Ep. 12 - To Convert or Not to Convert: How to Know if a Roth Conversion is Right for You.

John Bever |

Are you looking for a tax strategy that may help reduce the amount of taxes you pay during retirement?  How about a strategy that may help increase the lifespan of your retirement portfolio?  If so, then a Roth conversion may be the right move for you.

In this episode of The Year You Retire, hosts John Bever and Jim Uren delve deep into the world of Roth conversions.  They reveal the potential tax savings that a well-timed Roth conversion can provide during the retirement years.  Through their insightful conversation you’ll gain valuable knowledge and practical strategies to help you determine if and when a Roth conversion may be right for you.

In this episode you will:

  • Discover how a Roth conversion may help you maximize your retirement savings.
  • Understand the rules you must know before completing a Roth conversion.
  • Find out the eight considerations to keep in mind when deciding on a Roth conversion.
  • Learn about the Social Security tax torpedo and how to avoid it.
  • Gain a better understanding of our tiered tax brackets and how to use this knowledge to make an informed Roth conversion decision.
  • And much more.

The key moments in this episode are:

01:00 - The Power of Roth Conversions
Jim and John discuss the benefits of Roth conversions, including reducing lifetime income taxes and disinheriting Uncle Sam. They highlight the potential for stretching portfolio lifespan and paying less taxes over one's lifetime.

04:10 - Overview of Roth IRAs
John provides an overview of Roth IRAs and explains the difference between pre-tax traditional funding and Roth funding. He also mentions the potential for tax-free gains in a Roth IRA after age 59 ½.

07:01 - Understanding Roth Conversions
John explains that a Roth conversion involves moving money from the pre-tax side to the Roth side, providing control over when to pay taxes. He also discusses the options for paying taxes on the conversion.

10:20 - Factors to Consider for Roth Conversions
John delves into the complexities of determining if a Roth conversion is right for an individual, highlighting considerations such as federal tax brackets, IRMAA brackets, state tax brackets, the Social Security tax torpedo, the five-year rule, and more.

16:19 - Exploring the Impact of IRMAA on Medicare Premiums
John explains how income-related monthly adjustment amounts (IRMAA) can lead to increased Medicare premiums as income rises, and how this should be considered when planning Roth conversions.

18:40 - State Income Tax Considerations for Roth Conversions
John and Jim discuss how state income tax laws can impact Roth conversions, with specific emphasis on the benefits for Illinois residents who can avoid state taxes on Roth conversions.

20:14 - Navigating the Social Security Tax Torpedo
John delves into the complexities of the Social Security tax torpedo, emphasizing the regressive nature of the tax and the importance of strategic Roth conversions to mitigate its impact.

23:46 - Understanding the Five-Year Rule for Roth Conversions
John highlights the five-year rule for Roth conversions and its impact on accessing converted amounts, especially for those under 59 ½, providing insight into the considerations for tapping into Roth funds.

29:30 - Qualified Charitable Distributions (QCDs) from IRAs
Learn about the benefits of giving money directly from your IRA to a charity through QCDs and how your intent to use QCDs should inform your Roth conversion decision.

31:34 – A Summary of the Considerations for Roth Conversions
Gain insights into the eight key considerations for Roth conversions, including tax brackets, legacy planning, and charitable intent. Understand the importance of tax diversification for future flexibility.

Show Transcript:

Introduction: This is The Year You Retire podcast for people who want their first year of retirement to be right on the money. Your hosts are me, Jim Uren and John Bever, CERTIFIED FINANCIAL PLANNER™ professionals with Phase 3 Advisory Services. Retirement is one of the happiest times of life, but getting the most out of it requires you to be properly prepared.

Listen along as we explore the financial topics, tips, and strategies that will help you make your first year of retirement your best year yet. Now let's get planning.

Jim Uren: Are you thinking about converting some of your IRA to a Roth IRA? Are you wondering if it's worth paying the tax now versus later? Are you wondering if it's right for you? Keep listening as we reveal answers to these questions and much more.

Hi, John! Good to see you.

John Bever: Good to see you too, Jim. This is a great day because we're talking about Roth conversions.

Jim Uren: Yes, I'm excited about it. This is a tool in our tool chest that we use quite often because it can be very powerful. And so I'm excited to share with our listeners what you've put together today.

John Bever: Well, what I like about these is that they can stretch your portfolio lifespan by reducing your lifetime income taxes.  And, if done right, can result in less taxes paid over your lifetime.  In essence, disinheriting uncle Sam.

Jim Uren: And no one usually complains when that happens. That's a good thing.

John Bever: Not at all, no.

Jim Uren: Well, we, as you know, like to start off with trivia on a lot of our episodes. And so we're going to start off today with some Roth related trivia. Now Roth IRAs were created in 1998. But why are they called Roth?

Are they:

  1. Named after Senator Richard Roth?
  2. Named in honor of Philip Roth, the novelist?
  3. Created by the Retirement Offset Tax Harmonization Act?
  4. Really Over The Hill IRA?

What is the answer, John?

John Bever: Well, I know it's not really over the hill because we use these for a lot of younger people. So that's an easy one.  That one's off.

I don't know. The Retirement Offset Tax Harmonization Act sounds really good, but that's not the answer. It's A, “Named after Senator Richard Roth,” California sponsor of the Taxpayer Relief Act of 1997. And they were so profound that actually we did a seminar to introduce them.  We titled it, “The Gripes of Roth” because he was very concerned about the lack of retirement savings, which is actually still a concern today.  So some things just don't change that much.

Jim Uren: Very interesting. And that was just a few years before I started in the industry. So I do remember those coming out and it was very interesting. Next question. We've got one more. How much do Americans, speaking of retirement accounts, how much do Americans have in all their retirement accounts combined?  Is it…

  1. 13 trillion?
  2. 31 trillion?
  3. 45 trillion?
  4. 68 trillion dollars?

John, what's the answer?

John Bever: Well, if you know your, uh, chances on multiple choice questions where you don't know the answer, it is C, 45 trillion dollars. And that's a nice big number. About 15 trillion of that 45 trillion is in IRAs. So the 45 trillion is all retirement accounts, including pension plans.

But 15 trillion of that is in IRAs. And about 10% of the IRA balances are actually in Roth accounts. And of course that's increasing every day as people do more Roth conversions and learn about them.

Jim Uren: Excellent. And before we jump into the more specifics about the Roth conversion, John, I think it'd be helpful if we could just start with a quick overview of Roth IRAs. Would you mind just giving us a reminder of what a Roth IRA is and how it works?

John Bever: Yes. And in fact, we're going to talk about Roth IRAs and Roth 401(k)s, 403(b)s, 457 plans. So we're going to lump this into two different types of funding, pre-tax traditional funding and Roth funding. So you can put pre-tax money into an IRA, your 401(k), your 403(b), your 457 plan, or you can put Roth contributions in.

Now Roth contributions are after tax. Not all 401(k)s, 403(b)s, 457 plans have opened up to the Roth contributions just yet. Most 401(k) plans have. The others are coming on board. So again, it's two sides of the equation, two sides of the same coin. You're putting money into your account, but you can either put that in on a pre-tax basis, which means you're not paying tax on that contribution.  Or you're contributing on a Roth basis, which means you're going to pay full tax on that, which makes it a little harder to save because you're having to pay the tax against that.

Now, an interesting point, the Secure Act 2.0, that act introduced Roth funding for SEPs (SEP IRAs) and SIMPLEs (SIMPLE IRAs). It's going to take a couple of years for the custodians to change their systems to accommodate this, but before long, we should have the ability to fund all retirement accounts on either a pre-tax basis or on a Roth basis.  And Roth again is after tax.

So why is that a big deal? Well, it's a big deal because on a Roth account, it becomes totally tax free after age 59 ½. So right at age 59 ½, all the gains in that account now become tax free with one very small exception that we'll talk about a little bit later.

Now, I also need to distinguish that this is a little different than a voluntary after tax contribution to a 401(k). Not everybody has access to that, but if you do, the Roth is separate from the voluntary after tax contributions.  And it is also different than after tax IRA contributions Some people with their income situation, they actually are making after tax contributions to their IRA, but that is very different than making a Roth IRA contribution.

And after tax contributions, if you make those to that IRA, they grow tax deferred, but the gains are taxed upon withdrawal. Again, the Roth IRA at age 59 ½ is tax free.

Jim Uren: So just to summarize Roth is a pay taxes now, but not later.  Versus a more traditional IRA or 401(k) which is a don't pay taxes now, pay it later.  And that's really one of the biggest decisions that everyone has to make when it comes to saving for retirement is which track do they want to go on.

But the topic of our conversation today is Roth conversions, which gives you an opportunity to switch tracks, if you will, along the way. So John, what is a Roth conversion?

John Bever: Simply put, a Roth conversion is just moving money from the pre-tax side to the Roth side.  As you said, switching tracks.

And this is great because, you know, in the financial world, there's a lot of things we cannot control. We can't control inflation. We can't control the markets. But in the tax world, there are some things that you can control.  And when it comes to the IRA, 401(k), retirement plan question, you have some control over when you're going to pay the tax.

So simply moving money from the pre-tax side to the Roth side is a Roth conversion. You have to stay in the same type of an account. So if you're in an IRA, you're going to do a Roth IRA.  If you're in a 401(k), it's a Roth 401(k) and so on and so forth.

And you do pay tax on the move. Not necessarily the moment you move that money, but in that tax year, when you go to file your taxes.  There’s no penalty on that move either, but that income will be reported on a 1099R.

You can convert as much or as little as you want.  You don't have to convert an entire account either. And there is no limit on how much you can convert in any particular year.

Now, as mentioned, traditional IRA to Roth conversions, that's what we're talking about. That is different than a non-deductible IRA to Roth conversion. That has some different features that maybe we'll address in a future podcast.

Also different are transfers of your voluntary after tax account to a Roth IRA. Look for future podcasts on this subject. So brief summary, Roth conversion is simply changing tracks, going from the pre-tax side to the Roth side.

Jim Uren: And John, what type of accounts are eligible to do this conversion to the Roth?

John Bever: Yeah. So accounts that are eligible are IRAs and the vast majority of accounts that are IRAs can do this. There are a few exceptions, but they're very rare. 401(k)s if your plan custodian has the Roth side set up.  403(b)s if the plan custodian has the Roth side set up.  And even 457 plans, but again, the custodian has to have both the pre-tax and the Roth side set up to be able to do that.

Jim Uren: Since you are taxed on this conversion, John, where does this money come from to pay the taxes? Should I pay the tax out of the actual account that I'm converting or from somewhere else?

John Bever: Yeah, so this is an issue of the type of plan that you're in. So really the only way that you can pay the tax out of the conversion is if you do that with an IRA.  And you can do that. You can, in the conversion say, alright, I want to move money from my IRA to my Roth. I want to convert that money, but I don't have the money to pay the tax so just withhold the tax on that move. And so by withholding the tax on that move you're paying the tax. And the nice thing is you don't have to pull into other funds.

The bad thing is you have less money in the Roth IRA and the whole point of this is to get as much money into the Roth IRA. So ideally the better option is to pay with other resources.

Jim Uren: So other resources is ideal, but you can withhold if you need to. And the big question then, John, is how do I determine if a Roth conversion is right for me?

John Bever: Hmm. Okay. So there are many considerations and it's very complicated. You would think it's kind of an easy choice, I just look at the tax bracket, but there are many other things.

So just this morning, actually, I received an email from a client. He's reading a book on Roth conversions and Roths, and he's wondering, John, should we do more?  That was his question. I'm not going to be able to answer it in an email because he has a complicated situation. So we're setting up a separate meeting for this. So what are we going to look at?

We're going to look at the federal tax bracket for the client. We're going to take a look at the IRMAA bracket.  We're going to look at the state tax bracket. We're going to look at the Social Security tax torpedo. Maybe we'll have to consider the five-year rule. Also looking at any need for large withdrawals in retirement. Legacy planning and charitable intent.

For this one client, we're going to tick off almost all eight of those considerations.  So again, those considerations are your federal tax bracket, IRMAA bracket, state tax bracket, Social Security tax torpedo, five-year rule, need for large withdrawals in retirement, legacy planning, and charitable intent.

Jim Uren: So that's a lot of considerations that you need to keep track of. Let's talk about, John, the first one, which is also the biggest – the federal income tax bracket.

John Bever: Yeah, one of my favorite topics.  As I said, this is something we have a little bit of control over. We don't have control over the brackets, but you have some control over what bracket you're going to pay your tax on based on the year that you decide to do a transaction.

So would you rather give your money to the government or would you rather give your money to your family, charities, or towards your own goals? Well, that's a pretty obvious question. So we need to look at the federal tax bracket and pay your tax at the lowest bracket possible. In order to do that, you actually need to do a lifetime tax projection to understand your brackets at different times.

So this does seem simple, right? The brackets we're dealing with right now predominantly are the 12% and 22% brackets, and then the 24% to the 32% bracket. So there's a big differential between paying tax at 12% or 22%.  Or paying tax at 24% or 32%.

And these brackets are set up as tiers.  So your first chunk of income isn't taxed at all. That's the standard deduction. Your next chunk of income is taxed at 10% and it does vary whether you're filing single or married jointly. And then we go up into higher brackets that are charging higher rates of tax.

So if you're paying tax at 12% in the 12% bracket, you might not be paying tax at 12% on all of your income, just that money that's in that tier. When you cross into the 22% bracket from the 12% bracket, now the money that's in that tier is being taxed at 22%, but not all of your income. So it's set up as tiers.

Now this gets tricky in retirement, partly because of the Social Security tax torpedo.  And what happens with the tax torpedo is that as your income goes up, you have to recognize more of your Social Security income on the tax return. Under $25,000 for single, $32,000 for joint returns, your Social Security income is not taxed. But as you go above those levels, and it is a little bit of a complicated calculation because it's not just your income, there's some additions and withdrawals.

But once you go above that level, you're going to bring in up to 85 cents of your Social Security income for every dollar of other income. So you bring in $1 from your IRA, let’s say you have to do a required minimum distribution, you take out a dollar from your IRA, you may have to bring in up to 85 cents of your Social Security income along with that.

So what this does, this effectively changes the 12% bracket to a 22.2% bracket. So while it might be obvious, oh, do I do a Roth conversion or not? I'm in the 22% bracket now while I'm working, but I'm going to be in the 12% bracket when I retire. If you've forgotten about that Social Security torpedo tax, you might be looking at this incorrectly because your tax could be potentially 22% on that IRA withdrawal in retirement.  It might make sense to do that Roth conversion today in the 22% bracket.  If taxes are going to go up, if tax rates are going to go up in the future, that just adds more fuel to the fire.

You know, I just had a recent case with a client where what we do is a lifetime tax projection. And what we found was that we could help the client save an estimated $100,000 in lifetime tax savings by doing about five-years’ worth of Roth conversions.  And believe me, the client's very interested in proceeding with that.

Now I mentioned here, 2024 and 2025 may be the last years where we ever see the 12% and 22 percent tax brackets. We are in a tax law right now that is going to sunset. It is called the Tax Cut and Jobs Act, and that sunsets at the end of 2025.  So in 2026, we go back to the older system and older brackets. The 12% bracket will become the 15% bracket, and the 22% bracket and 24% brackets will become the 25% bracket.

Jim Uren: Lots of moving parts, but to summarize, basically, you got to take all that information into account to figure out when's the optimal time to do that conversion so that you're paying a lower tax rate.  And it can be very powerful, as you mentioned with your case study.

So second on your list of considerations, John, you mentioned is IRMAA.  Is that your mother's name? Is that why we're talking about that?

John Bever: No, but since you brought up my mother, she went by Betty, but her name was Mary Elizabeth.  Talk about confusing.

Anyways, IRMAA, this is from Medicare. Thank you, Medicare, for giving us IRMAA. IRMAA is the income related monthly adjustment amount, which just simply means you're going to pay more Medicare premium as your income goes up.

Now, the thresholds are fairly high. We're talking about single filers over a $100,000, joint filers over $200,000.  But what it is, is it's an additional Medicare premium on your Part B and your Part D.  That’s Part B Bravo and your Part D Delta. And when it starts, it starts to kick in pretty good. It's a 1.4 times increase on your Part B premium up to a 3.4 times increase. And on the Part D premiums presently, it's an increase of anywhere between $13 and $80 per month.

Well, what this means is for joint filers over $258,000 and single filers over $128,000, this would be based on the 2024 tax return, they could be adding up to $4,800 a year of additional premium for having crossed one of those thresholds. So it's something that we have to look at. We may be doing a Roth conversion, but are we going to push you into the next IRMAA tier, which then is really like adding an additional tax.  Now that's only for one year while your income is above that level. So it's not a permanent increase in your premium. It's just a one-year increase in your premium.

Example here, I had a client where the spouse was retired and the one that was working kept their insurance as the primary for the husband and wife.  And so they were able to delay Medicare and were able to convert several hundred thousands of dollars to their Roth IRAs. And avoiding the next IRMAA bracket because they weren't even in the IRMAA situation. They weren't paying Medicare premiums yet. So that can be very powerful and a good time that you might consider doing a Roth conversion is in that window where you're not yet paying Medicare premiums.

Jim Uren: So you got to watch out for those IRMAA brackets for sure. And then another consideration staying on the tax theme, most of us in the U.S. live in states where the state also can impose income taxes. So tell us about that, John.

John Bever: Yeah. So we are in Illinois with the home office of Phase 3 and Illinois does not tax money that comes out of IRAs, at least not yet.  So that means that Roth conversions, money coming out of IRAs, including a 401(k)s, 403(b)s, 457s. That 1099 is not taxable in the state of Illinois. So that's a great opportunity. So if we have clients that are actually looking at moving out of state to another state that might tax those distributions, they might want to do a Roth conversion while they're in their current state.

So think about what state that you are in presently, where you're thinking about doing a conversion and what state you will be in for your RMD. So the state of conversion versus the state of the RMD. Take a look at how that tax system works.

So you might be on the, on the threshold, maybe on the borderline of doing a Roth conversion, maybe yes, maybe not. But that state issue might push you over the threshold to say, yeah, it's a good idea to proceed because of the state savings you will experience by not paying state income tax on that Roth conversion in the state that you live in.

Jim Uren: That's a really good point. And you also mentioned Illinois doesn't tax yet.  And so that's certainly another benefit of a Roth, right? Is that if tax rates go up there's some additional protection there you get from the Roth IRA and so that can come into a consideration as well when you're doing the conversion.

The fourth consideration you mentioned is the Social Security tax torpedo, as it's called.  Now, we did mention this a little bit on episode 4 that we did on Social Security, and we may be covering this more in depth on a future episode because it is a bit complicated, but John, can you give us a brief explanation of how this can impact your decision to do a Roth conversion?

John Bever: So doing a Roth conversion is going to add income to your tax return. And adding that income can force additional Social Security income onto your tax return.

See your Social Security income is kind of interesting. You receive the income, but are not necessarily taxed on it. The taxation is whether you recognize that income on your tax return.  So what you receive may not be recognized on your tax return. The higher your income, the more of your Social Security income that is recognized on your tax return. And right now under current law, the maximum that is recognized is 85% of your Social Security income. So if you're at a level where you're not paying tax on any of your Social Security and you do a Roth conversion that could bring in ten, twenty or $30,000 worth of income to your tax return. That is going to add quite a bit of your Social Security onto the tax return. So as a result, your effective bracket increases.

So if 85% of your Social Security is coming in and you're in the 12% tax bracket, then really what you're looking at is an effective bracket of 22.2% on that Roth conversion. If you're in the 15% bracket, which we might see in a couple of years, then the effective tax rate is actually 27.75%, almost a 28% effective tax on that Roth conversion. So this is a really important consideration. And one of the reasons why we love to do Roth conversions is before collecting Social Security.  In fact, we may recommend delaying Social Security, turning on that benefit just to do Roth conversions.

And I have to say that this Social Security tax torpedo is very regressive. Now, I had a client that had about $25,000 in Social Security income and then an additional government pension.  And what we did in this case is we actually packed a bunch of conversions into one year to get over that Social Security tax torpedo. You see, it only affects you up to a certain level. Once you recognize all 85% of your Social Security income. Then you can add more Roth conversion on top of that and you're going to go back effectively to the bracket that you're in. It doesn't have that additional amount.

So it's not just a matter of staying under that Social Security threshold for the tax torpedo. If someone's close to being at the top of that, we may want to push them over and do some Roth conversion to get past that so in future years, when they're having to take out a required distribution, that required distribution is smaller and won't be taxed as heavily as it would be if they didn't do the Roth conversion. How's that one for a mental twist?

Jim Uren: Quite complicated. But as you said, that tax torpedo, unfortunately, is very regressive and it's targeted not at the very, very wealthy with high incomes, it's targeted squarely on the lower to middle class. And so you can have a lower income person who earns an extra $1,000 one year, and they're going to pay a higher tax rate on that $1,000 than someone with a much higher income. So it is something that we have to be very careful of in retirement.

Now, John, you also mentioned the five-year rule. How does this affect whether or not you do a Roth conversion?

John Bever: Yeah. So this five-year rule will probably not be applicable to most of you who are listening to this podcast because it's the year you retire and you may be over age 59 ½.  But for those that are listening to this, that are under age 59 ½, it's worth mentioning.

So the five-year rule works like this – When you convert money from an IRA to a Roth, the gain on the conversion is not tax free until five calendar years after the conversion.  So we've had situations where we wanted to convert some money, to free up some money, but we have to be aware of that five-year window because this affects your ability to tap the converted amount. Now this might not apply to a 401(k) because you cannot tap that money before you retire from the company, but it can affect your IRA.

Now here's the deal. That tax doesn't apply once you're age 59 ½, but you do have the five-year window that you have to get passed. So many years ago, I actually had a client who had a generous salary and stock, a lot of stock from Yahoo (that lets you know how long ago that was) and then they ended up with many years of low income. So we started converting the IRA to Roth in order to free up funds for children's college education, but we had to be aware that for the next five-years after that conversion, that money was not available for them to withdraw. 

The gains in the Roth are not available till after 59 ½, but your principal amount, your converted amount, your contributions are available on a tax free and penalty free basis.  It's important to remember though, that with the converted amount, you have that five-year window you have to get past before you can have that access.

Jim Uren: And that ability to pull some money out without taxes or penalties, even prior to 59 ½ is another powerful benefit of The Roth IRA.

Now consideration number six is the need for lump sum withdrawals.  In retirement, we know just like in pre-retirement, there are years where you need large withdrawals, right? For auto purchases, dental bills, trips, weddings, home repairs. John, how should this be considered when you're thinking about and evaluating whether or not to do a Roth conversion?

John Bever: Well, this is particularly important for those who have predominantly pre-tax accounts. If most of the money is there in pre-tax, recognize when you go to take one of those withdrawals, that's a big addition to your tax return that can bring in additional Social Security income that can throw you into a higher bracket that can trigger the IRMAA brackets. So it's a big consideration.

And so the point here is to make sure that you have enough money accessible that's not in your IRA that you can use for these larger withdrawals. That doesn't have to be on the Roth side. It could just be, you know, money held jointly or individually, what we call non-qualified money.

But if most of the money is in an IRA, in a pre-tax account, in that 401(k), there really isn't much else to pull from. It maybe wise to do some Roth conversions to get that money over to the non-taxable side for when they need to take that large withdrawal.

Jim Uren: Excellent.  And number seven on your consideration list is legacy planning.  And I'm assuming by that you mean thinking about the situation for the next generation. Tell us more about that.

John Bever: That's right. It is about the next generation. So you're looking at not just your bracket, but your children's bracket, if you anticipate leaving some of your portfolio, some of your accounts to your children.

Under current law, we have a 10-year withdrawal requirement from any inherited IRA. This was put in place by the Secure 2.0 Act, and it could create a very large tax bill when inheriting large IRAs because you can't stretch that inherited IRA over your lifetime anymore. You have to pull that money out within a 10-year period.

So I'm actually working on a case right now where we're doing a tax projection, not only for the clients, but for each one of the children in order to determine what bracket the parents should fill up with their Roth conversions. So we need to know what the children's brackets are going to be, and not just one year, but over that 10-year period where they potentially might be receiving the IRA.  So we have to kind of assume how long the clients will live and then take a look at that situation to at least get a sense of what bracket the clients should fill up with their Roth conversions.

It's a fun exercise that we go through, but it is a complicated exercise that we go through. And the point of this is, again, to have the family pay as little in income tax as possible, not just one generation, but two generations.

Jim Uren: Yes, because that Roth is also a nice wealth transfer from one generation to the next, as you mentioned, because it does come tax free, which is very nice.

Now the last on your list, John, is charitable intent. How does that factor into this Roth conversion decision?

John Bever: Right. So if you have charitable intent, that also plays in.  You can actually convert too much to Roth IRA or too much to Roth 401(k) or 403(b).

I just worked on a case where we're going to keep at least $150,000 in IRAs for the very purpose of doing qualified charitable distributions (QCDs). Now we've talked about QCDs in another podcast, but qualified charitable distributions give you the ability to give money to a charity directly from your IRA, not through your hands, directly from your IRA to the charity.  And that does not count as income on your tax return, which means it lowers your adjusted gross income.

It's a wonderful way to remove money tax free out of your IRA. So if you have any charitable intent at all, that should be accounted for with your IRA and make sure you leave enough money in the IRA to be able to do those qualified charitable distributions.  Now those qualified charitable distributions cannot start until you are age 70 ½ and it is exactly 70 ½ and not a day before.

This also though affects those that might want to do charitable giving out of their estate upon their death. IRAs are a wonderful account to give to charity because the charity isn't going to pay any tax on that IRA.  So you avoid taxation of that IRA by using your IRA for charitable purposes.

And then lastly, you can also use a donor advised fund to make a large donation to shelter income from a Roth conversion. Again, addressed in another podcast, but that's where charitable intent comes into being a factor in doing Roth conversions.

Jim Uren: Yes, and we love to use these strategies because it's certainly fun for us to assist clients in giving money to charity. And when we can do it in such a way that Uncle Sam loses out, uh, all the better. That's just more money that we can, can give to charity.

And now if you want some additional information on some of these topics of charitable giving, we did an episode on this.  It was episode 7 of this podcast so I would encourage you to check that out.

And that's why this convert or not convert is not a simple answer. As you've outlined, John, there's a lot of moving parts that you need to be aware of. Could you give us a quick summary of these eight considerations before we close this episode?

John Bever: Yes. First, your federal tax bracket. You want to pay your tax in the lowest bracket possible. Next, your IRMAA bracket. You want to avoid getting pushed into another tier because if you even go $1 into the next tier, you're invoking that additional premium. So you want to be careful with that.

Thirdly, your state tax bracket.  Does your state even tax IRA withdrawals or withdrawals from qualified plans? Based on where you are today, but also based on where you will be in the future when you're going to be taking your required minimum distributions.

Fourthly, the Social Security Tax Torpedo.  Number five, the five-year rule you need to take into consideration, especially if you're a little bit younger.

Also, number six, your need for large withdrawals in retirement, you want to plan out those withdrawals, kind of make an estimate of when you will be needing some of these larger withdrawals. Some of them you don't know, for example, dental work, but you might want to throw in a guess on that, and that can be pretty expensive.

Next, number seven, your legacy planning. Do you have a desire to give any of your estate to your children? Roths make a great transfer tool. And then lastly, number eight, any charitable intent that you have.

Jim Uren: And so those are a lot of things you got to keep in mind. And John, as you know, sometimes we do this analysis for clients and sometimes it's very clear that, yes, a Roth conversion is a very good move.  And other times it's a very bad move.  But there's also still those times where it's not clear cut whether it would be good or not. What do you tend to do in those situations, John?

John Bever: Well, my rule of thumb is to aim for half in Roth and half in IRA. That way we have half a chance of getting it right.

Jim Uren: And that's just called tax diversification because a lot of these things you mentioned, John, are really predicting the future. And we've got some good insight into tax codes and things like that, but things can change. And so that tax diversification can be a good strategy because we still have some options that are available to us to respond well if and when things change.  So thank you so much for giving us insight into the to convert or not to convert question when it comes to Roth conversions.

Now we do want to tell you before we wrap up this episode with our gratitude segment that on our next episode we're going to be covering Social Security spousal benefits So if you're married, widowed, or divorced you may be able to unlock some additional income in retirement. We'll cover how to know if you're eligible, how to coordinate your benefits with your current spouse and several pitfalls that you may also need to avoid along the way. So be sure to follow or subscribe to this podcast so you don't miss that next episode.

John, what are you thankful for today?

John Bever: Well, this session really got me thinking about our tax code. And I have to say, I'm not thankful for the tax code. It's really complicated, but I am thankful that we have some control over the tax that we pay. And I am thankful for paying tax. We have a lot of good government services in this country.  It's a wonderful place to live as hard as it is to pay the taxes. So I guess I'm saying I'm a little bit thankful for paying taxes.

Jim Uren: That is, that is excellent. And as you were recounting, you know, these considerations I'm sitting here and I'm thinking how thankful I am for a lot of the tools that we have at our disposal to help us calculate some of these things, because there is an awful lot of moving parts.  And if we had to do this just on a spreadsheet or in a calculator this would be a very difficult, difficult task. So I'm very thankful for a lot of the tools that we have at our disposal.

Well, thank you all for listening to this episode of The Year You Retire podcast. For show notes on this episode and a transcript of this episode, visit our website at phase3advisory.com/podcast. That's phase3advisory.com/podcast. Thank you for listening and we'll see you on the next episode.

Disclosure: The views expressed in this podcast are not necessarily the opinions of Phase 3 Advisory Services or Osaic Wealth and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein.  Unless otherwise specified, show guests are not securities licensed or affiliated with Phase 3 Advisory Services or Osaic Wealth.   Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results.

No strategy can assure profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice.  Securities offered through Osaic Wealth, Inc. member FINRA/SIPC.  Additional investment. and insurance advisory services offered through Phase 3 Advisory Services Limited, a Registered Investment Advisor.

Osaic Wealth is separately owned and other entities and or marketing names, products or services referenced here are independent of Osaic Wealth. Phase 3 Advisory Services is located at 1110 West Lake Cook Road, Suite 265 in Buffalo Grove, Illinois 60089. Our phone number is 847-520-5545. For additional information, visit our website at phase3advisory.com.