How Roth Conversions Help Reduce Income Taxes in Retirement with Nick Nelson – Ep 67

[INTERVIEW]

Matthew Peck: Welcome again to another edition of SHP Financial’s Retirement Roadmap podcast. I’m your host today, Matthew Peck. Very often on the podcast, we mention things like Roth conversion or conversions. And it’s not just us, whether it’s this podcast, whether it is Yahoo Finance or Bloomberg or Barron’s or whatever that may be, anytime you’re following a retirement company or a retirement venue and topic, the topic of Roth conversions comes up and I think people have questions about it. Because we do it on a daily basis that we might not think to pause and say, “Okay. Exactly what is a conversion again? Exactly what are the things that we need to consider if we’re going to do a conversion? What are the positives and negatives? Pros and cons? How does it work? What are all the mechanics to it?”

So, we wanted to take today’s podcast to truly dive deep into what a Roth conversion is, how it’s effective as a tool, and how often we do it here at SHP, and just things to be aware of all around the topic of Roth conversions. Now, I couldn’t think of a better guest or a better expert and specialist, whatever that nice fancy words may be. The Nick Nelson is a recurring guest on the podcast, so he’s not as nervous as some of the other people that have sat in the hot seat before. I can tell he looks pretty cool and collected. We’ll see.

Nick Nelson: I try to be.

Matthew Peck: I’ll try to ruffle him a little bit. We’ll see if I can get underneath that tough New Hampshire exterior. We’ll see.

Nick Nelson: You have a way to do that with me, Matt. So, I’m sure it will happen.

Matthew Peck: But all joking aside, we’re talking here with nearly ten years here at SHP helping navigate. I don’t even know like, honestly, real quick, how many Roth conversions do you think you have assisted on or that we’ve done here, top of mind?

Nick Nelson: Definitely hundreds. It’s probably approaching thousands.

Matthew Peck: Yeah, exactly. So, that’s why I mentioned to have someone to talk about it. Couldn’t think of someone better than here as our VP of Advisors. Sorry. VP of Advisory Solutions here at SHP Financial, Nick Nelson. So, Nick, let’s just start the very basic, right? Again, guys like us, we toss around. Guys and gals I should say. Sorry. We toss around the term Roth conversion, Roth conversion. We bring it up very often. And sometimes I feel like we almost assume people understand what it is and what we mean by it and how powerful of a tool it is. So, let’s start at the very basic. What is a Roth conversion?

Nick Nelson: Yeah. Great, great question, Matt. So, simply put, what a Roth conversion is, is if you have somebody who’s built up a retirement savings that’s primarily pretax, a Roth conversion could be something that could potentially benefit you both in retirement and also to your heirs for the next generation. And basically, what you’re doing is you’re taking those pretax assets, you’re paying taxable income on them or you’re paying income tax on them and you’re moving on to Roth IRA, which as long as you have that Roth IRA open for five years, that’s going to be eventually tax-free. It’s tax-deferred and eventually tax-free. So, basically, you’re saying, “Okay. I’m okay paying taxes now on whatever that portion of money is, knowing that in the future I will no longer have to worry about that as long as that money’s in there for at least five years.”

Matthew Peck: Okay. So, I definitely want to come back to the five-year thing. So, I think that’s sort of advance to Roth conversion ideas in a sense or part of the things that you need to consider when it comes to the mechanics. But just to stay on the basics, what money goes into a Roth IRA? I mean, how does it even get there? Or what are we even converting?

Nick Nelson: Yeah. Excellent, excellent question, Matt. So, with IRAs that are going into Roth, so there’s a couple of different ways to do it and there’s a couple of things that you have to be careful of and consider. So, I would say number one is your age, 59.5 being that important age, because if you’re under 59.5, the money that’s going over from a tax standpoint, you actually cannot withhold taxes on that conversion if you’re under the age of 59.5 or you’ll be penalized on that portion of money. So, there’s a little bit of a, you know, you’re limited a little bit in how you can convert. If you’re over 59.5, you have the option. You can withhold taxes or you cannot withhold taxes. It kind of depends on whichever way that you’re more comfortable with, right?

And in terms of what’s the better route, efficiency is a big thing. So, I would say if you cannot withhold taxes, you can move the full amount from IRA to Roth and pay taxes separately into the quarterly system. That’s going to increase the efficiency and maximize the efficiency of the Roth conversion and ultimately, reducing that break-even age a little bit.

Matthew Peck: What gets converted into Roth IRA money? What’s the source of the dollar?

Nick Nelson: Good question. So, that’s what I was going to go into next. And most of the time when we’re doing Roth conversions, what we’re able to do is actually convert shares themselves. Going back to what you just said, Matt, the majority of people that are looking to convert do have 401(k) money, 403(b) money, 457s where they have continuously saved that money, but it’s fully pretax. So, they’ve never paid taxes on that money, which is great because you get a tax deduction when you make those contributions, right? However, in the future, when you take that money out, when you take a distribution from those accounts, it is going to be fully taxable.

So, by doing a Roth conversion, it potentially allows you to have more flexibility down the road when you are retired, when you need to start distributing assets because you aren’t necessarily going to be taxed on every dollar that comes out if you’re not fully pretax, if you’re not fully 401(k). So, I think a lot of people, a lot of our clients, especially who are retirees, they’ve moved to that 401(k), 403(b), 457 money over to a rollover IRA, a traditional IRA, which keeps the same tax status, right? All that does is it gets the money out of the plan or the employer plan over to an individual retirement account fully in their name where they can, I guess, in lack of a better way, just fully control those assets. They no longer have to work with the custodian of their 401(k), their company’s HR. It’s fully in their name.

And it also allows us to manage that better for them, right? We have unlimited investment options in those IRAs, which is what allows us to easily convert. It’s a little bit harder, I would say, to convert from 401(k)s and things like that. You can definitely do it, but you don’t necessarily have a financial professional that has their hands on it that allows to walk you through it. Does that make sense?

Matthew Peck: Absolutely. And that’s kind of what I wanted to really have you explain to all of our listeners is the source of a Roth conversion, it can be anything. It can be IRAs that you slowly but surely contributed to during your working years up to the limit and taking that right off of the $6,000, $7,000, $8,000 that you put in while as an individual. So, just think of it like your traditional IRA. And then as Nick was saying, for all the workers out there, for all the people that took money out of their paycheck, took the tax deduction, did not pay taxes on that contribution via a 401(k) or a 403(b), those funds eventually become IRAs and then also can be part of this conversation of should I convert it or should I not convert it? And how does that work?

Because as Nick was mentioning, it’s all about your tax brackets. Like, okay, when you withdraw those money, when you eventually whether you spend the money that’s in this IRA that’s again accumulated from old 401(k). So, imagine just a big pot, everyone, right? And in that pot is your qualified assets that we have now poured in IRA money, 403(b), 401(k), 457, etcetera. Now, it’s a big taxable pot of money, right? And then the question becomes, “Okay. Should I convert it or what to do with all of this amount of money here that has never been taxed?” And so, now we go into one option is to convert it into a Roth IRA. All right.

And sorry to kind of just break it down to the numskull level for me, but it’s more so that people can understand that the steps to consider is, okay, first we get the pot of money of this pretax dollars, and then what? So, I guess when people say, “Okay, hey, I’m considering a Roth conversion,” when do you even bring it up to a client? Because you mentioned 59.5 to do before or after. But in your opinion, when should people start to consider a Roth conversion?

Nick Nelson: So, for our clients, good question, Matt, we look at that like an optimal window, which can vary from person because it’s going to depend on what tax bracket you’re in, if you’re in a higher earnings year, if you’re in a lower earnings year, maybe you’re in between jobs. Like, we’re looking for a window where we can strategically convert in a way that’s going to be efficient. I like to use that word ‘efficient’ because there’s a lot of factors that we look at when doing Roth conversions, right? And there could be a year, maybe this year, it makes sense for somebody to convert because their taxable income is lower or maybe they’re close to filling up their tax bracket, but they still have 50K and room or something like that. But next year it doesn’t make sense because they’ve already filled up that tax bracket. And to continue to convert, they’re going to be paying a high percentage.

So, my point here is that every single year I think this needs to be looked at. Just because someone might consider or even process a Roth conversion this year doesn’t mean it necessarily makes sense for them next year. And I also think people need to think about, “Well, why am I even converting in the first place? Am I just doing this because I think taxes are going to go up? Am I doing this to maximize legacy? Am I doing it because I’m going to potentially be able to access this money in retirement and I don’t want to worry about taxes?” I think that’s a big factor. And that’s always the number one thing I like to consider is like, first of all, should I convert? And looking at age, that’s obviously a big one, right, because when you convert money, you’re paying taxes upfront, as we talked about, right?

So, if you think about it from a portfolio standpoint, let’s say you did a $50,000 conversion, you paid $15,000 in taxes, so you don’t really have $50,000 if you look at it as a comprehensive view anymore because that $15,000 went to taxes, right? So, we know that’s going to have to happen at some point in time. But in regards to a conversion doing a larger chunk at once, we need to think about, okay, well, what’s the break-even age? How is this going to benefit my situation? As I was saying, is it going to benefit my retirement? Is it going to benefit me only if taxes go up? Is it going to benefit my heirs? So, that’s always the number one factor. It’s like, why are we doing this and how is it potentially going to make your situation better in terms of both retirement and/or legacy planning? Does that make sense?

Matthew Peck: For sure. But then to be clear, just so for all of our listeners, is it any age? I mean, is it just retirees that should consider? Can anyone consider a Roth conversion?

Nick Nelson: I think you can argue any age, but those optimal windows tend to be after you stop working and before RMDs. I think that’s like a great window to look at because once you get to RMD age, you can’t actually convert RMDs themselves. You can convert beyond them. However, think about it, right? If you have to take your RMD, that can reduce your flexibility and that’s going to increase your taxable income in itself. And then if you’re making a lot of money, you’re going to be paying a high percentage most likely on those conversions. So, as like to keep it really simple, that optimal window tends to be after retirement before you have to take required minimum distributions, which right now that age is 73.

Matthew Peck: Okay. So, let’s pause there for a little bit. Okay. So, we’re talking optimal window in your opinion is retirement to RMD age. Let’s just pause a little bit to talk. Okay. Remind everyone what is an RMD. What applies? Required minimum distribution is what it stands for. So, everyone knows the retirement age or not just the retirement age. But everyone knows, okay, now I’m retired. Everyone knows the beginning of this window, this optimal window that you speak of. Okay. But then what’s the other end? You mentioned RMD. So, explain RMDs, explain the age, what happens, etcetera.

Nick Nelson: So, RMD is if you have qualified assets outside of Roth IRA when you turn the age of 73, the IRS wants their cut of money. So, when you turn that age right now at 73, it’s actually going to go to 75 I think in 2033 if I’m not mistaken, right now it’s 73, you have to take those distributions out from your pretax money. So, again, your qualified money that’s not Roth money. You’ve never paid tax.

Matthew Peck: So, that same big bucket of cash I was talking about earlier, that combination of IRA, 401(k), 403(b), etcetera, all that of that money that’s the pretax dollar has never been taxed got the tax deduction on the money that went into this bucket. All of that now is subject to this RMD system.

Nick Nelson: Exactly. Exactly. So, RMDs would apply to that pretax money, that same money you would convert. The nice thing is if you get that money to Roth, RMDs no longer apply. So, that’s where all these things start to tie together, the taxation, the distributions, the RMDs, all these things play a factor in a conversion and how it’s going to potentially benefit you. And that’s why we want to look at these various things to identify this window.

Matthew Peck: And let me underscore that. So, Roth IRAs are not subject to RMDs, meaning that once you have money in a Roth IRA or whether it’s traditional Roth 401(k), which we’ll talk about all over the world at some point, but Roth IRA. When the conversion is done, this bucket now of tax-free dollars, income tax-free dollars is never subject, you never need to take money out of that.

Nick Nelson: You do not if you don’t want to.

Matthew Peck: Wow. Which allows it to continue to grow tax-free.

Nick Nelson: One exception to that that I can think of, if you inherit a Roth IRA.

Matthew Peck: Okay. All right.

Nick Nelson: So, that’s a whole another thing.

Matthew Peck: Yeah.

Nick Nelson: I just wanted to throw that out there.

Matthew Peck: All right.

Nick Nelson: The other thing I wanted to… Sorry. I didn’t mean to interrupt you but the other thing regarding that optimal window, there’s kind of a unique opportunity out there. I know you guys have talked about it before, and that’s the tax rate or the drawbacks, right, which is going to sunset after 2025. So, when you look at the average tax brackets for most people, you can say taxes are on sale maybe 2% or 3%, depending on where you fall on that spectrum. But that’s another thing where that’s obviously coming to an end. So, when we have these clients that are right now in that window after they are retired and they’re pre-RMD age, these next two years are another opportunity for us to convert and potentially save that 2% to 3%. Again, I’m going to go back to that word ‘efficient’ to maximize the efficiency of this strategy.

Matthew Peck: Well, yeah. Let’s pick that up a little bit because now we’re talking about we’ve identified what a Roth conversion is. We’ve identified the ideal situation from retirement to RMD stage and knowing that at RMD stage, we have to take money out of this big bucket if we have not taken some form of action. So, now let’s zero in even further. Okay. So, a client just retires or he retires in 2024 or 2025 or whatever that may be. Now, we start talking about Roth conversions. Is that accurate?

Nick Nelson: Yes.

Matthew Peck: What are we talking about with our client? How many? So, however you want to start, right? You mentioned there’s a number of different factors. You talked about the break-even age. You talked about the current tax brackets. So, expand on that a little bit. So, now I’m just retired. The window is now open for me to do Roth conversions. Walk me through all the different things I need to think about and how an actual Roth conversion works.

Nick Nelson: Yeah. There’s a lot, in my opinion. So, let’s say we kind of did that first step. We kind of identified that we think a Roth conversion could make sense for you based on your goals, your objectives, your age, etcetera. The next thing we’re going to look at is the one that most people are aware of, and that’s just your federal tax bracket. Where do you currently fall on that? Where do you project to fall on that? And can we use that to our advantage and convert dollars within our current tax bracket? So, the way we like to go about it at SHP is basically we’ll give the client a couple of scenarios to consider. The first scenario is usually a more conservative scenario, and I don’t mean conservative in risk.

I mean, a smaller number where we’re not trying to increase their tax bracket or jump them to that next tax bracket. We’re not trying to create any additional taxation that we don’t need to. So, we’re very mindful of these factors that we’re about to go over. So, the first one is that tax bracket. Where do you fall? Do we have room in that current tax bracket? That’s number one. I’d also like to mention, too, I think it really depends. If you’re in a 12% bracket and you’re jumping to 22%, that’s a 10% jump. So, we want to be extremely mindful of that. But if you’re in the 22% bracket and the next bracket right now is 24%, that’s not so bad, right? That’s a 2% jump. We can probably still get some benefit out of that in your retirement by not expanding that break-even age by a significant amount of time.

Matthew Peck: And let me just now interject really quickly about that 22% to 24%. You mentioned earlier about the tax cuts sunsetting in 2026, right? So, not only is it might only be 22% to 24%, but compare that same bracket, what’s that same bracket going to be in 2027?

Nick Nelson: Yes. So, I mean, I’d have to look at it but it’d be up about 2% or 3% most likely.

Matthew Peck: I think I believe the 24% is going to 28%.

Nick Nelson: It may. Actually, I might have it here. But, yeah, exactly. So, I mean, that exactly hits on the point as we can save, in that case, what at 4% or whatever that was, on taxes which is huge in the long run.

Matthew Peck: Right. No, because I mean back to again how tying all this together, right, think about connecting all the dots it’s like, okay, well, what would you rather do? Would you rather pay 24% taxes on that withdrawal, i.e., conversion? Or do you want to wait until you’re 75 or 73? Now, you have to take out the RMD and now you’re paying 28%. Your income didn’t go up at all, but the tax brackets did. So, you’re able to choose what taxes you control, the taxes that you pay on that distribution based on the knowledge of where the tax brackets are now versus where they’re going to go in the future. So, I think that’s just important to emphasize the control. And maybe it’s, again, well, efficiency will be our word of the day. But is it…

Nick Nelson: Control is big too.

Matthew Peck: Yeah.

Nick Nelson: You say that all the time. You can’t control a lot that happens in retirement and everything that happens in the outside world but you can control or at least you know where the tax brackets are or what you’re going to potentially pay, which is can we take that to our advantage is the ultimate question.

Matthew Peck: Right. And I think the other part, too, that I love about how and just obviously I’m biased towards what SHP does clearly, but I love about how it’s all related. And you mentioned earlier about goals and objectives. And I do want to talk about a couple of different goals, but the one I want to talk about now is that how income planning and budget management and cash flow management is also a part of this conversation. Because as that client leaves working, enters retirement, not only are we doing this tax Roth consideration and analysis, but the first step which I’m going to plug in now is that we’re also taking a look at the income. Like, how much does that client need to withdraw to sustain their lifestyle? And what money do we have to use? Right?

So, it’s like only after you establish a good income plan, knowing that, okay, well, if I withdraw X, here is my anticipated taxes that I’m going to need to pay in order to live my life because no matter what happens you’re not doing a Roth conversion if you can’t go out to dinner or go golfing or go fishing with your buddies and your girlfriends and whatnot and travel or whatever else your dreams are. So, you want to establish that first, and then you’re able to then, okay, well, this is what we need. To go back to what you were saying, well, how much room now do we have in the tax bracket?

Nick Nelson: Yeah.

Matthew Peck: Okay. So, again, I love the fact that income planning directly bleeds into tax planning as we go. So, alright, let’s go back to that. So, you mentioned, okay, we do a conservative. We do a moderate. And now talk a little bit more about that analysis that we do for the clients.

Nick Nelson: Yeah. So, we usually will start with that conservative and kind of these factors that we’re talking through right now. We’re looking at every single one of them for each outcome, each scenario for the conservative, for the moderate, for the more aggressive, depending on how in-depth and how many options we want to give the client. So, the next thing that we tend to look at, it’s like, okay, now we know where we’re at from a tax bracket standpoint. The next thing we tend to look at, and this isn’t really in a particular order, they’re all factors to consider, the next is IRMA. So, income-related monthly adjustment amount, which impacts Medicare primarily Part B, but actually Part D a little bit too, if it applies to you. Okay.

So, with that, if you’re going to be age 65, basically within the next two years or you’re over age 65, the amount that you pay for Part B is impacted by what’s called your modified adjusted gross income. So, there are some deductions that apply to that but think of it as like your total gross income for the most part, just for simplicity today. So, if your total gross income or your modified adjusted gross income goes over a certain point, I think it starts if you’re filing jointly, married filing jointly, if you go over, I believe, 206, then you could be paying in additionally approximately $100 per month in addition to what you were paying before. And that just continues to go up. So, as your modified adjusted gross income continues to rise, it could be another $100, it could be another $100.

Matthew Peck: Is the IRMA levels the same as the tax brackets or are they different?

Nick Nelson: They’re different.

Matthew Peck: Okay. So, let me get this straight. So, first off, we got to take a look at income. Like, I was just kind of ranting on and on about to make sure, okay, is your income sustainable? What are we doing when we withdraw our income? Is it cash flow? Other income sources, social security, capital gains, so forth and so on. Then we take a look at tax brackets to say, okay, well, based on all that information, where do we fall within the tax brackets? And then you’re saying we’re also taking a look at Medicare income levels, which are different from the tax brackets. And now we’re bringing health insurance into this calculation.

Nick Nelson: Yeah. So, it sounds strange when you first hear it but you have to because a lot of people who are retired, they’re on a budget and we work with them on that budget, on that income plan. And we want to be like, “Okay. How much do you need each month?” We’re sending them a specific amount of money. Now, it’s not saying we can’t adjust that, but retirement’s a long period of time for a lot of people and we want to make sure that we continue to stay on track and we’re mindful of different things that could increase our expenses. So, this is one of those things that can sneak up on us a little bit and potentially increase our expenses two years down the road when the IRS looks at our modified adjusted gross income.

That’s the other thing that’s kind of strange about it, too. I’m not sure why the IRS does it. I’m not sure if you know, but they actually look at your modified two years ago to determine what you pay in the current year for your Medicare premiums.

Matthew Peck: So, there’s a lag time with the tax brackets.

Nick Nelson: Which is why it can be confusing too.

Matthew Peck: Yeah. And suddenly, it sneak up on you. In a Roth conversion, everything’s good, and then two years later your Medicare bill doubles or whatever that may be.

Nick Nelson: Yeah. It could throw you off.

Matthew Peck: Yeah. Right, exactly. So, I mean, you certainly want to have an advisor. I mean, I think that the reason why I kind of wanted to unpack it and to kind of lay it out like that is really just to give the idea that people and even us again and shame on us because that’s why we really want to do this podcast. But people bandy about, “Oh, Roth conversions this. Yeah, just do Roth conversions,” or you’re going to consider a Roth conversion. It’s like, “Whoa, wait a second. There’s a lot you need to consider.” And this is something that you have to make sure you’re doing properly, efficiently, doing things the right way because if you kind of just like, “Oh, yeah, I’ll just convert this,” without looking at all these different angles, you’re doing yourself a disservice.

I mean that could eventually come back to bite, whether it’s within Medicare premiums or other paying more taxes than you should have or whatever that may be. So, it’s just so powerful to have an advisor that understands all of these different facets. And I’d also say too, I mean, you can’t be doing all these calculations in your head, I’m assuming. So, what type of tools do you use, that SHP use or whatever that may be to help then break kind of balance out all these competing interests?

Nick Nelson: Yeah. We have a few tools that we use to run these numbers, some that we use with actual tax returns, some where we’re actually inputting the data ourselves. But what I would say is that we also aren’t tax professionals. I think that’s important. We’re financial professionals, we’re financial advisors. So, we do work with CPAs and tax professionals to make these decisions, which I think is a very important point not to look over. Let’s say we do make a recommendation for a client. We’re looking at it more from a planning standpoint, from a portfolio standpoint, retirement, or legacy standpoint. And then we’re bringing in the tax professional or the CPA like, “Hey, like this is what we’re thinking and why this is how we see it benefiting their situation. Can you just make sure that we’re not missing anything on the tax side of things that could impact the client or negatively impact the client?”

Matthew Peck: Well, that’s great, man. It’s a great way of answering it. I mean, not only is there multiple call it financial planning tools and software that we use that some of it specifically from clients’ 1040s but then the other tool that we use is our CPA. You know, like other obviously people that are on the team, not just here at SHP but I really enjoy working with clients and then saying like, “Hey, who’s your CPA? I want to talk to him or her,” because I want to get them on this team to surround the client with good attorneys, good CPAs, and obviously, again, in my humble opinion, good financial advisors.

Nick Nelson: Exactly. Yeah.

Matthew Peck: Let’s go back to this aggressive, conservative moderate, this analysis that we then give the clients looking at IRMA, looking at their cash flow, looking at tax brackets both now and in the future, looking at it from all these different angles. What does the analysis kind of then spit out? What’s the pros and the cons of making the decision? Because you mentioned things like age and break-even ages and whatnot. So, how’s your client then? If they get that report, what’s coming to bottom line on that report? Like, what would a conservative one do for them? What would a moderate one do for them? Well, what would a client expect to see and to weigh out whether or not to do one? Well, one being a Roth conversion.

Nick Nelson: Yeah. So, what we can show them, Matt, is more the numbers behind it in terms of the pros and cons, right? So, like if you were to convert 50K versus 150K, what that’s going to look like in terms of the taxes that you actually own now and also what that’s projected to look like throughout your retirement, whether you use that Roth money for income or not. And also from a legacy standpoint too passing, say, 50K plus growth onto your heirs versus 150K growth to your heirs, right? That’s going to be a big difference, especially if you have 20, 30 years of growth behind that. So, we can show them here’s what their projection looks like in terms of what the next generation would pay in taxes as well as the overall amount of money that they would receive.

With Roth IRA, another point that I think is important is we can be usually, I should say usually, a little bit more aggressive with that portion of money and it’s because one of the factors you mentioned before is we don’t have to worry about RMDs. So, we can really have that be earmarked as one of the last places that we’ll touch, whether it’s for income or legacy. Now, we can, if we’d like to, and maybe we do invest a portion a little bit more moderately, depending on their risk tolerance and things like that. But we don’t have to take out those distributions. We’re not required at the age of 73. And again, if you have a goal of a legacy, like if legacy is a goal for you, then having that money in Roth is much more beneficial.

Matthew Peck: And I kind of wanted to go back to that. So, it’s like client receives because I’ve seen your reports that you send the client and certainly taxes paid. So, you have to be aware of, okay, hey, we do this conversion of $50,000 that you have to pay taxes, that you’re voluntarily paying those taxes and it will take some time for the portfolio to surpass and to exceed what it once was because I think you did an example of the client having $50,000. Let’s just say 15 goes to taxes and now they have 35 or 15,000 has to come from somewhere, obviously, to pay the taxes. Now, you mentioned quarterlies and whatnot. Maybe we can go there if we have time. We have a little bit of time. So, maybe we will go a little bit further into the weeds a little bit.

But on the higher level, it takes some time for that 35,000, that remaining amount that’s in the Roth to surpass the original 50. Now, it does happen and then it’s even more so if you look at from a long-term net worth perspective, a legacy perspective, etcetera. So, I like because you mentioned earlier and I do want to emphasize it because we use this term a lot, but the break-even age. Knowing the break-even age is so important when it comes to these analyses or Social Security analysis, a pension analysis. When we talk about things like break-even like, okay, if I do X, I know I’m a little bit behind the eight ball to start, but when do I get ahead? And I’ve seen break-even ages range anywhere from early 70s to sometimes higher.

But then it goes back to, okay, so let’s say you break even just later in life. Let’s say it’s 80, right? Because there’s all the different variables that happened that are very unique to you. Then we talk about legacy. Is legacy important? I mean, if legacy is important, then great, you still do it. If legacy is not that important and you have no kids and you’re not doing anything with charities and church, hey, maybe you don’t consider a Roth conversion. Right? And so, I think understanding when that break-even age, I think, is extremely important because obviously knowing when the taxes are paid, all the kind of nitty-gritty is important. But also, it’s like, “All right. When is this in my best interest?”

Nick Nelson: Yeah. And another thing just to kind of add to that, too, when we’re doing these analyses, most of the time we’re assuming that taxes are staying the same. We are factoring in the sunset after 2025. But outside of that, we’re assuming that taxes stay the same. So, the way that we’re building these plans, we’re still able from a numbers standpoint to see a lot of value for these clients if taxes stay the same. But what happens if taxes go up in the future? I know it’s a big question mark in this country right now. Obviously, there’s a lot of debt out there and things like that that make people concerned about it.

Matthew Peck: I haven’t heard either the candidates talking about it, but that’s just my own fiscal responsibility. I digress. I digress. Go ahead.

Nick Nelson: So, it’s just a factor. So, we have a lot of clients do, like personally, right, just worried about taxes and the future. They’re like, “I don’t know what’s going to happen. I just want to do everything that I can today to make sure that I can worry a little bit less in the future about taxes.” And that’s another factor in this. Obviously, we need to look at the numbers, but peace of mind is a thing, something we talk about with clients a lot, not just from a tax standpoint, but from income and a legacy standpoint, too. And I think you get the idea. All these things tie together. If we can provide peace of mind, not only that you’re going to get enough income, but that you’re not going to have to pay twice as much in taxes in 20 years. I know that’s extreme, but who knows? That makes people feel a lot more comfortable, too.

Matthew Peck: Oh, I love in everything we do, the behavioral nature of it, the psychology of it, just the feeling. And you can’t put dollars and cents on feeling good or comfort or peace of mind or knowing that, “Hey, I did everything I possibly could to make a well-informed decision.” Right? You can’t put a price to that but I would argue, which is it’s invaluable. I mean, having that comfort, I love to bring that comfort to clients. Let me put it that way. Knowing that we’ve looked at every single angle and yet we have no idea if it’s the right decision because you can’t predict the future but giving them the confidence to know that we crunched, we did all our due diligence, re-crunched every number we possibly could using all the software, working with CPAs, etcetera.

All right. So, now finally we get this report. We consider things like, okay, it’s going to feel good to have taxes kind of taken care of, at least for this sleeve of my portfolio. I’ve taken a look at the break-even age. I’ve taken a look at the taxes I have to pay right now. I’ve taken a look at IRMA in regards to what this impact is going to be on Medicare. Dude, look at my income, you know, and how this is going to impact, and do I need this money to live on? So, I finally did make a decision. I say, “All right. Nick, $50,000 is what I’m going to convert.” Now, what happens?

Nick Nelson: So, that’s where we come into play. So, actually, for our clients, we will actually process those conversions for you, right, as long as we’re managing your assets, of course. But it allows us that we’ll do that for you. So, basically, we’re looking at your portfolio, we’re looking at your positions, and we’re converting those shares from IRA to Roth, rebalancing the portfolios, making sure the IRA stays intact and the proper allocation. And then the money that’s going to the Roth is in the proper allocation, too, because going back to that break-even point, someone will be like, “Well, what’s my projected break-even?”

Everyone is different because it depends on how you’re invested, how that Roth IRA is invested. Obviously, the more aggressive you are, if the market performs well and that’s an if, that can speed up that break-even point. And if you’re invested more conservatively, most likely it’s going to be a little bit less unless, obviously, the market performs like out of what we would expect and things like that, which we all know a lot of different things can happen there. But it is going to be dependent on performance is the point I’m trying to make in terms of that break-even age.

Matthew Peck: True but concrete-wise, what are the steps? I say $50,000. Obviously, again, we help with the conversion for you but there’s two things to consider from my understanding. Number one is how to pay the taxes and I think there’s also in regards to timing, like is there timing involved with Roth conversions?

Nick Nelson: Yeah. So, in terms of how to pay the taxes, right, so we kind of mentioned it briefly. You have two options. Again, if you’re over 59.5, and that’s a key point. If you’re under 59.5, you cannot withhold taxes from the conversion. What I mean by that is you convert 20 and send 10 or whatever, 15 over to your IRA. You can’t do that. If you’re before 59.5, you have to pay taxes separately into the quarterly system. Does that make sense?

Matthew Peck: Yes.

Nick Nelson: So, for pre-59.5.

Matthew Peck: But usually more often than not, though, people that do this are over 59.5.

Nick Nelson: Correct.

Matthew Peck:  Okay. And then in that case, how does that play out?

Nick Nelson: Then you have two options. You have the option to withhold taxes, and that would be maybe a situation where you didn’t have a ton of assets on the side that were maybe after tax where you could pay into the quarterly system and cover those taxes. That would be withholding taxes. Or you cannot withhold taxes and pay into the system like we were mentioning, which I think personally, at least that’s my opinion, I think that’s the most efficient way to do a Roth conversion because you have more money working for you in the Roth. Think about it. Again, go back to that 50K conversion. Do you want $50,000 growing for you in the Roth or do you want the net amount after you paid the taxes working for you that’s going to also expand and have an impact on the break-even age as well?

So, determining which route you want to go I think is important. With that said, if you do need to withhold taxes, I wouldn’t say you shouldn’t do a conversion. You should just know the impact of it and how it’s going to play out.

Matthew Peck: Yeah. So, in other words, to maximize efficiency, you would do a full Roth conversion and then pay the 15,000 in this example, out of checking savings, CDs, etcetera. So, in a perfect world, you would do $50,000 full Roth conversion and then cut a check to cover your quarterly payments out of outside money. That’s ideal. Worst case scenario, again, if all the numbers work out well and it’s in the hypothetical client’s best interests, just do the withdrawal. I’m sorry. Do the withholding on the actual draw. I’m sorry. Do the withholding on the actual conversion. Do I have that right?

Nick Nelson: Yes, you do.

Matthew Peck: Lastly, what about timing? Is there a time to do a Roth? I know it has to happen within a tax year. Obviously, it has to happen between January and December. December 31st. Anything else besides that to know?

Nick Nelson: Yeah, I think so. So, number one, when you process a conversion, once it happens, it happens. You can’t undo it. So, it’s important to know where you’re going to end up falling from a tax bracket standpoint, from an income standpoint. And that’s why a lot of people if there’s uncertainty around that in terms of like, “Are we going to realize more gains this year? Am I going to need that IRA distribution? Is that part-time job income going to increase?” whatever it may be, it tends to make sense to convert towards the end of the year because you have a more full and complete picture of your tax situation. So, that’s number one in terms of timing.

With that said, it doesn’t mean you shouldn’t convert earlier in the year. I’m not saying that either. I’m just saying if there’s uncertainty around your situation, it tends to be a little bit more advantageous to wait towards the end of the year just to make sure we’re not missing anything. So, that’s number one. The other thing in terms of timing and this one’s interesting, it’s market timing, right? So, obviously, it’s hard to time the market. We don’t say we time the market, we don’t time the market. But when it comes to conversions, there’s things we can do to just try to get a little better price points in terms of converting.

So, for example, if we know we have a client who’s waiting to convert a portion of money and we see the market drop 3% in a day or let’s say 5% in a week or something like that, that may be like, okay, that’s a great opportunity for us to convert because this week the overall market is down about 5% and we’re converting those shares at a smaller price, which is then giving more potential growth in the future. And it’s also converting a smaller amount of money when you think about it because that portfolio went down from the week before and allows us to maybe get additional shares into the Roth, which should help with that future growth.

Matthew Peck: Excellent. Okay. So, if I summarize all the other, Nick, I mean, number one, we are sort of nicely running out of time, but my goodness, I’m sure everyone that’s listening needs to process this and digest this because there’s just so much to consider. I mean, as I say in the beginning, I love how we throw around these terms like, “Oh, yeah, you should consider a Roth conversion.” And then literally spent 40 to 45 minutes drilling down into all of it. I wouldn’t even say all because I’m sure there’s probably other things to consider.

Nick Nelson: We’re kind of scratching the surface, Matt, to be honest with you. Like, we’ve talked on some major points, but for us as advisors, there’s other things that we look at to make sure that conversions do make sense, right? So, like, I’m not going to necessarily go into all these details but we didn’t really talk about capital gains taxation today.

Matthew Peck: And, I’m sorry, another one that you mentioned that I kind of was like, “Oh, gosh, that’s another day,” you know, the inherited. The rules when it comes to inherited IRAs versus inherited Roth IRAs and how they differ. I mean, there’s a whole lot because we’ve talked a little bit about legacy and we mentioned that at the beginning, but that’s another area.

Nick Nelson: It is. It is. And then there’s Social Security taxation and there’s net investment income tax. There’s different things that we want to look at to, again, understand what we’re doing when we’re converting. And I think that’s why it’s so important to work with a professional who’s looking at all these things but I think even more importantly, tying it back to your overall plan. What is the benefit? Why are we converting? Because conversions are great. I think there’s an argument to be made that a lot of people should at least look or consider conversions, but they’re also not going to make sense for everybody. Right? You want to make sure it makes sense for you and your plan. And that’s when we come into play, especially working alongside the CPAs and tax professionals.

Matthew Peck: And I couldn’t agree more. Obviously, we work together, so we’re kind of in an echo chamber here. So, nothing too controversial here because we’re kind of both the same.

Nick Nelson: Not today. Maybe this afternoon.

Matthew Peck: Yeah, right. We won’t record that piece but, no, it’s just more the idea that maybe just personally speaking, right? I’m just such a planner and I love to put that together because you need to start there. I mean, you can’t just client or let’s say a prospect, right, or referral from a family friend or they see a TV show or whatever, find us on Google or whatever. When a client, when someone comes into our office, it’s not automatic we’re going to launch into Roth conversions. It’s more like, okay, we have to get a plan in place first. We have to know what is your legacy goals. What are your income goals? How are the assets currently taxed? Do we have this large bucket of IRA dollars or is it a blend? Do we have tax diversification? What’s important to us? What does make us feel good?

We talked a little bit earlier about the psychology of, I mean, that’s part of the planning process. And the onboarding process is you have to understand all of that, you know, understanding our clients down to their core as much as possible. And then you get into this deep dive about, okay, now let’s take a look at this Roth conversion from all of these different angles and all these different perspectives now that we truly know the client. And you need a plan to truly know the client. You need a process to truly know the client. You need a system to have that all tracked out with all projections and assumptions and stress tests and everything else that we do.

And so, it’s like there is no chicken and the egg here. It’s like that has to happen first. And then you go into these interesting strategies that have all these different levels to them. And that’s just what we do every day. And it’s just amazing you said that at the beginning over, I’m sure, hundreds that we’ve done because we’ve been able to get to know the client first and then apply this strategy as well as all the other strategies that are out there when it comes to tax planning and then tying it all together to achieve the client’s goals, make them happy, make the family better off and better off forever stepping in our doors at that point.

Nick Nelson: Yeah. Exactly.

Matthew Peck: So, Nick, thank you so much. Any final thoughts before we wrap up?

Nick Nelson: No. I just say, if this is of interest to you and you’re considering a conversion, definitely reach out to us and we’d be happy to help you. Also, too, if you’re somebody that is a self-doer and that’s fine too, a good thing to do is maybe start with your previous, your tax return, apply your changes, and kind of think about, okay, where do I fall and what should I consider converting? But I do think taking that full comprehensive view, working with a professional, it’s going to make sure that nothing is missed, which is obviously where we come into play.

Matthew Peck: Awesome. Nick, thank you so much. Thank you to our producer, Evan. Thank you to all of our listeners for putting up with my bad dad jokes every once in a while. They’re full of them.

Nick Nelson: Again, they’re getting a little better.

Matthew Peck: Yeah. Well, yeah, and actually we’re both dads, so maybe that’s why…

Nick Nelson: We are now.

Matthew Peck: Yeah, we’re kind of all like, “Oh, that’s a great one.” He’s writing down notes right now for sure to tell later.

Nick Nelson: Exactly. Yeah. Step my game up.

Matthew Peck: But again, thank you all so, so much. And we wish you the best. Take care.

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