Question #1 from Audience
So, the question comes from an anonymous attendee, and she asks, “My current financial advisor recommended that I do not make Roth conversions at this time. His belief is that my husband and I will be in the same tax bracket in the future as we are in the present. Is this accurate? We are both over 65. I am receiving Social Security. We will wait until age 70 for my husband to collect Social Security in two years. Our goal is to leave any monies to our only son who IS in a high tax bracket. Help!”
Well, not surprisingly, I profoundly disagree with that advice. Let’s even assume that the advice or that the projection is accurate. Let’s assume the taxable income―and I’ll even go further than that―and let’s even say that the tax rates don’t go up and taxable income is steady, and if you want to add inflation on that, you can do that either with or without, but the math on Roth conversions and our starting point is we don’t automatically assume the taxes are going to go up.
Let’s assume that the CPA did the projections, which I sincerely doubt, and that the income is going to stay the same. Income being the same, when you run the numbers, the Roth conversions are really good and are very favorable―even with steady tax rates and even with a conservative investment rate.
Now, if she would have said, “And my kid is in a very low tax bracket,” then it becomes a tougher question. So, I won’t even get into that. I’ll just address the easy part which is the kid is going to be in a higher tax bracket. So, let’s just say that the couple is in the 22% tax bracket, right? Not only would I do Roth conversions at 22% tax, I would actually test higher conversions where you don’t break even on year one (like I talked about earlier), and you run that out to reduce future required minimum distributions. And then after you and your spouse die, the money goes to the kid who might be in the 32% bracket, even if they don’t raise taxes.
So, I hate to say it, but the right advice that your CPA should have said is, “I haven’t run the numbers. I don’t really know. So therefore, rather than give you advice that will hurt you, I will just tell you I don’t have that area of expertise.”
There are a lot of areas where I don’t have a high level of expertise. When a client asks me a question that requires me to have that area of expertise to know the answer and it’s not readily available―but this whole thinking isn’t readily available―the CPA would actually have to read a couple chapters of the book and study it a little bit. The right advice is rather than giving you advice that’s going to harm you is to just say like Clint Eastwood said, “A man has got to know his limitations. I just don’t know.”
And that’s what your CPA should be saying. Instead, he is giving advice that not only as a matter of opinion I profoundly disagree with, I would say as a matter of math. Let’s even use the CPA’s own assumptions, which is income is going to be level. Let’s even further say tax rates are going to be level. I can mathematically prove that your kid and that the family is going to be way better off by doing a series of appropriate Roth conversions. So, I have to disagree with that.
Question #2 from Audience
Jose asks, “Are there any important gotchas that one needs to be aware of if doing Roth conversions while taking RMDs?” So, I guess that would be anything that you need to watch out for on the tax side.
Oh yeah, but by the way, there are gotchas all throughout the tax code, and a lot of people end up suffering because of them. Let me tell you one that comes up often. So, let’s keep the math simple. Let’s say that there is $1 million in your IRA. Let’s say the required minimum distribution is $50,000. And a lot of people say, “Oh, okay, well, since I have to take the money out anyway, can I do a Roth conversion?”
And they actually do the paperwork for a Roth conversion of their required minimum distribution. No, you can’t do that! If you want to do a $50,000 Roth conversion and you’re already taking a required minimum distribution of $50,000, you have to take your required minimum distribution, and you have to pay tax on the Roth conversion.
So now you’re paying tax on $100,000. That is an easy gotcha, and that happens all the time. And if you want to do a $50,000 conversion, you have to pay tax on the Roth conversion. And it bothers people to no end that they can’t do a Roth conversion on their required minimum distribution. And to those people, I say, “Good try, but you’re not allowed to do that.” In fact, now some of the companies won’t even let you do a rollover until your required minimum distribution is covered to help you from making a mistake.
But the other things that you might run into, I’ll tell you what happens all the time for the do-it-yourselfers. Sometimes they know enough to do a Roth, but they don’t know enough to get the amounts right, or some of the income limitations right, or they don’t take into account Social Security, Medicare Part B, or over taking into account the early years for Medicare Part B and not taking into consideration a long-term situation.
A lot of times people treat all their kids the same. To me, it’s not really a gotcha because that is what most people do, but there is so much opportunity with Who Gets What?, which we talked about in the first session. For example, leaving IRA money to charity, not after-tax dollars to charity, and that way you’re saving 24% for the family. I don’t know if you want to call that a gotcha or not. I look at anything that isn’t maximized as a gotcha, and there are a zillion of them out there.
We’re not taking advantage of some of the sophisticated strategies. Technically not a gotcha, but I love to maximize more for families, maximize more for charity, and minimize for Uncle Sam. And if you saw the first session, when I talked about significantly reducing Uncle Sam’s share of the pie, everybody else can get a bigger share of the pie.