Roth Conversions Before and After Retirement with Will Doty

Sign up for our Weekly Newsletter Share this Episode

Roth Conversions Before and After Retirement with Will Doty Show Notes

If you’ve been around Dean Barber recently and have noticed that he’s smiling even more than usual, we might know the reason why. He just got to talk with Will Doty about his favorite part of the tax code—Roth IRAs—on The Guided Retirement Show. More specifically, Roth conversions before and after retirement.

A lot of people might think that there’s nothing to smile about within the tax code. Well, it’s still easy to feel that way, but former Delaware Senator William Roth did his best to change that in the late 1990s when he created the Roth IRA. Dean says it’s the best part of the tax code because the money in a Roth IRA becomes tax-free if you follow to rules. Dean and Will are looking forward to elaborating on that in this episode.

In this podcast interview, you’ll learn:

The Perks of the Roth IRA Being Tax-Free
How to Get Money into a Roth IRA
What to Consider When Deciding to Contribute to Roth or Traditional
The Roth IRA Five-Year Rule
How Medicare Premiums and Claiming Social Security Factor into Roth Conversions Before and After Retirement

The Best Money Is Tax-Free Money

When you put money into a Roth IRA, you are required to pay tax up front. That might scare some people off who are focused on paying as little tax as possible in one year. That’s not the mindset to have in this situation, though. The goal is to pay as little tax as possible over your lifetime. The Roth IRA is designed to do that because of the tax-free growth you’ll get within the account and on the distributions when you take it out.

“Think about it this way. What if you got to take home every dollar that you earned as opposed some of it going toward a FICA tax, Medicare tax, state income tax, and federal income tax? Your paycheck is eroded every month by taxes. How would your life change today if none of those dollars had to go out for taxes? That’s the Roth IRA. Once your money is in there, all your future earnings and distributions are tax-free for the rest of your life.” – Dean Barber

The longer you have your money in a Roth IRA, the longer that compound interest goes into effect. It becomes a bigger and bigger deal.

How to Get Money into a Roth IRA

The leads us to discussing how to get money into a Roth IRA. You can contribute directly to a Roth IRA or you can convert into it (i.e.: Roth conversions, and why we’re going to be discussing Roth conversions before and after retirement).

Roth Contributions

We’re going to touch on Roth contributions first, though. We’re going to use an example of a younger couple that are a few years out of college and in the first part of their careers. They haven’t had kids and they might be thinking about buying a house. They’ve both started contributing to a 401(k).

We’re going to assume that their employers offer a Roth 401(k) and traditional 401(k). Where should that couple save to? First, since they’re early on in their careers, their incomes won’t likely be very large. Should they want tax-deferred savings? Probably not. Let’s look at what could be in the cards if they contribute to the Roth while their income is low.

“As we do projections, hopefully their income is growing. Therefore, they’ll be at a completely different tax rate later in life. That’s why it may make a lot of sense for them to not take that tax deferral savings and get the money into the Roth so it will grow tax-free for the rest of their life.” – Will Doty

Roth vs. Traditional

Let’s say that they do want to defer $5,000 per year into their 401(k) plan. If they put that $5,000 into the traditional side of their 401(k), that will save them $750 in taxes today. They could get short-sighted in thinking that that’s $750 that they didn’t need to pay in taxes today, so that’s $750 more that they could spend.

If they saved that $5,000 into the Roth portion of their 401(k), they have no tax savings. In order to put the $5,000, it costs them $5,000. The good news, though, is that every dollar that the account earns is tax-free.

Soaking in Knowledge from America’s IRA Expert Ed Slott

Dean and Will are fortunate to be members of Ed Slott’s Elite IRA Advisor Group^SM, which provides them the opportunity to study IRA rules with other financial professionals nationwide. Bud Kasper, Drew Jones, and Logan DeGraeve are members as well. Dean’s favorite Roth vs. traditional examples comes from Ed.

“He says to think of yourself as a farmer. A farmer in the traditional world today buys the seed to plant. They get a tax deduction for the cost of the seed. They then plant the seed, and the harvest is all taxable. But what if that same farmer could buy the seed and pay tax on it before planting it? Then, the entire harvest grows and they get the harvest tax-free. Which one do you think the farmer would choose?” – Dean Barber

They’d choose the second option (the Roth) and it would be a no-brainer. The seed in that example is your Roth contribution. You must pay tax on the contribution, but all your future earnings are tax-free. Getting the opportunity to accumulate tax-free savings at a young age is a big deal.

Re-asking the Roth vs. Traditional Question as the Years Go on

Now, let’s fast forward about 15-20 years for this couple so that they’re in their mid 40s. They’re starting to earn more money at that point in their careers. Let’s ask them that question again: Roth or traditional? It’s a harder question to answer. They may have a need for that tax deduction. And they might be at a point where they can start to look forward and see where they’re going to be in retirement.

“I think that’s the blurriest time of whether you should contribute to Roth or traditional. Once you get into your 50s and you’re in your peak earning years, it becomes easier to calculate. Let’s say that the couple is in their peak earning years and is in the 32% bracket. Based on their income objectives in retirement, they’re only going to be in the 22% bracket. Should they contribute to traditional or Roth?” – Dean Barber

In that case, it’s still not concrete on what they should do. At that point Will believes that the traditional makes the most sense. They’re at the 32% bracket, so they can save 10% now. The decision can be a little bit tougher if they have long-term estate goals, though. How are their kids going to be taxed? That’s a whole different topic, but let’s briefly dive into it.

Let’s say that couple is still in their mid 50s and in the 32% tax bracket. They want to max out their 401(k) and are putting around $20,000 into their 401(k) pre-tax. They’re saving $6,400 apiece each year to put that $20,000 in.

Roth Conversions

But if they can be in a 22% bracket once they retire, they can start taking some of that traditional that they’ve rolled over into an IRA and convert it to a Roth. So, they got to deduct the contributions when they were at 32% and are paying on the conversion at 22%. That can start to give you a look at Roth conversions before and after retirement.

“By doing that, they’re 10% ahead. That’s almost a 30% spread. Once they convert, it’s like you’re paying tax on that seed again—the conversion—and all the future growth on that Roth conversion is tax-free.” – Dean Barber

The Five-Year Rule for Roth IRAs

This is a good time to bring up the five-year rule with Roth IRAs and Roth conversions. Unlike with the contributory Roth, the clock starts the second that you put a penny in with your first contribution. Where it’s different with the conversion is that each conversion has its own five-year clock.

“For most people, that shouldn’t be an issue because they’re not going to be touching that Roth for a while. The other part of it is that Roths are set up on the accounting method of FIFO—first in, first out. Let’s say you converted $20,000. Three years later, there’s an emergency and you’re going to your Roth. You can still get the $20,000 out with no penalty. You just can’t take out the growth you’ve had on it.” – Will Doty

The earnings need to stay in for five years and you need to be 59½ to avoid a 10% penalty. Here’s another example. Let’s say that someone was 50, got laid off for a year, and wasn’t going to have any income. They wanted to convert all the way up to the top of 12% bracket and convert $83,000 to a Roth IRA. They can still access that $83,000 without penalty. But if they take out any of the earnings, they would need to pay a 10% penalty since they’re younger than 59½.

Roth Conversions After Retirement

When we start looking at Roth conversions, why does it make sense to consider them after retirement? You’ll oftentimes have money in all the different tax buckets—tax-free, taxable, and tax-deferred—if you’ve done a good job of saving. If you have money in after-tax, you may be able to live on that bucket—taking down not just interest, but principal. Therefore, you’re tricking Uncle Sam into thinking you’re not earning anything.

“That opens the door to do the Roth conversion. You can do more of a conversion and maximize as much as you can in getting from tax-deferred status to tax-free.” – Will Doty

Planning Around Social Security and Required Minimum Distributions

In our discussion about Roth conversions before and after retirement, we’re really just getting started with Roth conversions after retirement. Planning around when you’re claiming Social Security and when you’ll be taking Required Minimum Distributions are two pivotal things to think about when considering Roth conversions after retirement. Let’s start with the Social Security aspect of it.

“Number one with Social Security is that most people don’t know how it’s taxed. We need to look at the provisional income test. You’re taking all sources of income—even municipal bond income, which is tax-exempt income that is potentially federally tax-free—into this calculation and half of your Social Security benefit. When you hit certain levels, your Social Security becomes taxable.” – Will Doty

You want to understand that dynamic as we’re doing the income planning when you’re in our 60s. You have these three buckets of money which we just mentioned along with your fixed income of Social Security. So, when do you turn on Social Security? And does it create more taxable income? That can get in the way of doing Roth conversions. Long-term, that goes into how you changed your RMDs later in life.

Tax Diversification

This is why tax diversification is so important. That means that you have done a good job of saving to all three buckets. Doing those Roth conversions over time and living on that taxable account can reduce those RMDs from your traditional IRA and keep you from jumping up into that next bracket once RMDs start. It can also keep your Medicare premiums lower for a longer period.

A Retirement Savings Tax Time Bomb

That’s a whole different scenario from someone who has saved most of their money to a traditional 401(k). All they have is a traditional 401(k) that’s been rolled over to an IRA and then they have their Social Security. The person in that scenario has painted themselves into a tax corner.

“We have seen scenarios where someone has done a good enough job saving into their 401(k) that a normal systematic withdrawal of 4% or 5% gives them all the money they need to live on and they don’t even need their Social Security benefits to pay for their bills. If that person isn’t working with a CFP® Professional, they might just let their IRA keep growing and defer their Social Security to age 70. They’ll think that that check will get bigger and not worry about RMDs until they start. That’s the tax time bomb that Ed Slott refers to in his original book. He wrote another book recently, The New Retirement Savings Time Bomb.” – Dean Barber

Dean points out in some of those scenarios that you know you’re not going to need Social Security as a means of living expenses. So, think about turning that Social Security on early and use that money to pay the taxes to convert from a traditional IRA to Roth. Dean has seen that that usually reduces the long-term tax bill.

Understanding the SECURE Act 2.0

People in that scenario are going to leave a lot of money behind. If they don’t do some sort of conversions, they’re going to be leaving an account that’s infested with taxes. Under the SECURE Act 2.0, their beneficiaries are going to be forced to completely empty that IRA within a 10-year period.

Most of the people who inherit those traditional IRAs are inheriting them in their peak earning years. Now, you could be taxed at the highest bracket, 37%, and that becomes 39.6% in 2026. And then there’s also the state income tax. There could easily be 45% of that money that’s gone to Uncle Sam if it’s left in the form of an inherited traditional IRA. That’s a different story if you do some conversions and your beneficiaries inherit a Roth IRA.

“Since the SECURE Act came out, I’ve been telling my clients to think long-term and put themselves into one of two camps. When you’re thinking about once you pass away, you might just say that your kids should be grateful that they got a penny. If you lean into that mindset, you’re just thinking about you and your spouse while you’re both alive. You want to understand what your taxes look like. But what if you or your spouse die young? The surviving spouse becomes a single taxpayer.” – Will Doty

There are a lot of moving pieces with taxes when it comes to inherited IRAs and the SECURE Act. You need to understand those rules and how Roth conversions before and after retirement can make a difference.

IRMAA Rules

We briefly touched on Medicare premiums earlier, but there’s more we need to discuss on them when doing conversions after retirement. This involves the IRMAA rules. A lot of people don’t know that Medicare premiums are income tested. Essentially, we have brackets that can change, but right now, if you and your spouse’s modified adjusted gross income is below $194,000, you pay your base rate for Medicare Part B and drug card.

But if you go $1 over that, you go from $164.90 for Medicare Part B to $230.80 and have an additional $12.20 on your drug card. So, that’s up to $243 total. Your Medicare premiums can start to go up quickly. This is something that people don’t think about when doing Roth conversions.

“If someone is anti-Roth conversions, we have a tool that will fast forward them to their RMD age. It will mock up a tax return for them and it will show them the effect of the RMD in that first year. You can also see what it did to your Medicare premium and how much it went up.”- Dean Barber

Seeing How Roth Conversions Before and After Retirement Can Make a Difference

You can get up to $637 a month in Medicare premiums per person. Again, the base rate is $164.90. That’s another $12,000 a year in Medicare premiums just because your RMDs got too big. So, there’s a reason to do Roth conversions before and after retirement.

“It’s more than just the tax bracket itself. When we talked about the taxability of Social Security and figuring out modified adjusted gross income, one of the things we didn’t mention was one kind of income that doesn’t show up to term whether Social Security is taxable. That’s income from a Roth IRA. A Roth IRA can’t cause another dollar of Social Security to become taxable. It can’t cause a capital gain or dividend that could be tax-free to become taxable. But a distribution from a traditional IRA can cause 85 cents of Social Security to become taxable for every dollar that you take out. A traditional IRA distribution a dollar of a capital gain or dividend to become taxable that was otherwise tax-free for every dollar you take out. That locks you in.” – Dean Barber

You can find yourself in a scenario where you’re taking a dollar out of your IRA and losing 57 cents out of it to additional taxes. You might be saying, ‘But there’s no 57% bracket.’ Well, when you consider that it could cause other pieces of income to become taxable that would otherwise not be taxable, that’s when it does get that way.

The Tax Code in Retirement Is Complicated

This is a very complex part of retirement planning that most people never understand. They simply get the income from wherever they get it, report their information to their CPA, and the CPA tells them how much they owe in taxes. Then, you’re wondering how you owe that much. It’s because the tax code is super complex. The Roth IRA is the best tool to fight it.

Starting Early with Roth Contributions

If you have kids or grandkids who think that the topic of Roth conversions before and after retirement doesn’t pertain to them, hopefully you understand that’s not the case. Tell them that when they get into the workforce to go to the Roth 401(k) immediately. Don’t do the traditional. You don’t need the tax break when you’re at the 12% bracket. You need tax-free income when you’re in retirement.

Tax Rates Are Going Up in 2026

If you’re in the same camp that Will and Dean are in, you realize that tax rates have to go up in the future to tackle the mountainous deficit that our country is running.

“Think about it this way. Would you ever buy something today that you don’t necessarily need, but buy it because it’s on sale and know that you’ll need it in the future? Yeah, because you’re saving money. In the long-term, you would need to spend more for that. I want people to consider that the tax rates today are on sale. We know that the Tax Cuts and Jobs Act is going to sunset on December 31, 2025, and that all our tax rates will go up on January 1, 2026. If we can prepay some taxes by doing Roth conversions prior to 2026, we can pay our taxes at a discount.” – Dean Barber

Let’s say that someone is in the 12% bracket. That becomes the 15% bracket in 2026, so you’d be getting a discount by paying more tax now. Why wouldn’t they? That 3% difference is really a 20% saving in the taxes they would pay.

Working with a CFP® Professional and CPA

If you have a CFP® Professional and CPA that work together and meet with them throughout the year, the CPA should be doing longer-term tax projections. It’s important to take advantage of that. If all you’re doing in blindly saving and taking from random buckets, you’re inadvertently overpay your taxes. It’s not because your tax return was done wrong. It’s because you missed opportunities like Roth conversions before and after retirement.

How Roth Conversions Can Work for You Before and After Retirement

We hope that we’ve shed some light on the impact that Roth conversions before and after retirement can make on your retirement. That goes for Roth contributions as well if you’re still working. Roth conversions, however, can be done at any time and don’t have an income limit that prevents you from doing one.

So, there are a couple of ways in which we can help you see how Roth conversions can work for you before and after retirement. First, you need a financial plan that considers your taxes, risk management, estate planning, and investments when planning for retirement. If you don’t have a plan or have questions/concerns about your current plan, we’re giving you the opportunity to build your plan—considering everything we’ve covered here and much more—with our financial planning tool. This is the same tool that our CFP® Professionals use with our clients, and you can access it at no cost or obligation. Just click the “Start Planning” to use it from the comfort of your own home.

START PLANNING

We also want you to have the experience of working with a CFP® Professional that works alongside a CPA. You can get a glimpse of that by scheduling a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals (one of our CPAs would be happy to join in as well). We can meet with you in person, virtually, or by phone—it’s whatever works best for you.

Learn More About Barber Financial Group

Sign up for our weekly newsletter which includes educational articles, videos, and more. It arrives in your inbox every Tuesday morning to keep you up-to-date.

Roth Conversions Before and After Retirement with Will Doty | Watch Guide

Introduction: 00:00
Dean’s Favorite Part of the Tax Code: 01:33
Getting Money Into Roth IRAs: 03:49
Example of 401(k) Roth Contributions: 05:22
Roth in Your Peak Earning Years: 08:17
Roth 5-Year Rule: 11:22
Roth Conversions Post Retirement: 13:27
The SECURE Act and Roth Conversions: 19:48
Roth Conversions and Medicare Premiums: 20:58
The Savings of Getting Money Into Roth Accounts: 23:55
Conclusion: 29:02

Resources Mentioned in this Podcast

Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management, LLC, an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management, LLC does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.