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Mar23, 2023

To Convert or Not To Convert Pt. 2

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In this episode of the Great Retirement Debate, Ed and Jeffrey continue the discussion on whether you should convert or not convert your IRA to a Roth IRA.

Episode Transcript

[00:00:00] Intro: Hi, I’m Ed Slott. And I’m Jeff Levine. And we are two guys who just love to talk about retirement and taxes. Look, our mission is simple to educate you, the savers, so that you can make better decisions because better decisions on the whole lead to better outcomes.

[00:00:14] Intro: And here’s how we’re going to do that.

[00:00:15] Intro: Each week, Jeff and I will debate the pros and the cons of a particular retirement strategy or topic with the. Helping you keep more of your hard-earned money. Yeah, but we won’t know which side of the debate we’re taking until we flip a coin winner of the coin flip gets to pick which side of the debate they want to argue, and both of us will have to argue in favor of our respect positions, whether we agree with them or not.

[00:00:40] Intro: At the end of each debate, there’s going to be one clear winner you, a more informed saver who can hopefully apply the merits of each side of the debate to your own personal situation to decide what’s. For you and your family.

[00:00:52] Intro: So here we go. Welcome to the Great Retirement Debate.[00:01:00]

[00:01:02] Ed Slott: Hi everyone, I’m Ed Slott along with Jeff Levine and welcome back to the Great Retirement Debate. Now, if you remember last time we really got into it whether to convert to a Roth or not, and I would have to say I probably lost, I did lose the to the coin toss and I had to take an argument that I might not agree with.

[00:01:22] Ed Slott: But as usual, Jeff, we wanna give people both sides of the coin, and I took the side for reasons when it might not be favorable to convert to a Roth. And it got so, uh, it, we got so into it that we had to make two episodes. So this is the beginning of part two. So Jeff, continuing from last week, here are even more reasons or situations where it may be more favorable. Not to convert to a Roth ira.

[00:01:47] Ed Slott: It’s all about the tax rates and that’s what this Roth conversation is about, to convert or not to convert. It’s a big giant bet on where you think where, uh, where tax rates are today versus what they might [00:02:00] be in the future at distribution time. If you think tax rates will be higher later on, as Jeff just said, than, uh, the Roth is a good deal.

[00:02:08] Ed Slott: If you think tax, your own tax rates might be lower. But you have to look beyond too. Uh, you might even look towards beneficiaries. I remember one guy, uh, telling me years ago, and I, I told him all about converting and I talked about the tax rate argument and he said, well, I don’t mind it for me. Uh, but, uh, to put it nicer than he put it, he says, I got three kids and they’re all losers.

[00:02:32] Ed Slott: Uh, they’ll never be in a house

[00:02:34] Jeffrey Levine: That was nicer than he put huh?

[00:02:36] Ed Slott: What’s that?

[00:02:36] Jeffrey Levine: That was nicer than he put it?

[00:02:38] Ed Slott: Oh, that was way nicer. .

[00:02:39] Jeffrey Levine: Okay. .

[00:02:42] Ed Slott: He said they will never be in a high bracket, but granted that was back in the days of the stretch IRA, and he said they’re gonna always be a low bracket, so that might be a little different now with the 10 year rule.

[00:02:52] Ed Slott: But you have to look beyond the tax rates. You know, if you leave an IRA to beneficiaries, remember the more [00:03:00] tax returns, you could spread that income over, and that is totally about the beneficiaries. Let’s, for example, even under the 10 year rule, if you have three kids and they wanted to spread out, uh, the distributions on the IRA that you didn’t convert, that you left to them, and they wanted to do it over 10 years, they could spread that income over 30 different tax returns, 10 years times, uh, for each of the three of them and get that money out at almost nothing.

[00:03:29] Ed Slott: Now that’s on the backend. That may be a concern for you too. Another reason. So that may be a reason to hold on. Not convert and let them get that money out at bargain basement rates, especially if they themselves may be in lower brackets. Again, it’s all about the brackets, the marginal rates now versus when the money has to come out.

[00:03:47] Ed Slott: Another reason. Okay, go ahead.

[00:03:49] Jeffrey Levine: Good. Yeah. Lemme pause you there, Ed, because you know you’re talking about the brackets and the rates and when people get stuff, but you know, one of the things that makes IRAs different from just about every other type of asset is that you [00:04:00] can’t get it to someone else until you are dead right? There’s no way to gift an IRA to, to other heirs during lifetime. And most of the time, married couples, uh, will end up leaving their IRA to each other first, and then when the second one passes away, that’s when it goes down to the kids. Well, you talk about that and you said spreading, you know, spreading the tax bills over lots of different returns, which sounds great, but while you’re alive, there’s just one return. You could spread it over yours, and if you are married and one of you passes away and the survivor lives for some sort of extended period of time, you go from using the nice joint brackets down to the single brackets, which get you to much higher tax rates at much lower income levels and so that can end up being a significant impact. Sometimes people refer to as the widow or widowers penalty, and effectively what happens is someone who’s surviving can end up with slightly less [00:05:00] income cuz you lose the lower social security check. and you sometimes lose pensions, etc.

[00:05:04] Jeffrey Levine: Uh, there’s that word again, Ed. Uh, but you can sometimes lose some income, but still end up with a significantly higher tax bill because you’re paying a higher rate, because now you’re filing as a single individual. So converting while both members of a couple are alive is almost like buying, uh, tax bracket insurance.

[00:05:25] Jeffrey Levine: You’re ensuring that you can use those joint brackets as opposed to the single brackets.

[00:05:29] Ed Slott: But again, it all comes down to if you think you’ll be in a lower rate in retirement, some people believe they will be. Another reason you may not wanna convert, at least everything is if you’re anticipating, and a lot of people are, large medical bills, as you get older. You wanna have, if the only money, if that’s where most of your money is, is an taxable IRA, you’re not gonna wanna convert that because if medical bills go really high, and I have to tell you the last 10 years, it hasn’t been unusual [00:06:00] to see tax returns where people claim over a hundred thousand dollars of medical expenses. I had this, you know, with my own, uh, mother recently, uh, nurses age, uh, uh, nursing homes, uh, all, all kinds of uh, medical home improvements, ramps and railings and chair lifts and stair lifts and widening doorways and hallways. Bathroom and kitchen modifications. These are big ticket items. If the only money available to pay for that is in an IRA, don’t convert it. Use that IRA. If you convert it to a Roth, now you paid tax on money you could have got a deduction for that would be a reason to keep some of that IRA money use it to pay these medical bills.

[00:06:42] Ed Slott: At least you’ll get somewhat of an offsetting deduction. I know there’s a threshold amount, but I’m talking about big ticket items. Uh, you’ll get some type of big tax benefit by using regular IRA money. And there’s another reason you have to be careful and you should always do a projection. One [00:07:00] thing with Roth conversions, you better be careful what you do because they are permanent.

[00:07:05] Ed Slott: There’s no backies, there’s no getting your money back. There’s no do overs. That stopped a few years back. We used to call them Roth re-characterization, so I wouldn’t be so quick to convert. I, I’m not saying that should deter you, but you have to have an accurate tax, pro projection. You have to know what it’s going to cost before you buy in because you can’t get your money back. So those are some other reasons.

[00:07:28] Ed Slott: I’ll throw in one more reason. This may not affect a lot of people, but right now we have this, uh, oddball deduction, which does help a lot of self-employed people. The qualified business income deduction. If you convert to a Roth and you have a, uh, maybe you have a small business that has passed through income or your Schedule C, self-employed, or you have an S Corp or an L L C or a partnership, we have passed through income. You may or may not be always run this by your tax advisors. Uh, you may qualify [00:08:00] for a huge 20% deduction. If you are under certain income limits for certain groups, without getting into the weeds on this, a Roth conversion can actually kill that and cost in the wrong year, uh, cost you a big tax deduction on your business income.

[00:08:16] Ed Slott: So those are other things, not to mention if maybe your younger or you’re paying for a, a college and uh, uh, you, the income from a Roth conversion could throw you out for financial aid. So there are, uh, reasons on both sides of this debate.

[00:08:31] Jeffrey Levine: You know, Ed, you, you hit on something there that, uh, it’s not an argument for my side nor an argument against my side, but just a point that I think that we should really hit on.

[00:08:40] Jeffrey Levine: You talked about the phasing out of this Q B I deduction, and that’s just one example, this business deduction that Ed was just talking about, that, you know, that’s just one example. There are credits that phase out as income goes up, there are other deductions that phase out as income goes up.

[00:08:55] Ed Slott: IRMAA charges, or what we call sur taxes.

[00:08:57] Jeffrey Levine: Exactly. Sur taxes, right. The [00:09:00] 3.8% investment, surtax, all the good things basically that are on a tax return that go away. Yeah. Where the bad things that come in are somehow keyed to income and, and so when we talk about rates, so oftentimes people associate rates with brackets. The brackets help to inform what the rate is, but they don’t determine what the rate is.

[00:09:21] Jeffrey Levine: There are times when you might be in a lower bracket but be paying a higher tax rate because you’re phasing yourself out of some sort of credit or deduction you may not get in the future because of circumstances changing. For instance, you know, if you phase yourself out of an education, uh, credit.

[00:09:36] Jeffrey Levine: Right. Well, you only get that credit maybe while you or your kids are in school. Once they’re outta school, you don’t have to worry about phasing yourself out of the credit anymore cause you don’t get it to begin with. So, and whenever you’re doing this and talking with your financial professionals, either a tax advisor or your financial advisor, it’s important not to fall into the bracket trap of just looking at what bracket you’re in.

[00:09:56] Jeffrey Levine: You have to look at the, uh, the full picture. Now, Ed, [00:10:00] I wanna bring up, one maybe last argument here from my side and I think it is my, my Trump card, and that is peace of mind. You know, peace of mind. Uh, when we talk about retirement, there are so many unknowns. How long will I live? What will interest rates be? What will markets do? What, you know, what will my health be like? What will inflation be?

[00:10:21] Jeffrey Levine: All of these are unknown. So is what will my future tax rate? Will, uh, what will my future tax rate be? Unless that money is sitting in a nice, beautiful tax free account like the Roth IRA and there, even if I’ve overpaid a little bit.

[00:10:37] Jeffrey Levine: Now, I certainly wouldn’t suggest people make foolish decisions and dramatically overpay, but if you’re not sure. There are some times when people will just do things because it gives them peace of mind and security. The same thing goes for, for people who maybe, you know, like Ed, I know you drive a car.

[00:10:56] Jeffrey Levine: Thankfully, you are in a position where if, God forbid something happened, [00:11:00] if you, if there was an accident and someone hit your car, uh, you would be able to pay to fix your car. You don’t need insurance on your car. You don’t need collision insurance, but you own it because it gives you peace of mind.

[00:11:10] Jeffrey Levine: And the same thing comes with the Roth. And by the way, Anytime you buy insurance, theoretically on the whole, it should be a losing proposition, otherwise the insurance companies would be out.

[00:11:20] Ed Slott: Yeah. Damn, my house didn’t burn down and I had all that fire insurance.

[00:11:24] Jeffrey Levine: That’s right. Exactly. No one gets upset about that.

[00:11:26] Jeffrey Levine: No one goes and drives to work and says, ah, can’t believe I didn’t get into an accident today. Driving to work. What a waste of money. No. Sometimes you do things just cuz it gives you peace of mind and the Roth conversion can do just that. I rest my case with that argument. Good, sir.

[00:11:41] Ed Slott: All right. I think you rested your case to do a Roth conversion by handing me off the biggest softball in this debate.

[00:11:48] Ed Slott: On reasons maybe not to convert, you said, well, at least I have insurance. My Roth will be tax free forever. I never have to worry about it. Well, CPAs have an old saying, [00:12:00] tax laws are written in pencil, and the number one question, and you probably know what it is, I get in every program I do for consumers. Especially after I talk all about the great things which I love Roth IRAs, cause I love tax free.

[00:12:14] Ed Slott: They say, yeah, but can I trust the government to keep its word that Roth IRAs will always be tax free. What if they need money? Can they change the laws, I guess anything’s possible, but that sits in people’s minds. They don’t wanna be played for suckers paying a tax. And then the Congress can find some way around the fringes maybe.

[00:12:36] Ed Slott: Personally, I don’t think they’ll do it because if they kill the golden goose, which is the Roth IRA for them, that produces a lot of revenue. But it’s what people are thinking about. And if that keeps you up at night, that may be a reason not to convert.

[00:12:51] Jeffrey Levine: Well said. Well, you know, Ed, this one, perhaps more than any other that we’ve talked about so far, truly has two [00:13:00] very, very compelling sides.

[00:13:02] Jeffrey Levine: Uh, there’s lots of reasons to convert, lots of reasons not to convert. As you pointed out, Ed, for many people, this is not an all or a nothing decision, right? It’s ultimately, uh, you know, most people who do conversions. Probably should not do a giant conversion one time. It’s usually done over many years, uh, in a limited fashion each year, so as not to raise the rate too high, obviously the more you convert, the more income you’re gonna have, the higher your income tax rate will be, you know, save for maybe those at the highest tax rates already where it can’t get much worse.

[00:13:37] Jeffrey Levine: Uh, and we look at someone who might be paying more tax down the road when things expire, going from 37% back up to 39.6. With the exception of those who are already at that highest tax rate, uh, it’s likely that this is a multi-year process to shift money over, and for many folks it will ultimately be a combination of traditional IRAs, [00:14:00] Roth IRAs, and taxable accounts like joint accounts, individual accounts, revocable trust accounts that ultimately produces the greatest, uh, tax efficiency in terms of, uh, and, and, and …

[00:14:13] Ed Slott: What we call tax risk diversification.

[00:14:15] Jeffrey Levine: Tax risk diversification. Indeed. Now, I, I will say Ed at, uh, you know, at the risk of arguing against something I just said, I think too many people aim to have that diversification. The goal, as we talked about earlier, is pay your taxes when your rate is the lowest.

[00:14:30] Ed Slott: Right

[00:14:31] Jeffrey Levine: But oftentimes that results in having tax diversification, which you can then use to your advantage.

[00:14:37] Ed Slott: Right. That was a good point.

[00:14:39] Jeffrey Levine: Alright, well Ed on that note, when you say it’s a good point, that’s where I wanna end. So I’m gonna end there and call it a day. You know, Ed.

[00:14:45] Ed Slott: Like that Seinfeld episode where George, uh, makes an argument. I’m outta here!

[00:14:50] Jeffrey Levine: That’s it. I’m out. I’m done. The summer of George. All right. I’ve been watching old Seinfeld episodes lately. I got to that one the other night. Alright, well on that note, uh, you know, there are [00:15:00] two sides to every coin. We covered them today, but your life and your retirement decisions are too important to leave up to that coin flip.

[00:15:06] Jeffrey Levine: And that is why the one thing that. And I will always agree on is making sure that you talk through any big decision like should I convert to a Roth or not with a knowledgeable financial advisor or tax professional, so that you can weigh the pros and cons of these decisions against your specific goals and objectives.

[00:15:27] Jeffrey Levine: If you’d like to continue to discussion with Ed and I, we would love to hear from you. Let us know what you think. Do you have your money in a Roth, in a traditional IRA? Are you in the process of converting? Do you believe the government when they say it’s gonna be tax free in the future, let us know.

[00:15:40] Jeffrey Levine: Reach out to us on Twitter using the handle @TheSlottReport that’s @TheSlottReport for Ed, or @CPAPlanner. Once again, that’s @CPAPlanner for myself. We’d love to hear from you, Ed, this one was a lot of fun. I can’t wait for our next debate.

[00:15:57] Ed Slott: Oh yeah, on the Great Retirement Debate, this was a [00:16:00] big one to Roth or not.

[00:16:01] Ed Slott: Listen back a few times. There were a lot of points in this one, so you may wanna play it back. And we also talk fast. See you next time on the Great Retirement Debate.

[00:16:11] Outro: Jeffrey Levine is Chief Planning Officer for Buckingham Wealth Partners. This podcast is for informational and educational purposes only, and should not be construed as specific investment accounting, legal or tax advice.

[00:16:21] Outro: Certain information mentioned may be based on third party information, which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but it’s accuracy and completeness cannot be guaranteed. The topic discussed in corresponding arguments are those of the speakers and may not accurately reflect those of Buckingham Wealth partners.