Transcript:
Easan Arulanantham:
For the last couple of weeks, we’ve been talking about Roth conversions. And so, first question is, you said, when you do a Roth conversion, you should pay the taxes from another source? Why can’t you use some of the funds that is being converted to be used for taxes? For example, if I convert $100,000, from a traditional IRA to a Roth IRA, why can’t I use 20,000? of money to pay taxes?
Tom Vaughan:
Yep. Okay. So it’s a great question. So I’ve got $100,000, who knows how much I have in total, but I want to convert $100,000 from, you know, IRA to Roth. And so let’s say a 20%. Tax, I pay 20,000. In tax, where do we get the money? Why can’t I just take it out of that, but 80,000 in the Roth and send 20,000 to taxes. If you do the numbers, on a pure straight up setup, you end up in the basically the same place. In other words, if I let that 100,000 grow in the IRA, versus the 80,000, grow tax free, 10 years down the road, I cash out the 100,000, whatever it’s worth, and let’s say I’m still in the same tax bracket, by some chance, I’m actually up in the same place. They’re, they’re identical. As far as that goes. There’s some advantages still to the Roth, even in that situation, because of a couple of areas. First of all, right now, in 2025, the tax rates are going back up. So if I was able to cash some money out now, and pay lower tax, if they don’t keep the same tax rates, they could, but Congress actually has to approve that as a whole, they will sunset and go back up to where they were before, before the 2017. So like the 24% bracket is going to go to 28%, for example. So I’d have been better off right over the long term, paying the tax now, than paying it later. And as far as that goes, so that’s one advantage does if I do if I, if I’m at the same spot, but a more have more control over my finances going forward, because now I have tax free, I don’t have to take Required Minimum Distribution out of the Roth. So it can work. But the other way of paying the money for taxes with outside assets, allows me to move the entire 100,000 into that Roth. So if you think about this, this is really fascinating to me.
One thing that happens with an IRA is that you can look at it and let’s say it’s worth 100,000, it’s not worth 100,000 to you, the government owns part of that. And so let’s just say in this case, it’s 20%. So really what it’s worth to us 80,000, right, it just it is there’s no way around the taxes on those. And so if you roll that over, and you pull $20,000 out of your assets outside of retirement plans and put the whole 100,000, you now have 100,000. To you, that’s what it’s worth, because it’s tax free, it was worth 80, it’s now worth 100, what you just did was added $20,000, to your Roth, to your basically your overall retirement plan, and now it’s growing tax free. And when you do those numbers, it’s unbelievable. It really, really works well. And to the point where you know, it might override any potential future tax changes and different things that might happen that could affect a Roth, if you’re paying with outside assets. And so I would go out of my way to try to pay those, you know, taxes with outside assets. If I could, just because it’s so much better, I now have that 20,000 going tax free, you know, really for the rest of my life. Of course, that whole extra 20,000 then could be passed on to my kids, they can leave it in for 10 years growing tax free. If you do the big numbers on that. It’s a huge differential. And so we really try to encourage people to pay the taxes with as assets outside because it’s just so much more advantageous, but it could work. There are some caveats to that, but it could work to pay the taxes with the distribution. So with the conversion, just convert 80,000 and take the 20 and send it to the you know, to the to the IRS and your state taxes. But it still the whole conversation really revolves around the Roth which is fantastic vehicle it just is as far as that goes.