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With tax brackets changing in 2025? Should I consider Roth conversion? accelerating it? Or should I keep kind of the same pace?
Yeah. Okay. So essentially, what’s happening is the tax brackets that exist right now are designed to sunset in 2025. And they’re going to go back to the tax brackets that we had for personal taxes in before the 2017, tax law change, right. So that’s the parameters. So theoretically, the tax laws could not change the brackets could be extended, would take a congress, you know, that united to extend them. So I’m a little pessimistic on that fact, I think that they probably will go back up to the old brackets. But you never know. I mean, that’s raising taxes, which some people don’t want to do. So that’ll be interesting. The question is, should you be doing more of the Roth IRA conversions now, that would be cut before 2025. Because taxes are possibly lower than they will be, you could make an argument for that, although one of the things that I have seen in our work, we have a program that we use to go through and figure out the optimum tax bracket to fill. And so you know, you’re going to 10% to 12% 22,24, etc, which one is the optimal bracket to fill in the object is if I have a certain amount of income, and the bracket is above that, I can convert some money to fill in the rest of the money to fill in that bracket. And I pay the taxes with that, when we do this, the program that we’re using automatically assumes that the tax rates are going to go up in 2025. And so you do have to be a little bit careful there as far as that goes. Because if it’s an optimal bracket at 22, that’s going to turn to 25 and 2020, and 2025. You know, that could be something that doesn’t matter that much, as far as that goes. But I would push the envelope a bit. As you know, within this timeframe, if I was looking at my Roth conversions, for a variety of reasons, you get it for less, and you get, you know, a scenario where you’re now getting tax free growth sooner, rather than later. So, yeah, I actually think there will be some push here by people to do more Roth conversions as we get closer to 2025. I wouldn’t be surprised. I’m not surprised that this questions coming up now, but I bet you we hear it more often.
Yeah. And so you know, a Roth conversion is usually when you don’t have income coming in. So usually, it’s when you have after retirement. And if you’re not doing Roth conversions, I think that’s a great time to start considering it. If you have a kind of like a very big, you know, tax deferred 401k. And you don’t really have any kind of tax free assets, it’s probably good to try and diversify your your funds into different tax brackets, or tax.
Yeah, one thing that’s interesting, though, I mean, even if you are working, it depends on what you’re making, right? So if we go through the process to figure out what the ochman bracket is for you, most of the times it’s either 2224, right? That’s what we’ve seen most of times. And so what you’re trying to do is fill those brackets. So if you’re a couple, and I believe that 24% bracket goes to about 370,000 this year. And so if you have less than three or 70,000. And by analysis, your optimum bracket is the 24% bracket, you might still be able to do some conversions even while you are working. You know, as far as that goes, too. So it just it really depends on your situation. It is sort of a custom look, as far as that goes. Roth conversions are more complicated than than you think. But they’re really powerful to do. They make they can make a huge difference in somebody’s retirement.
Yeah, and the one knock against Roth conversions is it’s it’s a brutal feeling when you have to pay the tax bill for it. You know, when you even though an IRA, you know, when you look into IRA, always a portion of its the government, but it still feels like it’s all yours.
Yeah, exactly. No, I think that’s a really good point, I think is probably the biggest sticking point we have with clients is the actual. So it makes logistical sense. We show them that they’re going to have a higher net worth, theoretically, if they do conversions. But then when they look at, okay, what they’re going to have to pay in tax on that conversion. And ideally, you’re paying that tax with money someplace else, you’re not withholding it from that conversion, because that allows you to basically increase the value of your retirement accounts. So just so that’s clear, if I have $100,000 in an IRA, I might only have 75,000 That’s mine and 25,000 That’s the government’s you know, because once I pull it out, they take that tax, but if I convert that $100,000 IRA to a Roth, right, and I take $25,000 from my taxable accounts and pay that. Now I have 100,000 in Roth that’s now worth 100,000. So that to me, that’s super powerful. I just added $25,000 to my retirement plans, and now it’s growing tax free. But But to answer your point, I think one of the things that really has to be considered here and that people don’t realize is that although it’s painful, right now, to pay these taxes, somebody is going to pay the taxes on that account, somehow, some way, tax rates are very low right now. And although it’s painful, it’s better to pay them when they’re low. And because the other problem is your retirement plans are going to continue to grow, hopefully, 72, you’re going to have to take money out by age 85, you might find that you have a tremendous amount of money you’re having to take out and then you’re really in pain, you can’t get out of that, because now you’re in top tax brackets, and you’ve got a situation where you’re paying three, five times more for Medicare, you cannot get out of that situation, because there’s no ability to convert within a lower tax bracket, because you’re Required Minimum Distribution. So I think what’s happening there, when people are worried about not about the taxes and the tax bite, they can’t see the whole picture, we can, we’re dealing with the 85 year old, we’re dealing with the 75 year olds that are currently paying more for Medicare, just because the Required Minimum Distributions, we’re dealing with these situations where we had to earners to 401k is one person dies. Now it’s all focused into one person’s IRA, that RMD is focused around that one person, but they’re now in the single tax filing situation, right. So they’re having to file single head of household situation, their taxes are much, much higher. And they really even within the Medicare. So it’s two people’s money originally combined into one person, and now they’re getting hammered on on the taxes and you’re stuck. And I’ve got clients like that. And I it’s why it was what made me convert all of my assets, you know, last year at 2020, and 2021. Because I’ve seen what’s happens. And I think if everybody truly understood what the future was for them, with their IRAs, they would be much more interested in paying those taxes even though it is painful. One caveat, it really makes a bigger difference. If you have more in this area, you got $50,000 in an IRA, it’s not going to make a big difference, because the minimum withdrawals are going to be that high. You know, you get a million to $5 million in IRA, which is what we’re seeing, you know, all the time here in the valley. Boy, you’re talking about tax time bomb, it is unbelievable. And if you could really understand it, you would happily pay those taxes now, especially since they’re lower, the other rates are lower. As far as that goes so and you know, doing it sooner than later allows it to grow tax free for longer, right. That’s a big deal too. So anyway, it’s very fascinating.