This episode focuses on a question David recently got from a couple – they made $650,000 per year and wanted to know whether they should consider doing a Roth conversion.
Some details about the California-based couple who asked David their question: they’re both age 50, with $1.5M in their old IRAs and 401k. They had a lifestyle need of approximately $100,000 after tax, and had about $1M in liquid savings in their taxable bucket. And, lastly, they were contributing $100,000 per year to that bucket and were growing it in plain taxable mutual funds.
The couple, which represents the case-study for this episode, are in the highest marginal tax bracket (at 37%). In addition to that, they would have to pay another 11.3% in California State tax. This means that, were they to do a Roth conversion, they would be paying tax on top of all their other income, and they would be paying tax at 48.3%. In other words, they would be giving away nearly half of whatever portion of their IRAs or 401k they converted back to the IRS.
Having all of the information above, the question becomes: does it make sense for a couple of 50 year olds to undertake a Roth conversion? For David, if they believed that the rates at which they’d be forced to pay in the future are going to be higher than today’s rates, then the answer is yes. Then, they should pay the tax today before the IRS absolutely requires it somewhere down the road, at higher rates…
However, if they don’t believe that taxes down the road are going to be higher than they are today, then they shouldn’t do a Roth conversion.
David discusses the fact that, sometimes, we get so caught up in the idea of getting to the 0% tax bracket at all costs that we fail to do the math along the way to see whether the cost of doing so actually makes sense.
For David, Roth conversions tend to make sense for people who will be in a similar income range in retirement – particularly if they’re currently in the 22 or 24% tax brackets.
David warns against allowing ourselves to become so consumed by the fear of higher tax rates that we make irrational decisions about the timing of our payments. We have to be patient, thoughtful and methodical.
David shares the fact that the situation this podcast episode revolves around is a classic case where it may make sense to utilize the tax-free qualities of the LIRP (Life Insurance Retirement Plan).
With the LIRP, we’re getting as little death benefit as the IRS requires, and we’re stuffing as much money into it as the IRS allows, in an attempt to mimic all of the tax-free benefits of the Roth IRA without any of the limitations of a Roth IRA.
Mentioned in this episode:
David’s books: Power of Zero, Look Before Your LIRP, The Volatility Shield, Tax-Free Income for Life and The Infinity Code
PowerOfZero.com (free video series)
@mcknightandco on Twitter
@davidcmcknight on Instagram