The Great Retirement Debate: The New Impact of the SALT Deduction Welcome, everybody. I'm Ed Slott along with Jeff Levine right here on the great retirement debate season five. And today, we're talking about the new impact of the salt deduction. What is salt? It's a spice that is on the table next to pepper, I believe. No. And the impact on Roth conversions. That's right. Well, yeah, the Roth. We always talk about seasoning time. No. The Roth conversion decision can be impacted by salt, but salt here being state and local taxes. So if we go back, let's go back in the way back time machine all the way back to two thousand and seventeen. In two thousand seventeen, this is the year the Tax Cut and Jobs Act was passed, but it wasn't yet effective. And so in two thousand seventeen, individuals were still able to take, at least for regular income tax purposes, an unlimited amount of deductions for their state and local taxes. So this included their property tax payments for, you know, for their homes, etcetera. Plus, the the bigger deal for a lot of high income folks, especially those who live in high tax, largely blue, largely coastal states was their income tax. So maybe you had thirty thousand dollars of state and local income taxes and another fifteen thousand dollars of property taxes. That was forty five thousand dollars of itemized deduction on your tax return. If we fast forward then into the Tax Cut and Jobs Act, that Tax Cut and Jobs Act put in place a SALT limit. In other words, a limit on the amount of state and local taxes that an individual could claim as a regular itemized deduction, that limit was ten thousand dollars for everyone except those who filed married separate who got a limit of half of that amount of five thousand dollars. And that was the exact dollar limit that was in place for two thousand eighteen, nineteen, twenty, all the way on up through when we passed the One Big Beautiful Bill Act. So we'll fast forward down to two thousand and twenty five introducing the one big beautiful bill act, which changed the SALT deduction cap for twenty twenty five through, I believe, twenty twenty eight now from ten thousand dollars for most individuals up to forty thousand dollars. However, the trick, if you will, or the catch is that this new forty thousand dollars maximum deduction can be viewed as sort of the old, if you will, ten thousand dollar SALT deduction limit Right. With a thirty thousand dollar bonus deduction amount. And that bonus deduction gets phased out as your income rises. And that income level for folks this year is roughly five hundred thousand dollars to six hundred thousand dollars of income. So suffice it to say, if you have five hundred thousand dollars of income from whatever sources that may be, including Roth conversions or not, then you can deduct up to forty thousand dollars on your state and local taxes on your income tax return. But should you have another one hundred thousand dollars of income, which could be a bonus from work or as in the case of our discussion today, a Roth conversion, that extra hundred thousand dollars is going to not only cost you the tax in the hundred thousand, but it's going to reduce your state and local tax deductions to no more than that ten thousand dollar minimum amount. You'll lose the thirty thousand dollar bump. So what happened here, all those years that Jeff was talking about where you were limited limited to the ten thousand, according to IRS owned statistics, more than ninety percent of taxpayers were taking the standard deduction. Yep. Because it was that SALT deduction for those states, like you talked about, that got you what I call into the club, like a club with red ropes and stuff like that. What club is that? Well, it showed up on the first returns this year. When I say this year, we're in twenty twenty six, I think. But we when we talk about our taxes, the the twenty twenty five tax return, That just showed up. So we saw the first return where you got into the itemized deduction club. Now it was mainly the SALT that added SALT deduction that got you into the club. We'll come right in. Yeah. Because once you get to the SALT deduction, it may even exceed the standard deduction. You can pile on with mortgage interest, charity, medical expenses if they're over the limit. So now you're talking about some serious deductions, which back to our theme, can really impact the tax cost of a Roth conversion. More people are able to itemize now. You know, Jeff, I was talking about this. You talked about the states that have the high taxes. I was talking about about this in Texas, which has no state income tax. So I was about to talk about this whole SALT deduction, and I caught myself. And I said to the group, well, this doesn't apply to you. You don't even have state taxes. I said, hold on, boy, you know, with the big hat and cattle and stuff. They said, we have big parcels of land and our real estate taxes are big. So I didn't even think of that. So again, more people can use the SALT deduction to reduce the tax cost on their Roth conversions. So I I think if we want to put this into numbers for folks, right, let's just imagine a a hypothetical worst case scenario. Let's imagine you go and visit the worst financial adviser in the world. Right. And you walk into this worst financial advisor's office in the world with five hundred thousand dollars of income, and the financial advisor looks and he says, hey, you have no Roth IRA. I think we should do, I don't know, let's just call it a hundred thousand dollar Roth conversion. Just a nice round number. And so your worst financial advisor in the world decides to help you make this hundred thousand dollar Roth conversion. You now go from five hundred thousand dollars of income Oh, I know we don't. Up to six hundred thousand dollars of income. The question is, how much does that cost you to make the conversion? And the answer is going to surprise a lot of people. It's a lot more than you may think. In fact, if you think to yourself, well, I know the top tax brackets this year in two thousand and twenty six. I don't know exactly where they fall, but I know the top rate is is thirty seven percent. And I know that doesn't happen until, you know, six or seven hundred thousand dollars of income. So whatever you tell me, Jeff, it's gonna be some amount less than thirty seven percent. So I don't know, on a hundred thousand dollars, we'll just say thirty five thousand, thirty five percent. Well, believe it or not, it's actually significantly more. That conversion of a hundred thousand dollars could actually cost you roughly forty five thousand dollars in federal taxes only. That doesn't even count any of the additional state and local taxes that you might have to pay on it. And you go, well, Jeff, hold up. How could how could I possibly have forty five thousand dollars of taxes on a hundred thousand dollars of income? There is no bracket that high, and that's true. But what's happening here, if we go back to what we were talking about before is you're not paying tax on a hundred thousand dollars. You're paying taxes now on about a hundred and thirty thousand dollars. Because not only have you potentially added the hundred thousand dollars of new income that you didn't have before, so you now have to pay tax on that hundred thousand dollars, But that bonus salt cap, if you will, of thirty thousand dollars, the amount above and beyond the ten thousand dollar, what you might call base amount or or smallest possible maximum salt deduction, that thirty thousand dollar bonus salt deduction gets wiped away. So now you're paying tax on the hundred thousand of real income plus your thirty thousand dollars of lost deductions. And so you're paying tax at a less than thirty seven percent tax bracket, but you're doing it on more than a hundred thousand dollars of income. And when you put all this together, it very easily can exceed forty five percent, again, at the federal level only. And when we talk about Roth conversions, Ed, one of the things we always say is, it's like a magic wand to make income appear when you want to do so. And when you want to do so should be when your income tax rate is lowest. Well, when are you gonna be in a higher tax rate than forty five percent? I mean, that would have to be an all time boneheaded time to do a Roth conversion. Now just to put it in context, what Jeff is talking about is when your income is in that bubble of or that level of five hundred thousand dollars to six hundred thousand dollars which is now a little more. There's a one percent increase, but let's just call it yeah, five hundred thousand six hundred thousand dollars So at six hundred thousand extra bonus, the thirty thousand, phases out, and that's where you get that forty five percent extra rate on that amount. Now it's interesting though because so far, and I think rightly so, we focused on how this can negatively impact people if they're not focusing on it. But it's fair to say that there are also opportunities here for positive Roth conversions. In other words, Roth conversions that will be accretive to your bottom line. You know, if your income is expected to rise here in the near future, maybe you're expecting an inheritance. Maybe you think you're likely to make more from work over time. Whatever that may be, if you think your income might rise so that you will otherwise be in that five hundred thousand dollars to six hundred thousand dollar range, a Roth conversion today can help you manage that. For instance, if you do a Roth conversion today, you don't have to take required minimum distributions of those amounts later in life. That could help you later in life keep yourself below that five to six hundred thousand dollars of income threshold. And look, that is a a very high threshold. A lot of people are not going to be there, not only not in retirement, but not ever. But for those who are fortunate enough to approach that, that is an important consideration that not only a Roth conversion could be harmful, but you can look at the other side. It could be helpful if you think in the future, you're going to be approaching those areas. And what's interesting is right now, you have a great projection tool because that's what you need. For the first time, you have a return that includes all of the new ABBA deductions. That's what I was talking about before, the twenty twenty you say ABBA, mean that big One Big Beautiful Bill act that was passed last No. That's banned. Oh, okay. They have that song Money, Money, Money. Ah, that's it. Yes. It's a good tie in. Alright. Let's do it. Yeah. The One Big Beautiful Bill Act. So you have the first different new tax return, twenty twenty five, that can give you a pretty good idea where things are. We knew about a lot of the new deductions, many of them showing up for the first time on the twenty twenty five return. But as you know, you don't really see how it all works out till you actually see how it plays out on the social on the twenty on the tax return. I was going to say how the the Social Security, which I didn't even want to say that, that was a mistake. The enhanced senior deduction. That's right. Yeah, not the no tax on Social Security, that does not exist. The enhanced senior deduction, the other new deductions, so and the SALT deduction. And and now you have a good planning tool to start with. That's your jumping off point, this new twenty twenty five tax return. Alright. I wanna I wanna take a moment here. So I think we've covered the core of our question pretty well, which was, you know, how can the SALT deduction impact your decision to make a Roth conversion? But there's a lot of related items here. For instance, you know, you talked about just now the senior deduction enhanced senior deduction. Which a lot No tax on Social Security. Not no tax on Social But it isn't another deduction that could phase out. There's the QBI deduction. Like, we talk about Roth conversions, the idea is to do it when your rate is the lowest, not when your bracket is the lowest. And a lot of times people simplify it too much. They go, oh, I'm in a low tax bracket. Maybe you are, but maybe you also have kids and you have a child tax deduction and you're going to phase that out now and later on you won't have to worry about it. You have to look at the full picture and that's really where either the tax return or software could be particularly valuable because it's very hard to eyeball everything on a tax return. For instance, even doing a Roth conversion this year might cause more of your charitable contributions to become nondeductible. That's new. Let me stop you there. I said that's your twenty twenty five tax return is your jumping off point, but it doesn't include what you're about to say. That's new new new new new. Very new. Ultra new. Yes. That's for twenty twenty six. And in twenty twenty six, beginning this year, there is a new half percent floor that you have to exceed before your charitable contributions are deductible. So for argument's sake, if you have a two hundred thousand dollars normal income amount, if you will, that's your income before you make any Roth conversions. The first one half of a percent times two hundred thousand dollars or one thousand dollars that you contribute this year to charity is nondeductible. So if you give four thousand dollars to charity this year, you can only claim three thousand dollars of it as an itemized deduction on your tax return. If you were to go ahead and, let's say, do a two hundred thousand dollar Roth conversion, an additional Roth conversion, maybe to try to stay in the twenty four percent bracket this year, your total income now is two hundred thousand of regular income plus your two hundred thousand dollars of Roth conversion. It's four hundred thousand dollars of income. And now a half a percent times four hundred thousand is two thousand dollars. So now of your four thousand dollars that you just contributed to charity, it's not one thousand that's nondeductible. It's two thousand, and you can only claim an itemized deduction for two thousand dollars on your tax return. So, really, when you're thinking about making a Roth conversion, it's important to not just focus on your tax bracket, but to look at all these other knock on ancillary effects. I remember Ed being when I was much younger, you used to use the analogy like your tax return is like a pinball machine. Oh, yeah. Yeah. And you used to say, you know, you you start, you know, throwing the ball around and all sorts of lights go off and bells and everything and sounds, and that's exactly right. And I think it's important for people to remember that and to look at the totality of the cost that is going to what cost will you incur by making a Roth conversion to focus on the big picture? And there's another one for twenty twenty six as long as you're talking about Sure. The itemized deductions being cut down in twenty twenty six. If you're at the top bracket, you'll it's thirty seven percent. You'll only get the benefit on itemized deductions at thirty five percent. Yeah. So, ultimately, I I think what it comes down to when we think about our our key question for today is, you know, how can the SALT deduction impact your decision to make a Roth conversion? The answer is it can because it can adjust your tax rate arbitrarily high, or you could look at it in the future and say, if I don't do a Roth conversion now, I will be in a higher tax bracket or higher tax rate situation in the future. And that same concept can be applied to all other aspects of the tax code where there's a credit that gets phased out or a deduction that gets phased out as income rises or even things like a surtax where as income rises, new taxes kick in. But it's important to take advantage of this. This is one of those provisions in the ABBA law, the one big beautiful bill act That is temporary. It it's going to end. So you may only have a few more years to get that big hit. Well, we'll see. Who knows what the future holds? We don't know what permanent means, and we don't know what temporary means. No. But one thing we do know, Ed, is that in general, more informed decisions lead to better decisions, and better decisions lead to better outcomes. And, Ed, that's what you and I are all about here when it comes to the great retirement debate, arming you with better information so that you and your families can arrive at better decisions. Thanks so much for joining us today, and we look forward to seeing you right back here for the next episode of the great retirement debate. Pretty salty. 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 focus partners.