I’m 62 with $1.5 Million: Can I Do a Roth Conversion & Save on Taxes in Retirement?

Ready to take control of your retirement tax strategy?

Casey Weade: So you're 62 years old with about $1.5 million in your tax-deferred retirement accounts, your IRAs, 401ks, and you're wondering should I be doing a Roth conversion? Today, I'm going to show you that you probably should be considering at least a Roth conversion. We're going to take a look at two different scenarios; scenario A and scenario B, with scenario B potentially saving you as much as seven figures in taxes in retirement.

Hey, I'm Casey Weade, CEO and founder here at Howard Bailey Financial. I'm also a certified financial planner practitioner, and I'm here to talk taxes. I love taxes. Don't you love taxes? Probably not that much. I do love talking about taxes and tax planning because I find that this is one of the areas that a great financial planner can make the biggest impact in your financial life.

Today, we're going to walk you through the basics of Roth IRAs so that we can understand why a Roth, why a traditional at any point throughout your life. We're also going to be discussing why this is such an important point for you to be making a decision on right now because of where we find ourselves throughout history and what's going to happen with future tax rates so that you can make better decisions today. Before we will then jump into some scenarios and show you the impact of doing different types of Roth conversions and just how much that's going to save you in taxes over a lifetime.

Now as we get started, let's talk about the basics of a Roth IRA and traditional IRA. I come from a background that a lot of our family was farmers and those farmers would often say, I get this bag of seed, I throw it out into the field and it grows into this big old crop and then I have to pay taxes on all that. What would be really preferable is if I could take that bag of seed, just pay taxes on the bag of seed, throw that out in the field, watch it grow, and then harvest it all tax-free. That's really what a Roth IRA allows you to do. You're paying the taxes today, letting it grow tax-free and also allowing it to be free from required minimum distributions and pass on to your heirs tax-free as well.

With a traditional IRA, we put the dollars in today, we get a tax deduction that grows tax deferred and then someday Uncle Sam's going to come along knock on your door, and say, "Hey, whether you want to take the money out of that IRA or not, you have to." You have to take them out as required minimum distributions that are going to be taxed at your highest marginal tax bracket, which could be impacting not just your tax bracket, your federal taxes, your state and local taxes, but it could also be impacting things like Social Security taxes and even Medicare premiums.

Let's take a look at another great chart from our good friend Michael Kitces. He's got this great graph that he put together for us to take a look at that you can find on his website. We'll have a link in the description so that you can follow yourself right over there to the Kitces blog, which is a financial blog designed for financial advisors. In this graphic, I think it does a great job of helping us determine whether we should be putting money into a traditional IRA or Roth while we're working or whether we should be converting and whether we're working or in retirement. It all has to do with our current tax rate and our future tax rate.

He has this great illustration of really a teeter-totter. If currently, you find yourself in a higher marginal tax bracket, then you're going to be in the future, then you should be putting dollars in a traditional IRA. Take that tax deduction while taxes are high and when taxes are lower you take those funds out. When it comes to a Roth IRA, you want to do the Roth IRA when your current marginal tax rate Is low and your future marginal tax rate is going to be higher.

We know that makes sense, however, things are changing. It used to be that it was just common sense. While you worked you always deferred those taxes because most people knew that they would be in a lower tax bracket when they stepped into retirement. Now we don't have that same level of certainty because there's a high risk that taxes are going to be higher in the future for a couple of different reasons. One of those reasons is our US federal budget.

I'm going to take you over to my favorite doomsday website. That is the US National Debt Clock or usdebtclock.org. I'm going to take you up here in this top left-hand corner. This is the important one here. Our current US national debt is running just shy of $35 trillion. That means every taxpayer owes about $266,000 and every citizen owes about $102,000. That means if you have children, you have grandchildren that were just born, they're being born into this world and they're already carrying with them over a $100,000 in debt.

It's not slowing down as a US federal budget deficit is running nearly $2 trillion and our US debt to GDP ratio, it's not slowing down, from 1960 at about 53%, 1980 34%, 58% in 2000. Now it's at 123%. In large part, that's not just due to Medicare expenses, Social Security expenses, defense expenses. It used to be largely due to these first two items, Medicare and Social Security, really the third rail of politics. Now we have interest on the debt becoming a much larger number nearly reaching a trillion dollars before we know it if Interest rates don't come down sometime soon.

Now we know the risk of rising taxes is pretty darn high just by looking at the numbers. We know that one or two things have to happen in order to get this under control. Either we're going to have to see taxes increase in the future or government spending is going to have to decrease. I think it's much more likely as most others do believe that it's much more likely that we see taxes increase than we see government spending actually decline.

There's another factor and that is something called TCJA or the Tax Cuts and Jobs Act. What I want to take a look at here are tax rates for married couples filing jointly because the example we're going to be using today is for married couples. Now, if we looked at individual tax rates, we'd see much the same thing that we're living in a very preferential tax rate environment. These tax rates are set to expire in 2026. If you're watching this video in 2024, you have 2024 and 2025 until we go back to the old TCJA tax rates and those are roughly going to most likely result in you paying about 20% more in taxes.

Let's take a look at the hard numbers. If you're in those very low-income brackets, $0 to $19,000, you're not going to see any change whatsoever. You're 10% today 10% later. Now, when we get into these further brackets. This next bracket up, a lot of people underestimate just how big of an increase this really is, going from a 12% federal bracket we find ourselves in today up to 77,000 in income to 15% in the future. They go, "Well, it's only a 3% change." That's actually a 25% increase in the amount of taxes that you're paying in that bracket. That's some significant change.

In the next bracket, that 25% bracket is currently at 22%. 28% is at 22%. 28% is at 24%. Then we get into this level of 240,000 to 315,000. This is the biggest tax savings we have right now. That is future taxes resetting back to the old tax rates pre-TCJA. That'll be 33%. Currently, it's 24%. That's a 38% tax savings you're getting right now if your income is landing in this zone.

Now the benefits don't get that much better beyond that. We get into these levels of up to 400,000, 425,000, 480,000. There's some places here where you're actually paying more taxes today than you will be paying in the future. In all likelihood, you're going to find yourself currently or in retirement below this $315,000 level. This is where the opportunity is because if you're converting Roth IRA today-- if you're taking dollars out of your traditional IRA and going up to this $315,000 bracket, paying taxes today, moving it into a Roth, you're paying at most a 24% federal tax rate on those dollars being converted. Which could be 33, could be 28, could be 25.

Those tax savings, we can see are just so significant in those lower brackets right now. 25% savings, 14% savings, 27%, 17%, 38% savings. As we said, this is why it's so vital that you're watching this video right now to make sure that you're making really good decisions for your future. Now what I want to do is jump into an example so you can see just how significant of impact it can make in your financial life by paying close attention to taxes and potentially doing some Roth conversions.

We're going to jump into this example here. We have David and Lee Roth if you will. David and Lee Roth, we're saying as we open the video, this is that example, they're 62 years old. They're 62 years old and they have just stepped into retirement as of the recording of this video. They stepped into retirement February 2024. They have some Social Security benefits at age 62. Decided to file for Social Security early. We are not recommending in this video you file for Social Security early or late for that matter. We are trying to illustrate the concept today of Roth conversion and why it might make sense and how that functions, what the long-term impact of that is. As I always say, you can't look at taxes in a vacuum, Social Security in a vacuum, long-term care, retirement income planning. All of these things have to be taken into consideration. Ultimately, we do that when you visit with our team. If you want to pull all of those things together, all you have to do is call the number on your screen, schedule time for a free financial analysis with one of our advisors, and we'll walk you through a more customized process for your own unique situation.

Now this couple, they also don't have a pension, like many of the families that are retiring today. We said they have about 1.5 million in an IRA. We can see that $1.5 million IRA here. They have a little Roth IRA, so about $75,000 in a Roth IRA. Then they have after-tax funds of $175,000. They're allocating that 175 fairly conservatively. These are going to be bond holdings here. Over here, we have stock holdings in those other two categories of traditional IRA and Roth IRA.

This is often what we find. This is just what we like to refer to as just out of balance. You have three different tax buckets. You have your 1099 bucket, the dollars that you pay taxes on every year, whether you spend the money or not. You have your tax-deferred bucket, which is that traditional IRA, 401k, 403(b), maybe a 457 plan if you're a government employee. Then you have a Roth, maybe even a Roth plan by your employer.

What we often find is that it's very heavily over-weighted to the tax-deferred bucket. If nothing else, what you want to accomplish is some tax diversification and start to move more of those dollars into some of these other buckets, maybe a 1099 bucket even. We know that tax-free is where we want to go, so most likely you want to over-weight the Roth dollars. That's just typically not what we see. This couple, they would like to create some tax diversification. They would like to have more of those dollars in that tax-free happy land called a Roth IRA.

Now let's apply some rates of return for our analysis here. We're using an average weight of return of 9.05%. Again, we're not projecting what rate of return we're going to earn. We're not projecting any type of model return or any specific product or tool. We're just illustrating how a Roth conversion can benefit you. Depending on this rate of return, it can greatly increase or decrease the overall benefits of doing a Roth conversion. This rate of return was actually derived from two different places.

The bonds that we have allocated here, we have averaging 1.44%. That is what bonds have returned on average. The US aggregate bond index through S&P has averaged about 1.44 over the last 10 years, whereas the US market, so US stocks, the S&P 500 from 1928 through 2023 averaged about 9.9% per year, dividends being reinvested. If you'd like to see exactly where we derived those numbers from, we put the resources right there in the description. You can check those out for yourself. Feel free to play with those numbers.

Then we have expenses, of course. They're planning on spending about 10,000 a month after tax. That is after tax. Again, a lot of this income, they have great Social Security benefits. It's not going to be enough to cover all of their expenses. They're going to have to withdraw some from that IRA. When they take funds out of that IRA, they'll have to pay taxes. Of course, we have to meet this number. We have an average inflation rate plugged in there at 3%. That inflation rate number of 3%, we look at the 10-year average, about 2.82%. 110-year average, about 3.27. We're using a reasonable inflation rate of 3% a year based on 100 years of historical inflation. Are they okay?

When they step into retirement, our software is going to show us that their first-year retirement here, they're 2024, they have about $2,600 in Social Security income. Their net expenses are about $10,000 a month. They need to fill a gap there of about $7,500 a month, $84,000 a year. Guess what? With those rates of return, those inflation rates, and all of those numbers we've plugged in, we can see they're going to be perfectly fine. They're going to have plenty of dollars to keep up with inflation over time. They're even going to be able to grow those assets quite significantly over their lifetime.

Now what we want to do, though, is do some tax planning. When it comes to guarantees in life, what are the two guarantees? We know it's death and taxes. This is where I often get disappointed with financial planners, that they don't plan around the areas you can actually get guarantees. We can't guarantee what the rate of return of the market's going to be, but we can get some guaranteed tax savings if we were to reduce your tax bill today. That would save you money today. We want to make sure we do at least some tax planning today and look at what that's going to be over your lifetime.

For this couple, their current tax, effective tax rate is 8.37%. You might say, "How could it be 8.37%?" Let's look at the brackets. When we look at their brackets, not all of those dollars are going to be in the 10% bracket. Some of those are going to be in the 12% bracket, and they have their standard deduction. They're going to have some deductions they'll be able to apply to get them to an effective tax rate that's neither 10 nor 12. I often see that mistake being made, that we're assuming just because we're in the 12% bracket, that we're paying taxes at a 12% tax rate. We also want to look at what that effective tax rate is. We can see they very quickly fill up that 12% bracket in retirement.

As the required minimum distributions kick in, now they're starting to creep not just into that 22% bracket, but then they eventually fill that up, end up in the 24% bracket. If they live long enough, they're going to end up all the way out here, believe it or not, in that 32% bracket, which we illustrated a moment ago, could be quite a bit different in the future, whether that is due to tax rate increases or just a default back to previous tax rates.

Now let's do some tax planning. When we do some tax planning here, we're going to use our software to help us illustrate what the benefits are and just how much we should be converting. This couple, they said, "Hey, we want to do Roth conversions for the next five years." They want to do five years' worth of Roth conversions. The system recommends we do $101,000 per year in a Roth conversion. Pay the taxes on the 101, convert it over to the Roth IRA. We are showing their projected top tax bracket would be 27.6%. Projected tax rate, 17.39%.

Their required minimum distributions, if they live long enough, will peak out at $600,000 per year. Projected RMDs of $8.7 million over their lifetime, that's projected lifetime taxes of $3.3 million. I think that's often what people find astounding is that you could end up taking all of the dollars that you have today and over your lifetime, all of those dollars essentially going to taxes. You could have a $1.5 million IRA that's costing you more than $1.5 million in taxes over your lifetime. This is why we want to get a handle on this. Then we have a projected legacy at about $8.4 million. That's what they would be projected to leave behind to their heirs.

Now, after that Roth conversion, they would be moving all of those dollars over their lifetime to Roth IRA. Their RMDs would end up being about $110,000 over their lifetime. $30,000 would be their maximum RMD throughout their lifetime, much better than $600,000. Their projected lifetime tax at about $733,000. Projected legacy of $8.2 million. You might go, "Why would I do that?" Sure, we have a significant tax savings of, what, $2.5 million or more here over your lifetime. My legacy is a little lower than what I started with. Let's keep in mind that these dollars aren't all going to be Roth and tax-free.

Actually, at the end of our lives, we're going to have about $3.4 million left in traditional IRA versus having all of those dollars in Roth. If we have $3.4 million in IRA when we pass away, what's the tax going to be to the heirs? It used to be that your heirs could take that $3.4 million IRA, and they could roll it over into their name and do what's called a stretch IRA. They could stretch the distributions out over their lifetime based on their life expectancy, essentially taking required minimum distributions each year. Now they don't have that luxury.

Now, due to the SECURE Act changes, they have to take those dollars out of that traditional IRA over a 10-year period. $3.4 million, $340,000 a year, not even thinking about what would happen if that account actually grew over that 10-year period. We know on $340,000, it's going to be a significant tax. When are they going to inherit those dollars? Your beneficiaries are most likely going to inherit those dollars in the peak of their earning years.

Now, that $340,000 gets stacked right on top of their working income. We can see that easily $1.5 million of that IRA could end up going to Uncle Sam. What's the tax savings to the heirs? That legacy could be increased by easily seven figures, $1.5 million or more by doing some simple tax changes here.

Now, let's take this analysis just a little bit further and see what's happening year after year to how much they're paying in cumulative taxes. In those early years, they have taxable income that's around $100,000, $150,000 not doing the Roth conversions. I also want to make sure we highlight the Social Security taxes here. They're paying taxes on those Social Security benefits that end up being very quickly taxes on 85% of those Social Security benefits. If you've been watching our channel, I've created some other great videos around Social Security so you can better understand how that Social Security taxation is happening.

Eventually, 85% of their Social Security is taxable. Their cumulative taxes increase quite significantly. Then we see those required minimum distributions continually increasing how much they're paying in taxes. When we do the Roth conversion, we can see our taxable income is significantly higher in those first several years as we're doing Roth conversions over a five-year period here. Their cumulative taxes are much higher.

We always want to ask that question, what's the break-even? The break-even is going to happen in their about 80 years old. In 2044, they're going to reach their break-even. After that, they are in tax-free happy land. They're never going to be paying taxes again for the rest of their life until maybe they get down here and they have some state taxes that kick in, maybe a little Social Security.

For the most part, after they get through this period of time, they're never going to be paying taxes again. That tax savings gets quite significant over their lifetime. We want to make sure that we're paying attention to that break-even point. I also want to make sure you're not over-emphasizing the break-even point because I find too often people say, "I'm not going to break even until I'm 85." I say, "What's the real break-even point?"

If you're never going to spend all of your IRA, the real break-even point could be tomorrow, depending on who's going to inherit those dollars. If you do these Roth conversions over the next five years, then you pass away, what are your beneficiaries going to be paying in taxes? Especially understanding that we know that stretch IRA provision isn't going to be allowed, we need to take into consideration what our heirs are going to be paying in taxes.

Now let's take a look at required minimum distributions. What are those RMDs? Those required minimum distributions in 2036 are about $100,000 a year, quickly breach $250,000 a year, quickly get to $500,000 a year, and end up being taxed at $1.5 million. With those Roth conversions, we didn't convert the whole IRA to Roth, but we did for the most part. As we can see, the RMDs are significantly lower after that strategy rather than prior to the strategy.

I don't know your unique situation, but given your unique situation, you should have a unique financial plan, a unique tax strategy put in place. What we're offering to do for you is to run a free tax analysis. We're offering the opportunity to visit with one of our fiduciary financial planners, get a free tax analysis, and start to figure out what the best strategy is for you at this point in your life. To take advantage of that free tax analysis and personal financial review, just give us a call at the number on your screen at 866-968-3658.