The Great Retirement Debate: Should You Convert Your Entire IRA to a Roth IRA? Alright. Welcome back to the great retirement debate. I'm Jeff Levine joined as always by my colleague and good friend Ed Slott. Ed, good to be back with you. Yeah. We have an interesting one today. Should you convert your entire IRA to a Roth IRA? Alright. This is not like should I convert or not? Should I go all the way over? Alright, either all in or all out. Right, so that's a big item. There are so many factors. First of all, have to give you, you know my bias. I'm a big Roth fan, I love Roth IRAs, I love it for the long term, I love the income tax free feature of it, that you never have to worry about RMDs for the rest of your life, and even under the SECURE Act for ten years beyond to the beneficiaries, the non spouse beneficiaries. All of that money growing, building, compounding, accumulating, absolutely income tax free. So I'm a big Roth fan, but going all the way, that may be a little bit much. All right, let me back you up for one second. So we talked about all these benefits or whatnot. I know most people listening already know the answer to this question, but for those who don't, let's level set. What do we mean when we talk about a Roth conversion? What is it and why would someone do that? And why would someone not do that? Why would we say convert the whole thing? Why not? What's the problem there? Well you move your IRA funds obviously to a Roth IRA and you pay the tax. There's no question it's the most efficient and greatest account ever created. It's growing absolutely income tax free. So why doesn't everybody have it? What I just said. The catch, you have to pay the tax, and that rubs a lot of people the wrong way. It's a major psychological hurdle. They just can't get over paying a tax before you're required to. Alright, so to start, when we put money into a retirement account, basically have two choices. We can put money into a pretax account where in general, we're gonna receive a tax break upfront for that. That money grows without being eroded by taxes while it's in the account like a traditional IRA or a four zero one k. But ultimately, as you mentioned, when we take it out down the road, we have to pay tax on it at whatever rate we happen to be in at that time. So maybe we're in a high tax rate, maybe we're in a low tax rate, whatever it is, we owe it at that time. By contrast, we can put money into a Roth account, and if we do that, when we put the money into that Roth account, we get no current tax break. But over time, whatever it grows to, presumably as long as we meet certain rules, we can take it out later one hundred percent tax and penalty free. Now this Roth conversion though is sort of like a portal, if you will, to take money from one of these accounts, the pretax side, and move it over into this after tax or tax free side, the Roth side. But you can do it at a time of your choosing as opposed to deciding at the moment when you put the money in. You could basically, at any later date when you have access to those dollars, say, alright, I'm I'm tired of having the money in this account that's growing that's gonna be taxable. I will make my deal with the devil so to speak, pay the tax now and move it over to this account that's now growing tax free. Is that right? Right, well the important point is what you said. With the Roth conversion, you control your tax rates. That's pretty important, especially now with tax rates at an all time low. You can lock those in now. But there's another problem. We have people that have actually, I believe, too much money in their IRAs and 401s. They have all their eggs in a tax deferred basket. So I'm listening, I'm sitting here and going, how can I have too much money in an So explain what do you mean by that when you say that? They have what I call no tax risk diversification. Any good investment person will always say don't put all your eggs in one basket. But retirement planning wise, most people have all their eggs in an account that will be taxed, not if but when, at some future rate, at a future date, probably on a higher balance and maybe at a higher rate. That's a lot of risk to have all your eggs or most of them in one big basket. It's not unusual now, I know people have all different amounts, but with the market run up as we've seen, and the balances, it's not unusual to see multi million dollar IRAs. And to me, I look at that as a tax bill waiting to happen. Yeah, no question about it. A large IRA can produce large distributions that at some point you don't have a choice you have to take, and you are subject to whatever rate that is at the time. If you've done a good job saving in IRAs, maybe you also have money elsewhere. Well that's the key. Social Security payments, go ahead. Yeah that's the key which ties into what we're really talking about. We've talked about Roth conversions before, but this was converting everything. Should you convert everything? Alright, so let's make it a big number. Let's go seven figures. You got a million dollars in an IRA. Should you convert it all at one time? Well it depends about the tax treatment when it comes out. Obviously the Roth is always a big bet on the future rate being higher, you always win with a Roth as opposed to now. But there are certain situations, for example, if you have somebody or you may have named a trust as an IRA beneficiary, and we recommended that for our advisors to tell their clients before the Secure Act. The Secure Act changed everything, and this may change that decision. What the Secure Act did, it took away what we used to call the stretch IRA, where beneficiaries could stretch, defer their RMDs, required minimum distributions for twenty, thirty, fifty, seventy years if you had a ten year old, And they could do it through a trust. And we said, oh that's great, the clients love that because they got what they wanted. Yes, the kids could get some crumbs each year, small RMDs based on their age, but the lion's share was protected in the trust because the reason they named a trust, and this is mainly people with a million, two, three, four million in an IRA, they don't trust their kids. They're worried they'll blow it, they'll have lawsuits, divorce, all kinds of problems, be taken advantage of, so they have a trust. So if you have a traditional IRA that was left to a trust, which many people, that was a good thing before twenty twenty, but if you still have that, that plan absolutely does not work. It doesn't even matter what kind of trust you have. In that case, I would say if the control and protection is everything you wanted, that's most important. I would say in that case, convert everything to a Roth IRA and leave the Roth IRA to the trust. I'm not saying trusts are bad. They're needed in many cases for post death protection and control. So why? Well, let's go back. I'm gonna come back to your trust argument in a second. But I think we set the stage of should you convert everything. I I think in general, we would both agree that in the majority of situations, the answer to that question for most people listening is going to be no. Right. Right? Should you convert everything all at once? And the reason why is if we go back to our seven figure million dollar IRA, unless you find yourself already in the thirty seven percent tax bracket today and you believe you're likely going to be there in the future, you're overpaying. For instance, if you could be in if you're in the twenty four percent bracket today, maybe you convert some at twenty four percent this series of small conversions. That's right. Doesn't have to be an all or nothing type of deal. So for most people, spreading this out over time, doing some conversion this year, some that makes more sense, right? Yeah. But in the trust situation, we have a different scenario now. Ever since the Secure Act, if you still have that trust you had, assuming it was all done perfectly, right, met all the IRS requirements. Sure, which is a big stretch, no pun intended, in and of itself, but go Let's say best case scenario. Best case scenario, yep. Now you're still sitting with that trust, and maybe you did it when you had a million or two million, now you have five million. Under the Secure Act, for most beneficiaries, a trust is also a non spouse beneficiary. For most beneficiaries, they will still be stuck and so will the trust with the ten year rule. There's no more stretch for most of those non spouse beneficiaries. All of that income will come out by the end of the tenth year after death. It will all come in either to the trust and be held there depending on the type of the trust, or be paid out. In year ten that would be one hundred percent RMD. If you leave it in the trust, the trust rates are the most compressed, the highest rates in the land. After sixteen thousand in twenty twenty six you're at the top bracket. An individual wouldn't hit that bracket till over six hundred thousand of income. And you might say well if you did a different kind of trust where the kids get the money, but that was the whole point. You didn't want them getting five or ten million ten years down the road. So this is where the Roth can really help. I know that's a huge tax bill, but it's not if but when. This tax will have to be paid. So I would say that's one situation. You may want to look at what you have. The trust may still be okay, but convert to a Roth and leave the Roth to the trust. It takes out the whole trust tax issue. Look, at the heart, the Roth conversion is an opportunity to choose to pay tax when your rate is the lowest. So I think you hit on an important point there. With a trust, the idea here of why you would convert everything all at once is if you're going to leave your money to a trust and the money is going to stay in the trust providing that control, chances are most, if not all, of that IRA distribution is going to be taxed at the highest rate because whereas you or I don't get to our highest income tax bracket today until about six hundred and fifty or seven hundred fifty thousand dollars of income depending upon our filing status, you hit on it. The trust gets there at sixteen thousand dollars. So even a more modest IRA, you know, we're talking about a million dollar IRA, but it doesn't take a million dollar IRA to produce a distribution of more than sixteen thousand dollars in a year, and especially when we're taking it out over only ten years. So that's that's a great example of where choosing to pay that tax now, even if you're at a top rate, you're doing no worse than the trust is probably going to end up doing down the road, and you're preventing the risk of higher tax rates in the future eroding even more of those dollars. So that's one. And you're getting what you really wanted when you set up the plan, the post death protection and control and low taxes because they were paid up front a lot. Can give you another situation where maybe converting everything. Everybody's going to have, there's gonna be every financial advisor or there are people out there, married couples, where one spouse has already died this year or will die this year. That would be a situation if there's a large IRA, you may want to convert most or all of it to a Roth IRA in this year of death to get it onto the final joint return. Alright, so the idea here being that while you're married, generally get to file a joint tax return where the brackets are are wider, if you will, than compared to if you're single. And in the year that one spouse dies, that becomes the last year. So you still file even if someone dies at, like, twelve o one AM on January first, you file a joint tax or you're able to file a joint tax return for that year, still enabling that survivor to have relatively large tax brackets compared to what they will likely have the following year, much smaller tax brackets where perhaps they might end up at a higher rate anyway, is that right? Right, and the big, again the psychological hurdle might be a big retirement account, big IRA, and who wants to pay the tax? But again it will be paid. If you don't do it, look at what's happened. Let's say the husband dies first, and what we call the widow penalty to now the wife, and husband and wife leave everything to each other, which is fine, that's what they mostly should do. And now the wife, other than maybe the adjustment in Social Security, will have essentially the same income they both had together, and on the IRA the same RMD, but now filing at single rates. That's going to jack the rates up for the rest of her life. But let's say they bit the bullet and paid the big tax and got it on that final joint return because the year after, unless there's a remarriage, but in most cases she'll be filing single. I noticed how you killed him. Just pointing that out. It's just statistically. That's fair. It's the husband. But let's look at what you get for your money because we're talking about who's gonna pay all that tax, who's ever going to do that. Well, I feel like on a game show, show them what they get. That's it. Tell them what they've won Johnny. Tell them what they want. Now they did the conversion, and now the wife, the widow, the next year is filing single, but she has a Roth IRA. She never has to touch it for the rest of her life unless she wants to, and if she takes it, it will be income tax free, won't raise IRMA charges, Medicare charges, Social Security, anything tied to adjusted gross income. If she needs the money, she takes it. If not, it's growing and compounding absolutely income tax free for the rest of her life, and even ten years beyond to her beneficiary. So you really do get some bang for the buck, and at the end of the game, and that's where a big Roth conversion, that's how you have to look at it. Where do I end up at the end of the game? In the grand scheme of things, am I paying, and it's just not me. It's a lifetime tax planning strategy for not only lifetime, multi generational out to beneficiaries. Sure. I think that's a that's a really important point there, looking at the beneficiaries. When we talk about, you know, should I convert everything? Again, if the idea is to try and pay taxes at the lowest rate possible, what we're really looking at is scenarios where you feel like converting everything today still is better than your alternative would be in the future. So I think you hit on one, which was a great one, where your trust is the beneficiary because that trust might be at a very high tax rate. Now, if you don't think you're going to die this year, you still might convert it over a number of years. Right? You could still do some partial conversions. But there are other scenarios. For instance, let's say you are in the thirty seven percent bracket today, and you are an extremely good saver, or you're extremely fortunate, maybe you just won the lottery, whatever it may be. Right? But you think you're always gonna be in the thirty seven percent bracket or the highest bracket, then by converting today, you're no worse off than you'd be down the road, and you're getting the safety, if you will, of knowing you've paid that tax. If tax rates do go up in the future, you've done that. So someone who is always going to be at the thirty seven percent bracket. Maybe you expect a large inheritance. Right. You know, that's another reason. Right? If you're if you're expecting a large inheritance, your tax rate may be higher in the future than it is today. Converting everything all at once could be good. Or we could go the other way. You talked about beneficiaries. Maybe you convert everything because you believe that your beneficiaries are in a high tax bracket. Maybe you're eighty, eighty five now. You've got low income. Right. Maybe, hopefully not, but maybe you're listening to this and unfortunately you've gotten some bad news and you just don't have that much longer to live. But your son or daughter is fifty, fifty five and they're a neurosurgeon and they're gonna be making a lot of money for the next ten, fifteen years, especially during that ten year rule. You could convert and effectively pay the tax for them when they would be at a higher tax rate. And I'll I'll throw in one more. That's like a gift to the beneficiaries. That's right. A gift to them benefit you're not only giving them the savings of that IRA, but you've kind of prepaid the tax for them. A gift without really being a gift, right, from a tax perspective. And one more that I can think of is maybe you just have a really low income year, and this is an opportunity for you to convert everything. And that low income year doesn't even have to be a quote unquote bad year. It can be a bad year on paper. Maybe you're a business owner and you bought a new piece of machinery and you depreciate the heck out of it Right. Using things like bonus depreciation or whatnot. On paper, you had a really bad year. May not really be a bad year, but on paper, you didn't make a lot. In fact, you may have lost money. You can offset your Roth conversion income with business losses, up to a degree. There are some limitations on that, which we won't get into today, but a good that's a good question if you're listening. Bring it back to your tax adviser, your financial adviser. Figure out how much you convert. But in many cases, if you have a what's called a net operating loss, you have negative business income, you can do a tax free Roth conversion and get your Roth account growing today at a cost of zero. So there are, while I think it's not the most common best practice, right, to not convert everything all at once, There are these kind of exceptions to the rule. Yeah, that's what we're talking about. But let's go back with all that said. In general, other than these few exceptions, it's probably good even if you think your rates may not be as high in the future. It's probably a good idea to always keep a bedrock layer, I call it, of traditional IRAs to make sure if you don't have other income, you're using up the standard deductions or the itemized deductions or some of the new deductions that came out each year. Or maybe you give a good way use the Charitable planning, QCDs. Or medical expenses, you can't really plan on them but everybody will have them. Probably better, definitely better if you had to pay it out of one, it's better to pay it out of an IRA even with the limitation. And another point, you talked about the beneficiaries, gift. Sometimes people say well, I don't have the money. And that's an issue too. If you don't have outside money, it may not be for you. Nobody should go broke or change their lifestyle to converting. And some people say, well let my beneficiaries convert, let them do it, I don't wanna pay the tax. I think it's important to know because there's a lot of misinformation on this. IRA beneficiaries cannot convert an inherited IRA to an inherited Roth IRA. The parents or grandparents can do it for them, but they can't do it for themselves. What they can do if they do get stuck with RMDs is take their RMDs that they have to take, and maybe use that money to convert their own IRAs to a Roth IRA. Alright, so as we look to settle this debate, if you will, I think we're largely in agreement that most people listening today should, if they're thinking about doing Roth conversion, stage them over time Right. To do smaller amounts at manageable tax brackets or max manageable tax rates over some number of years. But, you know, everybody's situation is different. And there are going to be those people listening where a all or nothing Roth conversion right now is still going to be the best thing. And Ed, you know, that's what this is about. It's about education. It's about understanding what makes your situation unique. Because at the end of the day, that's what we're about. We're about giving people the knowledge on both sides of the coin so that they can make the best decision for themselves. Because better information leads to better decisions, and better decisions tend to lead to better outcomes. And that is the mission, Ed, that you and I are on, is to help as many of you out there get to those better outcomes. So thanks so much for joining us for this episode on season five of the great retirement debate. And Ed and I will see you real soon for our next episode. Jeffrey Levine is chief planning officer at Focus Partners. This podcast is for informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. 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 its accuracy and completeness cannot be guaranteed. The topic discussed and corresponding arguments are those of the speakers and may not accurately reflect those of focused partners.