Complex Financial Planning: Roth Conversions - Benefits, Considerations and Strategies

Are you concerned about how taxes will impact your retirement? Wondering if there is anything you can do? How would you feel about paying some taxes now in order to save yourself a lifetime of taxes?

In this episode, we embark on an engrossing journey into the world of Roth conversions, breaking down the complex idea into easy-to-understand segments. Also, we emphasize the crucial role of long-term financial projections in making decisions and underscore how inflation and income taxes come into play.

From there, we steer our conversation toward an often-overlooked aspect of financial planning: tax planning. We highlight the significance of weighing both short-term and long-term implications before making any financial commitments. Additionally, we discuss the essentials of understanding your current and future tax bracket, individual circumstances, and financial goals. 

Could you be leaving your heirs a tax bomb? Wanting to name your heirs as beneficiaries on your retirement accounts is a noble thought, but it could be a costly one. Listen in as we decipher tax strategies for charitable inheritance and how they could potentially shape your financial legacy.

Our final leg of the journey takes us into maximizing Roth conversion benefits, where we shed light on the need to understand projections and the potential pitfalls of online financial decision-making. We discuss the benefits of strategic asset allocation, particularly placing more aggressive investments in the Roth for tax-free growth.

Join us in this riveting exploration as we aim to help you get the most out of your money and life!

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Looking for additional content that can help you get the most from your life? Check out Unleashing Leadership with Travis Maus, premium bonus content from Ditch the Suits Fans, at https://unleashingleadership.buzzsprout.com/

Thanks to our sponsor, S.E.E.D. Planning Group! S.E.E.D. is a fee-only financial planning firm with a fiduciary obligation to put your best interest first. Schedule your free discovery meeting at www.seedpg.com

Ditch the Suits is produced by NQR Media. NQR also produces the One Big Thing Podcast with Steve Campbell.

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Transcript

Speaker 1: 0:08

Welcome to Ditch the Seats, a movement, awakening and opportunity for you to start getting more from your money and life. I'm Steve Campbell. With my amazing co-host, travis Moss, we're going to share industry insights nobody wants you to know about, so buckle up and enjoy the episode. Well, welcome back to Ditch the Seats podcast. Steve Campbell, travis Moss we're about to blow your mind again, talking about complex, simple questions. If you missed the first episode, we broke down this question that people ask all the time, especially in regards to financial planning, on when should I take Social Security. We spent 34 minutes describing that it's not that easy of an answer. Well, this is going to be another big one today, which is a question that a lot of people are asking should I do a Roth conversion? There's tons of information out there on the internet. Everyone's asking this question, but again, it's a complex, simple question, travis. When we think about this in those terms, why is a Roth conversion considered a complex, simple question? What's the starting point for a listener today?

Speaker 2: 1:14

I just realized that this episode will come out right before the end of the year. Here's the perfect time to have this conversation, because this is a year-end time sensitive thing. However, if you waited to this point and you don't have a good grasp on it, it's going to be challenging, because the first step to this question this is a five-part step, maybe four-part. I added an extra one for a bonus. You have to unpack this Really. When you're asking about should I do a Roth conversion, you have to rephrase the question. You're asking the wrong question. The Roth conversion is the tool. It's a tax management tool. That's all it is.

Speaker 2: 1:56

The question is whether or not to do a Roth conversion. The question is it regards the future of yourself and possibly your children. If you were going to rephrase the question, it would be will I benefit by paying my tax bill today rather than kicking it down the road? It's really. I mentioned you and your heirs. You may benefit, your heirs may benefit, your heirs may benefit, vice versa. There's all different ways here to look at that, but it's really about does it make more sense to pay the tax bill today than it does to pay it tomorrow? I think we're actually googling the wrong question. Should I do Roth conversion? We should be saying should I pay my taxes today? When's it better to pay the tax bill?

Speaker 2: 2:54

I think you can't even this is step two. You can't even think about the tax bill until you establish really a long-term projection. Detail is the key word there. A good projection is not something you can do in 10 minutes. We actually will spend hours both working with a client and then working with software. Then sometimes there's things we can't even model in the software because life is that variable. We will spend hours upon hours upon hours establishing a projection that we have a high degree of confidence in. Here's the thing with projections they're never going to be right. Your life is never going to happen the way that you think it's going to happen. However, we can be fairly confident of a range of output. Regarding finances, we have to have it as detailed as possible so that we can limit the range of output. If you're sloppy with the details, your range becomes so big or you could potentially make it so narrow that you don't even consider certain things.

Speaker 1: 4:06

Well, I want to pause right there for one second because the question is should I do a Roth conversion? It would be easy to assume you're listening to this because you know what a Roth conversion is. For those that may not, and this is the first time you've ever heard of a Roth conversion we hear from potential retirees all the time that the majority of their retirement savings is built up in pre-tax retirement accounts. So they had 401Ks in their working years. They had 403Bs. When they retired they converted it to a traditional IRA. Well, they know that from our last episode we talked about, at some point the government's going to make them take an RMD, a required minimum distribution. Any money that they take out of that traditional IRA they're going to have to pay tax on because they've never paid taxes on it.

Speaker 1: 4:49

So conceptually, a Roth conversion would be taking a portion of that money and converting it to a Roth account, paying part of a tax bill now because of the Roth's ability to not have to take RMDs and money comes out tax-free. So if you're new to ditch the suits and financial literacy and you hear Roth conversion, you don't even know what we're talking about. It is a strategic tool that can allow you to understand how to begin to convert. If you may be somebody who, honestly, is cash poor in retirement because you've accumulated millions in retirement dollars, but it's all pre-tax. When you go to enjoy the fruit of what you've worked hard for, you're going to have to pay tax every single time you take money out to do the things you want to do. So a Roth conversion could be a strategy over a period of time to start to understand what that tax bill is going to be. So I want to just park right there for one second so people understood, when we say Roth conversion, what we're talking about.

Speaker 2: 5:43

Well, while we're on the long-term perspective of this, you got a long-term projection and we were talking about how detailed this has got to be. I've seen lots and lots of long-term projections that don't properly allow you to account for inflation and how inflation actually really works. That don't properly account for income taxes or some of the nuances. For instance, if you're in New York state, you get not just an exemption or a special deduction on $20,000 of your retirement income, but if you're a state employee, your state pension that's going to be tax-free in New York and stuff like that. A lot of times the software is not sophisticated enough to account for that. Especially as you go down, the quicker that you can get a projection, the less sophisticated the software is. You have to think and you would say, well, but these people who produce this stuff know better. They don't know and they don't care. They're tech people and they're creating software that people are paying a subscription for they're selling ads for on it. It doesn't matter if it's perfectly accurate, because there's a disclosure on it that says you're playing with it, so it's your fault. Or you go to a financial advisor who's selling you products and they literally they are not your fiduciary for financial planning. They are your fiduciary for selling you products and they will literally tell you I don't do tax planning. If you want to talk about taxes, we'll talk to your CPA, and that's because they don't know how to model taxes. What they do is they go in there and they say you're just in the 32% bracket and they project you out at the 32% bracket forever.

Speaker 2: 7:10

It's a very primitive way of as far as the manner in which most people build a long-term projection. It needs to be very detailed and it needs to be some different scenarios in it, because you have to look at risk. The reason why is because you're looking at your future tax bracket situation. We talked in Social Security that there's facts or some things that you know. You know what the tax rates are today. You don't know what they're going to be tomorrow. We can make an assumption. We can say well, we figured that they're going to raise taxes in the future. Over the last couple of years, taxes are actually lower than they historically were in the past. It's not always like that, but let's pretend that you make the assumption that tax brackets are going to be the same as they are now, or higher, in the future. You want to look at that and say from my projection, can I tell if I'm in a lower bracket now and will be in a higher bracket in the future? A lot of people don't understand this. It's how the actual tax brackets work. I think I'm getting ahead of myself, but they're Most people.

Speaker 2: 8:15

When we look at our income tax return, we don't actually understand how to read it. You know, and you'll see the effective tax rate. It's like oh, you know, you paid 14% taxes last year. That's not the tax bracket. That's like if you took all the taxes you're paying divided by all your income, that was your average rate, but it's not the rate of the next. You know $1,000 of income that you make, that's going to be the actual bracket that you've fallen.

Speaker 2: 8:38

So there's some things that we need to understand and we need the projection to show us that and we need to be nerds with the projection. This is another issue with projections. If you are not a and we teach all of our financial planners is when you start to learn software and financial planning. We actually make them live in the ledgers so that they look for errors in the sequence of numbers, because that's how you figure out if you've got a problem in your projections and you can say, well, that's not important if I have a couple of errors in the projections or I get a number wrong. You could get a number off by 1% and then all of a sudden, the cascading impact of that is you can make a completely wrong conclusion that a Roth conversion is good or bad for you. So you got to have detail, and not only detail, but you got to be able to understand the model. When the model is not right, or when the model needs to be adjusted, or when you know you need to play with some assumptions, or sometimes you can't even build them into the system.

Speaker 2: 9:36

I and I'll just say this one more time with with modeling. So people do a model for you and they'll say, okay, this is you without a Roth conversion, this is you with a Roth conversion. And one of the things that always strikes me as interesting as they'll have the IRA, the retirement account where the money is being converted out of, they'll have that with an average return of, let's say, 8%. And then they put it in a Roth and that's got an average return of 10%, because I say, you know, we'll be more aggressive over there, which is there's good reason to be.

Speaker 2: 10:05

How much of the benefit of the Roth was the extra investment risk versus the actual taxes? If you're not going apples to apples, because then you'd have to create a scenario that says, well, I take a, you know, I'm going to make my IRA more, more risky so that I get 10% return, like getting a Roth, and then I'm going to do conversion. So we have to be very careful with these models of their detail. But we actually understand the details. I know word salad to get there, but I can't overemphasize how important it is to know your numbers. You need to know your numbers.

Speaker 1: 10:39

You're like the guy at a party you know what I mean that you feel like you know a little bit of information and you kind of open up and then the next thing you know 15 minutes later you're like, wow, I really don't understand. Based on what you just said, that was a masterclass, in the way of again what I always try to say on this show. I think people's intent is in the right place. They want to do the right thing. So they hear of the idea of a Roth conversion from a friend, from a colleague, from an online chat on Facebook, and people are doing it. So they go to the internet and they ask should I do a Roth conversion? And then I had told you the first four things that show up on should I do a Roth conversion? Well, we're all sponsored ads by investment firms telling you not even should you do it, but we will help you do it. So you see the little sponsor and immediately your spider sense should go off.

Speaker 1: 11:26

Well, I think what you're trying to help model out is it is more complex. It's not a simple situation because of the specificity of your unique situation. What does it look like? Again, when we talk about financial literacy, you'd be taking chunks of money from your traditional IRA, paying the taxes, converting it and then opening a Roth IRA, which then would be funded by that money, which then would allow you to choose your own investments and do things. So what would it look like if you could get that number right every single year? Not because you used an online calculator God forbid AI or something that told you that idea of living in the ledger, I think, is so powerful, because there is a human element to all of this, when you grow as a professional and you understand through trial and error and years of experience what to look for. A computer can never duplicate that, because it only spits out what it's told and how it's built on a chassis, and so there's a lot of people that are taking this information almost as gospel truth online by saying, well, I plugged in the numbers and I got the information. There's a lot more involved and I think what I found is almost contradictory to what you just said, as you started off with understanding your long term projection.

Speaker 1: 12:35

The very first blog post, again, if you missed our last episode, travis and I use the internet not to find information ourselves, but to do a little bit of due diligence on what is the internet telling people. I clicked on a blog from an actual well known organization that said should I do a Roth conversion? And their very first point is you need to actually factor the short term complications. So you presented that you have to think about the long term and the very first point in this blog post is only think about the short term. So think about the conflict there, like what's right for me this year? And I think what you are trying to say is a planner of do you want to save on a ton of taxes over your lifetime by getting this right, or just kick the can another year to save a little bit this year? So I think these next points will really kind of highlight what we're talking about.

Speaker 2: 13:20

Yeah, and I think that the planner of the future so everybody thinks they can just do everything online and artificial intelligence is going to make this all irrelevant anyway, or they already have a planner and their planners just you know, they got it all figured out. The planner of the future if I passed away and my wife was looking for a financial planner, she should be working with a financial and tax planner, somebody who is competent in both, or a firm that has the resources in both and their recipients. Because if you are making financial decisions without clear understanding of the long term, not the short term, the long term tax ramifications, then you are not doing financial planning. All you're doing is moving stuff around in your paper. Right, I mean, that's it. That's you're not doing planning. You have to be able to account for the long term ramifications of the tax decisions.

Speaker 2: 14:25

The typical tax preparer you go to. You go okay, cpa, I'm here to do my taxes. They're trying to keep the candidate. Look, we saved you tax money this year, right, but you saved me tax money this year, but what happens in 15 years when I have to take that money out? Is that going to be a better or worse situation? I don't know, talk to your financial advisor. You go to your financial advisor. You say, hey, I want to do a Rothkofer. They go, you know, that's a great deal. In fact, we're all that 401k over here and we'll convert it to a Roth for you and get it invested for you. And then you say, but you know, what about the taxes? You know you had to talk to your CPA about taxes, the advisor of the future that cannot even be replaced with technology, as a person or the firm that can do both of those at the same time. Right, that doesn't have to kick you over to somebody else who's not interested in talking to the other party and really get into the gory details of tax planning and financial planning. And I think that that's important because the way that you look at these situations as an individual is there is an awful lot of individual circumstance related that is very, very difficult to actually pull out on paper or to put into a online calculator or projection or tell chat GPT to account for, because there's calculated risk essentially, or gambles that you're taking with some of your decision making.

Speaker 2: 15:51

So a couple of things. Let's say that you got a long term projection and you got it built up. Well, first we talked about you. Got to understand your current tax bracket. Somewhere you follow them. Are you in the 12% bracket, 22% bracket, 24% bracket, a higher tax bracket what bracket are you in? And not like, oh I had $100,000 of income, so I must be in the 22% bracket. No, if you're married, that's probably going to put you in the 12% bracket. Like, actually truly understand what bracket you're in and how far into that bracket you are Right. And not only that, but where are you likely to fall in the future?

Speaker 2: 16:25

If I'm in the 22% bracket today and because of how my assets look in retirement, I'll never be about the 12% bracket. Why would I want to pay taxes today? Pay them in the future. I'm going to pay 12% in the future. Today I pay 22%. That'll make any sense, right? Or let's say that I have money that I'm never going to spend and when I pass away, I'm going to leave it to charity. Charities don't pay income taxes, so why would you do a Roth conversion? Leave that money to the charity. Let's pretend you had a million dollars. You have a half a million dollars in an IRA and a half a million dollars in cash. Leave the cash to the kids. Leave the half a million dollar IRA to the charity. Don't worry about the taxes If that's what you're going to do.

Speaker 1: 17:08

Yeah, but most people don't get to have that conversation, travis, because they have glorified salespeople. And I appreciate the little bit of feistiness coming out of you in this conversation, because you shared some things that are a little bit unleashed. You know, and that's what I appreciate about you is you're saying things that people need to hear, because a lot of what people are looking for is exactly what you just said is an advocate or somebody that is going to try to understand like, hey, tell me what you're trying to do. Okay, charity is important to you, your children are important to you. What's the thought process? I'm going to do this and then I'm going to do that. You want somebody who's going to say, hey, great idea, executions a little off. Actually, what we want to do is use this asset that you have to fund a charity the other one to leave to your kids, because it's going to net you this much in tax savings and it's going to make your plan look like XYZ. Somebody's going to go holy frickin crap, like I might have done that wrong. Right, you might not have executed the wrong moral thing, but the way in which you would have gone about trying to do something.

Speaker 1: 18:04

I think when we have the pleasure of talking with new people through ditch the suits and through what we do for a living with financial planning. There's not people that I think are just completely missing it because they're trying to. They're trying to do the right things because they've been acquiring information, but many times it's the execution. It's not understanding truly how tax brackets work. Where it's. You're talking about the difference in small decisions that, added up over time, can make significant differences, not only for you, for your surviving spouse, for your children, for organizations that are near and dear to your heart. Man, you got to get this stuff right because it can lead to significant amounts of getting the most from your money in life.

Speaker 1: 18:44

So why don't you hit us with a couple of the last steps and points here? Hey, at ditch the suits, we're all about bringing you great resources and you're obviously here because you love podcasts. Well, what if we told you that I, one of your co-hosts at ditch the suits, has now launched my own podcast? If you like the tone of obviously you've learned in this episode? I try to always bring kind of the heart of the issues that we bring, to bring it full circle as to how to apply it to your life. Well, if you want to head over and check out the one big thing podcast, it's an inspiration and encouragement podcast where my job is to help you, as a listener, really move the ball forward, to take you from inspiration to transformation. So, if you'd like podcasts, be my guest. Head over to the one big thing podcast today and take a listen.

Speaker 2: 19:26

And that made me think of something too when you do a Roth conversion, you also have to account for where the taxes come out of, because if you have cash in the bank account and you can write a check to cover the income tax bill, that's very different than doing a $100,000 Roth conversion and having to take out 20 grand for income taxes. And now you get an $80,000 conversion. So you paid income taxes on the money that you're going to use to pay income taxes on. So it's like almost getting taxed double. And so you really understand how all these things work is so important. But there's a thing called QCDs qualified charitable deductions and that is once you're over 70 and a half. You can actually give up to $100,000 a year right out of your IRA to charity. You can't do this out of four. Okay, it's one of the reasons why a lot of people might decide to do an IRA rollover in retirement so they can do this, but straight from the IRA. You can send money to charity up to $100,000 a year and it comes right off the top. You get that plus your standard deduction, so you don't have to worry about if you're itemizing, so everybody who's writing those little checks every year and then they're getting their standard deduction. You don't get any credit for the tax deduction Because you have a standard deduction. Well, you switch over when you're 70 and a half and you haven't come out of the IRA and you essentially get to give the tax or the gift of charity from your tax deferred money, but you'll never pay the tax bill on it and you still get your full standard deduction.

Speaker 2: 20:53

But the reason why I bring this up is let's say that you give $30,000 a year to charity. I have people do this, or maybe it's $10,000. Whatever the number is. Let's say you give a bunch of money to church and charity or whatever, and let's pretend you had a million dollar 401K playing and so you say I give $30,000 every year. I got lots of money, I'm going to be fine with that, and I got the million dollar 401K plan. I'm going to go ahead and get that out of that, I'm going to convert it to a Roth and I'm going to get done with Uncle Sam. I'll never have to pay them tax dollars again.

Speaker 2: 21:22

So this $30,000 a year that you get to charity, you could have been giving tax free out of your IRA. Instead, you said you know what? No, I'm just going to pay the taxes on it. So you pay the taxes on it and then you give tax deductions, of which most of it you're probably not able to get a credit for on your deduction. Now, if you're giving 30,000, you're going to be itemizing, but the first 20-odd, some thousand dollars, you're not going to be itemizing because that's part of your standard. So you're not going to get credit for it. So it's like and I've seen this before Client has absolutely no use for the IRA or the 401K, but they do give $30,000 a year to charity. Well then, fine, leave it down to count alone and just take it out of that account from $70,500 going forward and give it to charity and you won't have to worry about the tax bill. You know, you can have your cake and eat it too. I mean, it's a wonderful thing. And then the other one is IRD income and respect to descendant.

Speaker 2: 22:15

Let's say that you figure out. Well, geez, you know I'm in a. I'm in a high tax bracket right now and I'm gonna be a lower tax bracket when I retire me. My tax brackets not gonna change All. So actually it's all the same, doesn't matter if I convert anything.

Speaker 2: 22:28

But then you did a good job raising those kids of yours. And your kids are real successful and they're making some serious money, more money than you ever made, and they're and they're doing a good job because you taught them Well, they're saving their money. So what? You gonna leave them a tax bill? Oh, good for you. You die. You have two million dollars.

Speaker 2: 22:44

They each of your kids inherit a million dollars. They're both making more money and you're both in a higher. You're in the 22% bracket. There are two brackets ahead of you, right? They're paying a lot more income taxes than you. Maybe they even live in a city where they have a municipal Income tax and they have, you know, a state income tax or something like that. So they got a lot of taxes going on. And you're like well, you know, here's my million dollars. You inherit it. Now you have ten years to cash it out, because that's the rules and you have to pay the income taxes over ten years and your peak earning years.

Speaker 2: 23:17

Versus Talking with the family I love my family I want to make sure they're doing. Well, I know I'm gonna leave the money because I'm not spending other money what's your tax situation? Oh, you're in a high tax situation. I'm in a lower tax situation. I'll pay the tax bill now. Thank you very much, because that way you're gonna save 20% when you inherit it 20% more than what you otherwise would have paid. So maybe you would have inherited a million dollars and got 600,000 out of it. Now You're gonna inherit a million dollar like an 800,000 dollar inheritance, but not actually own any taxes left on it. It's so important to understand these projections and how they work and to go beyond the five minute Easy online click, click, click, click, click. Okay, by this annuity or by this insurance or by this investment, we have to go so much further.

Speaker 1: 24:05

Well, it may be hard if you're just audibly listening to this to conceptualize what you're talking about. But if you just just to help kind of paint a picture for people, if you did have this two million dollars right In a traditional IRA and you have named your spouse as your beneficiary and your children as your contingent and your spouse pre-deceases you, so when you pass, you leave this money to your children, it passes directly from your traditional IRA to your two children, who are successful in doing well, and they inherit a million dollars each. They're going to get crushed Because the tax laws changed that when they inherit this money, they have 10 years to get that money out of their name and spend through it. So if they're making serious money and now they inherit a million dollars, which you would think I did my job, I left a legacy you did, but it also came at a cost, because they're going to inherit a million dollars, as is an inherited IRA, and they only have 10 years to spend that through completely, which is going to crush them every single year because of all of this income that they're going to show.

Speaker 1: 25:04

What you're talking about is if we have a long enough runway and we know that we want to leave money to our children. Hey, let's start to convert some of this traditional IRA money the two million to a Roth. We'll understand how much every single year to convert. We'll take that money from the traditional IRA, pay the tax on it and start to fund the Roth IRA, and then we will name the children the beneficiaries of the Roth IRA, because what's going to happen is, when you pass, however much money is in that account the 800 thousand dollars, whatever it is your kids are now going to inherit that tax-free. They do not have to take an RMD.

Speaker 1: 25:41

If that is the only thing that you got from this entire episode so far that if you do this Well, you have the potential to leave your heirs basically a tax-free asset Because you are going to pick up the tax while you're alive Think about a tremendous. Not only are you having your cake you need it to that you talk about you're talking about the legacy, which is extremely important to you, but also the mechanics of how it's going to happen that will set your children up in a better Position without having to pay a tax bomb. This is the kind of stuff that gets me excited, because you want to listen to financial planning, to know what investment to pick and how to get rich quick.

Speaker 1: 26:16

Solid financial planning is not getting rich quick. It's a series of really good small decisions, one after the other, with Intentionality and purpose. To understand that you do not make any one of these decisions in a bubble, you have to understand all the moving parts, which is, through the first episode of social security, what you did, and this one man. This has the ability to throw juice on everything you're trying to do, but you have to really understand all the moving parts and I think you're doing a really nice job of explaining that.

Speaker 2: 26:43

Well, the interesting thing here, because it gets even more complicated. You know, if you're doing Roth conversions, considering them, you also have to consider what your social security strategy is.

Speaker 2: 26:52

You know, go back and listen to the last episode should I do a Roth conversions, like you tell me about your social security strategy. Well, what's that got to do with it? You know, and again it goes back to you got on, you got to understand how all these things go together. So there's two more steps left, two shorter steps here. We can get through these a little quicker. So let's pretend that you've done the analysis. You figured out I should do a Roth conversion. Question then is how much? Because you can. What you're doing is you're accelerating your tax bill and you're so you're moving money from a future tax bracket into a current tax bracket. Right, and so you could. You can move too much forward so that the tax bill becomes so high that you lose the benefit of paying the tax bill today because you have to give up so much. Principle. So there is an art to finding out how much Roth conversion you should actually do. And again this goes back to our projections. You have to make sure that you you don't have errors in your numbers that are allowing some other factor to be the reason why the, the Roth, looks like it's a benefit. For instance, if you have the higher rate of return on the Roth versus the IRA, that's going to skew whether or not it's in your best interest to do the conversion. And the problem with performance is it doesn't always happen. So we don't. We need to understand that. But we have to come up with the right number, and so that's where a lot of tax planning, a lot of projections come in. A lot of financial planning comes and not, and not just like you know, oh, here's a perfect world, but what about a contingency like, oh, when do you have to redo your, your roof again? Or when are you gonna need a new furnace or a new duct system in the house and you're gonna have to take out an extra 20,000? Well, that's gonna impact your Roth conversion plan quite a bit, because you gotta make sure there's cash available for it. You know, or jeez, if I do a Roth conversion and I get up, you know If I'm married and I get up over hundred ninety four thousand dollars for my modified, adjusted gross income, which is completely different than that them? You know the income you're paying taxes on. So it's a different number that you probably would not be necessarily aware of, because we don't normally think about that number. Well, let's say it is that number and you hit a hundred and ninety four thousand five hundred. Now your Medicare premiums go up. So that's like having a tax, you know, because they're gonna come back and say thank you very much each you. You can pay us a little extra every month. Now, well, you got an account for the loss or that extra tax in whether or not it benefits you to pay the tax early. So there's a lot of things that we want to do. So that's step four. Step five this is this is the freebie, this is the extra one.

Speaker 2: 29:30

You figured out that you wanted to Roth conversion. You did the Roth. You figured out the right amount to do. You did the rate amount. Once you've done it. Now this is just the fun part.

Speaker 2: 29:42

Now is when you go back and you look at the performance. So you think about it like this there's two big things to think about Timing and I'm not saying that you should be market timing, but there's times where it's obvious the stock market has done bad. Last year it did bad. It was pretty obvious. At the middle of COVID it was doing pretty bad. It was obvious. If you know you're going to do a Rothbard, you've already done your due diligence. You know you're going to do somewhere around a $40,000 Roth conversion coming into last January and the market did what it did Somewhere around the middle of the year. You'd be like, let's do that Roth conversion.

Speaker 2: 30:16

Now that's counter to most people Don't touch the investments, they're down. No, you want to do it. When they're down, you sell the investment that's down. So let's pretend you have investment A and it's down 40%. Right, you sell investment A, that's down 40%. You take it from the IRA, you put it in the Roth, you pay taxes on what it's actually worth at that time, which is 40% less than what it was worth at the beginning of the year. Right, so you're going to pay a smaller amount of taxes.

Speaker 2: 30:44

And then the market recovers. And this is what happens every time the market recovers, in that Now it doesn't guarantee your investment is going to go back up to 40% because you might have had a bad investment. But assuming let's pretend, you have an index fund and the index fund was down 40%. Well, when the market recovers, it goes back up to 40%. So you took, let's say, $40,000 and you put it in. You took it from the IRA, you pay taxes on it, you put it in the Roth and then that $40,000 essentially goes up. Actually it would be more than 40%, right? Because if you're going back up let's just pretend they went back up only 40% that's another $16,000. That means it goes up to $56,000. But you only had to pay taxes on 40 to get 56 over there. So you really want to take advantage of those dips, right, and again, they're obvious when they happen. But in order to take advantage of them, you already have to know that this is something that you're going to do, because you have to do a lot of calculations to get the right numbers.

Speaker 2: 31:43

The second thing is is when we're doing the Roth conversion, we tend to think of our accounts as separate accounts, right? Well, I got my IRA and what's my risk over here, and what's the portfolio? Then I got my Roth and what's my risk in my portfolio, and maybe I just have the same thing in both of them, or something like that. You have to get more sophisticated than that. Well, you don't have to, but you're leaving money on the table Like you're just wasting your money, right? So it's so funny when people are like I don't want to pay a fee for investment or financial advice, and it's like if I could show you that you're leaving an extra one, two or 3% on the table, would you pay me? Nah, it's not worth it. It's like, well, if you don't care about the one, two or 3%, why won't you give it to me? Then you know like, maybe I'll help you with something else then if you don't care about the money, right. But it comes down to I don't want to believe it. I don't want to believe that I can do this.

Speaker 2: 32:32

Listen, take your portfolio and look at your portfolio. But look at all your accounts as if they were one giant account. And in your portfolio maybe you want to have 50% in stocks and 50% in bonds. You know the difference between stocks and bonds. Stocks can go up indefinitely. You can have the years where you make 40% on them. Bonds aren't going to do that. Bonds have really a finite amount of return that they can bring you. So in general, we're going to say the bonds are conservative and maybe you'll get 5% a year off of them, and the stocks are aggressive and maybe you'll average 10% a year off of them. Now when you see your portfolio and you have a 50-50 mix, it comes out to 7.5% average return because you got 50% in each one. One's doing 10, one's doing 5.

Speaker 2: 33:15

But in reality, inside of that household portfolio, you've got these sub-accounts. You have an IRA, you have a Roth and an after-tax account. What if you looked at that Roth and you said, hey, roth you could be, you make up 20% of my money, which is well below the 50-50 split, right? So if you had a million dollars, you'd have $500,000 in stocks and $500,000 in bonds. And then you go well, I got a $200,000 Roth. You're supposed to have $500,000 in stocks overall. So instead of doing 50-50 in each of the accounts, put $200,000 in that Roth, all in the equities. And again, there's other things you got to look at. You got to look at when you're going to need the money and everything like this. So I'm not telling people to go out and do this, but this is conceptually where you want to go with this.

Speaker 2: 34:04

If the average return, the long-term average return in the Roth is 10% instead of 7.5%, right, you're going to have more money in the Roth, more money growing tax-free. And then what happens in the IRA? Well, there's less stock money. So that mix ends up being something like 40-60 or something like that, or 30-70. So it becomes a lower allocation to stock. So the average return in the IRA goes down. You're still averaging 7.5% because you still have the same percentages, just more of it's in the tax-free bucket. So what's happening is your future RMD, your future tax bill, is growing slower and your future free tax, tax-free money is growing faster Same 7.5% return, but you'll get less IOU.

Speaker 2: 34:51

So in one scenario maybe you would have got to the end of the race and you would have owed $400,000 in income taxes. The other one you get the end of the race at the exact same dollar amounts, but now you owe, let's say, $200,000 in income taxes. So we call it asset location. That's understanding how to construct a portfolio. So people could say well, there's nobody who can make me more money in the market, so I don't actually need to make you that much more money in the markets. I need to teach you how to take advantage of the different tax situations that you have in front of you for the rest of your life, and then we can use the markets and maybe you'll get a little bonus from that too. But there's so much to be made by just understanding how the taxes actually work.

Speaker 1: 35:32

Come on, man, let's get fired up. And for those that again.

Speaker 2: 35:34

That was boring right?

Speaker 1: 35:36

I mean like oh that was good, that was gold If you entered this conversation and you had never heard Roth conversion. We always try to remind people too, because we hear it every day in our work, that people say my IRA made so much money or my 401k made so much money. Those are just tools and vehicles. The investments within those accounts is what made you the money. What people don't realize is, just because you convert money from a traditional IRA and put it in a Roth, you still have the opportunity to grow your money tax deferred, so your Roth IRA can hold individual stocks, bonds, any types of investments. You can invest it however you want. But what a lot of people do is they convert money from a traditional IRA, put it into a Roth and then buy all the same exact investments, and so there's no real strategy involved, other than maybe I did the tax thing, yay, hurray. But what you did in this entire conversation is show people the specificity that you can use. That can create long term legacy type building and then understanding just that freebie at the end there. I remember when we were first going through. That whole idea of amplifying your investment accounts by understanding the asset allocation through those accounts is just. I mean, that's an incredible concept, if you really understand that. So don't forget, if you're like guys, I want more information. We told you it matters about social security.

Speaker 1: 36:47

Go back and listen to the last episode in this series. We got two more talking about should I retire in a bad economy? Go Google that one. And then the last one should I get rid of an investment that is losing money? So, as always, you can visit ditchthesuitscom, get in touch with Travis and I. Again, we hope that this is not your last stop, but if this is you just entering the DTS train, don't forget to subscribe, follow this show, because I think we bring you really good content, but I'm extremely biased. So, partner, great episode. Thanks for stopping by ditchthesuits. It's our goal to help you get the most from your money in life and, until next time, thanks for being our guest.