tax on that money.
It then grows tax deferred, and then when you pull the money out it’s completely taxable as income in your current income tax bracket. So different from the Roth IRA. When you put money in a Roth IRA you don’t get a tax deduction. So, you’re putting after tax money in. However, that money grows forever until you use it. When you use it, you pull it out. There’re other rules that go.
Darryl: Yeah, yeah.
Joseph: Roger covers those. We’re doing the big basics. But when you pull that money out, it’s completely tax free. So, all of your principal and all of your growth that’s accumulated over those years comes back to you and doesn’t get taxed the and doesn’t affect your tax bracket.
Darryl: It’s really cool in a lot of ways. And again, we’re not going to get into the big whys because I want to spend some time on the construction of it today, specifically in the area where you can convert your traditional IRA to a Roth IRA. And so, we’re going to talk about the conversion process. Why would somebody want to convert their tradition to Roth?
Joseph: Yeah, good question. Several reasons. Step back a little bit. Not everyone’s allowed to fund a Roth IRA. If you make too much money they don’t allow you to put money in a Roth IRA. We’re not going to go into those numbers, but when you talk to an advisor, they’ll know. So, if you can’t fund a Roth, you spend all of your time funding traditional assets.
Your 400K traditionally is traditional. Pretax, pushing forward all these tax dollars. So, at some point in the future, if you want some of your retirement to be tax free and you didn’t get to fund a Roth IRA, you must take time to convert. So why would you convert? You would convert because you want future tax free dollars, either for your retirement plan or for inheritance for your heirs.
Darryl: Yeah, we’ll get to some of the strategies there. So, some people want to convert, but the timing matters. So, when’s the best time to convert?
Joseph: In general, in broad terms, the best time to convert is right now. And I use that loosely. You know they say when is the best time to plant a tree. 20 years ago. Second best is today, right?
Darryl: Yeah, I get you.
Joseph: So, all the analysis that I’ve done shows that no matter what the scenario, it’s best to convert your Roth IRA. Except for those very specific ones. Rodger actually talked about one. Very specific. Yeah. Last one. So, if you haven’t listened to his, listen to his podcast that Darryl did with him.
But in general, if you have heirs that you want to leave tax free money to or if you have a potential tax situation in retirement, now is the best day to convert. However, there are better days. It is always good to convert because it always wins. Pushing forward tax free money always wins. From all the analysis that I’ve done, even if you’re now in the highest tax bracket, believe it or not.
But there is ideal. When is the ideal time? Well, there are some opportune times, like if the market drops 15/20 %, it’s a pretty neat time to take some of your traditional IRA money that has dropped 20% and convert it to a Roth because it’s compressed. I think of it like a spring. Once that money is in the Roth, when the market comes back, it’s rebounding tax free, so you didn’t have to pay as much taxes because you converted a smaller amount.
And when it comes back, it’s going to grow back to where it was and beyond. And you take advantage of tax-free growth.
Darryl: It’s a little bit of a hack.
Joseph: It is a hack. It is a hack. It’s tough. Everyone out there is like, yeah, well then, I’m just going to convert when the market’s down 20%. The trick is that the market goes up a lot before you might get that chance.
So even just recently I’ve been dealing with clients, and we have decided we are going to convert at some point this year.
Darryl: Yeah.
Joseph: And then the client says well I want to wait until the market’s done. Okay. We can try to do that. We’re not going to be able to get it perfect most likely. And we don’t know how fast the market will go up before it starts going down.
Darryl: Yeah.
Joseph: Back to my first point. The best time is probably right now to do it.
Darryl: Yeah.
Joseph: Now that you kind of walk through the scenario. Of course, buy stocks when they’re down.
Joseph: Exactly
Darryl: It’s the same kind of scenario. It’s just tricky to do in an ideal Pollyanna world. You know the market’s down. You convert. You’re excited and you beat demand.
Joseph: You get that perfect opportunity to beat the IRS. That’s right.
Darryl: Yeah. And that feels good.
Joseph: So, the second ideal scenario is when you’re in a low tax bracket okay.
Darryl: Yeah, that makes sense.
Joseph: So, if you are for whatever reason in a lower tax bracket than normal, and some people go through this where they retired and they’re going to wait to turn on Social Security, or maybe they’re in between jobs for an entire year where…
Darryl: living off savings or something. Right?
Joseph: Yeah, income is a little bit lower than it normally is. And the tax brackets, the biggest jump is from 12% to 22%.
Darryl: Yeah.
Joseph: So, if there’s any chance at all for you to convert even a little bit and only pay 12% taxes, that is for sure ideal and should almost always be taken advantage of.
Darryl: So right now, if you’re unemployed and you’re listening, you got a bunch of traditional IRA money you might want to consider converting.
Joseph: Yes.
Darryl: And the market’s down.
Joseph: And if you have the money to pay the taxes you’re going to generate.
Darryl: Oh yeah. I forgot about that little part of that. You got to pay the taxes when you convert. But the idea is you’re paying him now and it’s less.
Joseph: Yeah.
Darryl: Yeah okay. How do you pencil this thing out? Use pen and paper old school style or how do you calculate these things?
Joseph: Definitely not. We’re using some pretty high-tech software. So, for years now we’ve used Money Guide Pro for our financial planning software. Money Guide Pro has become pretty efficient at showing how conversion will affect a client’s plan long term. So, we can use multiple scenarios and we can show, okay, if you convert this amount of money each year for the next ten years, this is what it saves you in taxes.
And this is how much of your money will transfer to your heirs tax free, that was going to be fully taxable if you had not done it. So that’s really neat. It’s really, really good at that. It’s not quite as efficient at telling you exactly how much you should convert each year and remain below a certain tax bracket.
That’s where another piece of software comes in that we use called Holista Plan. We use Holista plan to help us look over taxes. We’re not tax advisors. However, we can look at your taxes and use your taxes to be better planners.
Darryl: Yeah, that makes sense. Yeah.
Joseph: And so holistic plan allows us to do that and to get much more precise. It’s not perfect because you still have to assume that last year’s income matches this year’s income on some level. But if it does, then we can get really precise on how much you can convert and remain below the tax bracket that you want to remain.
Darryl: It’s actually a really cool strategy. I kind of geek out on the tools, and so think about both of them, how they work together harmoniously.
Joseph: And you’ve done years of research on those tools though. Thank you for bringing them to us.
Darryl: I don’t know how to turn them on anymore, but I do like the outputs. But yeah, you and your team, y’all work on that together. How did the CPAs get involved with this stuff? Because for years this was supposed to be the CPAs job. And the market’s been strange because there’s fewer CPAs, but more people that need tax planning than ever before. So how do they play a role in your conversion conversations?
Joseph: Great question. CPAs are really important and generally I will get the clients CPA involved almost every time, as long as they’re willing. And the difference between what a CPA does and what a financial planner does is their perspective.
A CPA has the perspective of this year and last year generally, whereas the financial planner has a perspective of this year and every year beyond for the rest of your life and the next generation. So that perspective is slightly different.
Darryl: That’s a good point of view.
Joseph: Once you have a good relationship with the CPA and you’re on the same page, and the client has a good relationship with the CPA and is not judging the CPA on how little taxes they are going to pay right now, because that’s typically what a client is judging their CPA on.
Darryl: I love my CPA. He got me a big refund.
Joseph: He saved me so much in taxes. Yeah. Yes, it would expense. Yeah, a pretty large potential expense as you are transferring that money to your heirs later on in life. So, once we’re in a good relationship with the CPA and the client and CPA relationship is good, CPAs are extraordinarily talented and are a big help.
And so, what we do is we say, hey, we’re not trying to be so safe in protecting from taxes this year. We want to use X tax bracket, whether that’s 12 or 22 and we want to convert as much as we can in that tax bracket. Here’s all the data. CPA, please confirm that we’re okay converting $80,000 this year and what will the tax hit be as you’re projecting that out.
Darryl: So that’s really the best symbiotic relationship because they’re kind of double checking saying okay, I get your strategy. I’m singing from the same sheet of music. Let me just double check. And then everyone gives a thumbs up and there’s no surprises. Generally speaking.
Joseph: You kind of have to have a partnership there. You can’t have an adversarial relationship because they’re going to be trying to protect their own area. And you’re trying to protect yours.
Darryl: Yeah. And I find that for the most part, to your point, most of them are pretty good to work with.
Joseph: For sure.
Darryl: Yeah. Every now and again you get cranky old CPA, been around 80 years, I don’t know what your boys are doing.
Joseph: That’s just something to overcome through a relationship.
Darryl: Yeah, that’s right. Overall, working with a CPA and the advisor in a collaborative process, thinking through both taxes in the short term and long term, it’s really a beautiful relationship. So, as we kind of close this out, I’d like to know if you do a lot of Roth conversions. You alluded to it earlier for inheritance and legacy planning. What’s the benefit there? I want to tease that out just a little bit more.
Joseph: Yeah, I would say the two main benefits of Roth conversion, one required minimum distribution avoidance. So, you are creating a tax time bomb if you’re putting all of your money in traditional IRAs, you are. And when we project that out and you see that the government is going to make you take 2, 3, $400,000 out of your IRA in one year, and it’s going to bump you into a very high tax bracket.
You realize I need to deal with some of that now. That’s a main reason to do it for the client, but it’s an even bigger reason to do it for their heirs. When you look at a plan and it has all traditional IRA money, traditional 401K money, that passes to their heirs at the end of life, taxable, and they are not allowed to stretch that to the extent of their life anymore.
They must take it all out over a ten-year period. That can be really, really expensive. And so, when you look at how to most efficiently transfer wealth to the next generation, excluding estate taxes, this has nothing to do.
Darryl: Sure. Yeah, it’s different.
Joseph: But how can you transfer wealth to the next generation on a tax efficient manner? Planning with Roth conversions is the key.
Darryl: Yeah, that makes sense. And we’ve talked about this before, on many shows. But being very intentional about the legacy both orchestrating with your key advisors, finalizing and executing all the documents and then also, and this is often loss, making it to where the beneficiaries aren’t burdened with taxes. It’s kind of all these things to consider. And it’s not just like, hey, you’re going to come in and meet with Joseph one time and we’re going to solve all these problems.
It’s constant. That’s why we do checkups so often. Okay, let’s check in and make sure that we know what’s going on. It’s a relationship. An ongoing relationship. That’s why you’ve kept your clients that you’ve served for so many years and we hardly lose clients now. And it’s because you’ve just got this ongoing relationship of this is how we’re going to do tax planning going forward. It’s pretty nice.
Joseph: That’s right. We’re always bringing new ideas to the table, some of them fit for clients and some of them don’t.
Darryl: Yeah
Joseph: But the Roth conversion, from my perspective and from almost all the clients I show, is 90% a viable solution for everyone.
Darryl: Yeah. Great job. Thank you. Today. This has been fun.
Joseph: Yeah. Wonderful. Thank you. It’s been fun being here.
Darryl: It goes by fast, right?
Joseph: Oh yeah.
Darryl: So, thanks again for tuning in, I appreciate it guys. I want to encourage you, if you do need to speak with an advisor about these Roth conversions, just hit the ‘contact us’ on the website. We want to thank you for listening to the very end and as always, I want to remind you, you think different when you think long term.
Have a great day.
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