Often times I've found that people think they don't have enough for it to make sense to consider converting their Traditional IRA to a Roth IRA. Some people think that unless they have a really large IRA that it probably doesn't make sense. However, each situation is unique. In this video I share with you the actual numbers that I ran for somebody comparing converting to a Roth vs not. Some of the things that are often overlooked include how you can potentially reduce your Social Security taxes by doing a conversion. Other factors include the potential for increased tax rates in the future and the impact on a surviving spouse when one spouse passes away (especially if they pass away early).
Full Transcript:
Hey, how's it going everybody? It's Ryan here.
I was just talking to a guy the other day. He's 62 years old, his wife is 59. She's already retired, he plans to retire in another five years when he's 67. And he said, "I've got $550,000 in an IRA. And between my IRA and my social security, I think I'm going to be fine for retirement. I'm not really too concerned about that. I'm going to have my house paid off, or my mortgage paid off, by the time I retire and that we live a fairly modest lifestyle. My real question is, does it make sense for me to consider doing any Roth conversions or do I not even have enough for it to even make sense?"
And I've gotten that question quite a bit over the years. A lot of times people don't think that they have enough money, and it almost doesn't matter how much money you have. Whether it's $100,000 or $1000,000 or whatever that number is a lot of times people think maybe the amount I have isn't enough for me to be considering doing this. So I said, "Well, why don't we go ahead and check it out? Let's just run some numbers real quick and let's find out here together." And so that's what we did.
What I'm going to do here is I'm going to share my screen with you and just walk you through what we did right here. Now, this isn't an extremely comprehensive, it's just something that we did real quick here together but hopefully this is helpful and you can learn a thing or two from this.
Let's go through the inputs here. This is Bill and Mary, so I've changed our names to protect the innocent, last name Sample. And I didn't actually get their dates of birth, but I know that they're 62 and he's 59. So I've got that plugged in here. I just made the dates of birth November 1st each.
And so again, she's retired already. He's going to retire at 67. And for social security Bill said that his full retirement age benefit, which for him based on his date of birth, 1958 is 66 years and eight months is 2,600. But I just want to assume I'm going to retire on on 67. So his benefits projected to be 200,669 at that age. So that's where we have it right now for him.
And then Mary, he said, "I'm not sure what her benefit is. I think it's about 900 or a thousand." So we just plugged in nine 50 right here. And we assumed that projected COLA of 1.5%. That's the cost of living adjustment. We took a look at the history of cost of living adjustments for social security, the 46 year average, the 10 year average. I don't want to get all into that right now, but they said let's just go with 1.5. They don't have any pensions, so that part was blank. Again, he has an IRA, traditional IRA. He's got $550,000 in there, approximately. And then I also found out he has an additional $75,000 in a savings account. Typically, they keep he said about 20 to $25,000 in the savings just for emergency reserves type of money. But his wife's mom had recently passed, so they inherited a little bit of money there as well. So that's why they're $75,000 now in the savings account.
I said, "okay, what rate of return do you want assume that you can earn on the IRA over time?" And so we plugged that in down here. He said, "well, let's just presume 6%. I think that's reasonable."
So I said, "okay." And do keep in mind, this is all just a very basic calculation. We're not doing any Monte Carlo simulations or anything like that. We're not stress testing for sequence of returns risk, withdrawal rate risk, anything. This is just assuming a static 6% rate of return each and every year. And I said, "what about on the savings account? What interest rate are you getting on that?" He goes, "I don't think I'm getting anything." I said, "well, okay. Interest rates are definitely very low right now." So we just, went with zero for the savings account.
And I said, "now when you do retire, what do you want to live on? On a monthly basis? What's the goal?" And he said, "if I can live on $5,000 a month after taxes, that would be ideal. That would be awesome." I said, "okay, let's go with that." And he goes, "I'm living on 5,000 a month gross now. So this would be after tax. So, that would actually be an improvement." And I said, "what inflation rate do you want to use?" He said, "let's go with 2%." We went through the inflation history right here, 106 year average, 10 year average. He wanted to go with 2% on that. I said, "okay, let's just do that." And let's take a look just based on these simple numbers.
So this is the output here, and I don't want to go into all this right now, but the bottom line here is what this is calculating is year by year. We can see the social security coming in. We can see what their total monthly expenses are when we factor in inflation, the cost of living adjustment. And we could see how much money he's going to need to take on a monthly basis from his IRA, his retirement portfolio, in order to give them the additional money that they need on top of the social security to maintain that $5,000 a month after taxes, inflation adjusted.
Now at the end of the day, what we want to look at first down here. Is we go all the way down to the bottom and all the way down on the bottom gets us out to 2061. Now, if he lives that long, which he didn't believe that he would and chances are, he probably won't live to 103, but if he does at this age his wife would also would be a hundred.
If she was living that long as well, they would have a $1,188,000. You'll see right there in the bottom right, $1,188,836 at that age. Based upon all of our assumptions that we've put in here so far.
So, just like he said, chances are he's going to be fine, for retirement, based upon the amount that he wants to live on. Now, of course, a lot of factors are not coming into this again, there's... We're assuming a static 6% rate of return. We're not assuming any unknown health risk, we're assuming inflation is going to be where it is, all these things, but we just want to focus on the Roth conversion. If we look at where the scenario would play out, by the time 2061 plate comes around, they'd have almost 1.2 million.
So here we go. I said, "all right, well, let's go ahead and take a look and see if it might make sense to incorporate any Roth conversions into the mix." And by the way he is in California, but just for the sake of this, I just made the tax bracket zero, because I want to for California... Or I made it 0% for California, just because I want to keep things simple. That way we can just focus on the federal tax. So what I did here, was took a look at this and said, "all right. So for this year, for the year 2020, you could have an additional $45,050 of income and still remain within the 12% tax bracket." Now, if you take one more dollar on top of that, that next dollar is taxed at the 22% rate. I said, "but we could get $45,050 out of here and just paid taxes at 12%." Because eventually, you're going to have to pay the taxes eventually. You're going to have to take out required minimum distributions when you're 72. And you're also going to need this money anyways, or at least some of this money on a monthly basis to supplement your lifestyle because social security, wasn't enough to get him to where he needed to go.
So let's take a look. What if we started to convert some of this money, that's just in the 12% tax bracket? And so just very quickly what we looked at here was doing Roth conversions. And what I plugged in was just doing a Roth conversion. Let's go to the preretirement. Starting now, this year, just doing $30,000 a year. Again, I didn't get real detailed into this. I just did this real quick. But I said, so what if we just did $30,000 a year between the year 2020 up until, go to the retirement tab, now he's retired up until the year 2030. What if we just did that? What would the impact be? Well, the impact would be, and you could see it all the way down here at the 1.77 million, but you can also see it here. This is our summary. We can see you'd have 1.77 million at this age. Now, if you don't recall what that difference was, it is significant. So the difference before, before doing the conversions, he would have had. At this age, him and his wife would have had about 1.2 million almost by doing the conversions. They would have almost 1.8 million.
That's about a $600,000 difference. That's a big difference, but not only that it's... Keep in mind a lot of that money, actually, all of this money down below by this point is inside the Roth IRA. So he's paying no taxes, they're paying no taxes whatsoever. That's a good deal. Also if they do, or when they do pass away and their kids do receive the money at this point, they won't have to pay any taxes on it. And that's also really nice too, because you can no longer stretch out an IRA over the course of your lifetime. You've got to take the money out over 10 years, which means you could potentially have to pay money at a higher tax bracket. So, for your kids to receive that money tax free, especially if tax rates go up in the future can be just an extra added benefit.
The thing is, you're not sacrificing anything for yourself. You're actually putting yourself in a position to have more money, but also you're allowing your kids to have more money as well, if you don't spend it. It's a win-win really. This is just real quick. We just looked at this real fast. Now in reality, we look at things a lot more... much more carefully here, and it may not be just exactly $30,000 per year. We may want to use up all of the tax, 12% tax bracket for instance. And we've got to see where he's going to get the money to pay the tax year by year, because we want them to pay the tax primarily from the savings account money. And that's the way that this is set up right now.
So bottom line, huge improvement. But one other thing we looked at is, because you said, "what if tax rates do rise? Because that is on my mind. And keep in mind the tax cuts and jobs act is set to expire in the year 2025." And so I said, "let's just go take a look at that here real quick."
This is the current scenario again, this is if they did not do any Roth conversions. And if tax rates went up, wrong tab, if tax rates went up 50%? Now I know that seems perhaps like a lot. It's probably not as much as it sounds. What it's doing here is it's saying that in the year 2026, instead of the first tax bracket being 10%, it becomes 15. Instead of the next one being 12 it's 18. Instead of it being 22, 33 and so on. Let's just say tax brackets went up 50%. What would the scenario be for retirement? By the time 2061 would roll around huge difference? There down to 840,000. I mean they're still going to be fine. They're still going to have all the money that they're going to need for retirement, but it's still, that drops significantly. Now, if they do the conversions, let's take a look at that.
Roth conversions. Again this is the same thing. Let me just confirm though. Yeah, we've got the 50% increase in 2026. Now look at the difference. Same year 2061, they've got $1.5 million in there. The other one was like 800,000 something. Well, let's take a look. Right here. 840,000.
Based on their current scenario, meaning they do not do any Roth conversions, but the tax rates go up as we showed it there, up by 50% in the year 2026. They'd only have $840,000 left here versus over here. If they do the Roth conversions, they'd have a 1.5 million. That's almost twice as much money. And again, this is all down below, this 1.5 million, is all tax-free because that's all on a Roth IRA at that point. Versus over here in step three most of that is all going to be taxable. Not all of it because some of it's outside of the IRA because let's take a look at it, actually. Go down here. It should say IRA, but it's 401k. IRA, same thing. Let me change that. Don't want to cause that confusion.
You'll see right there, the IRA 314,000, that would be subject to taxes. This other 526,000 that you see right there to the left right here is money, that's the RMD. We call us the RMD account. So this is the money that he had to start taking out of his IRA. And he didn't even need to take the money out. And he didn't even need to take the money out. But to satisfy RMDs he absolutely needed to.
Bottom line to me, you could see here definitely does make sense to look at doing some Roth conversions in his case. Now we may not do exactly $30,000 per year. He may want to consider doing a different number. So we may want to use it... More of the 12% tax bracket, may want to change the numbers year by year and really get more detailed on this. The 30,000 was just a quick number I had put together.
But do hope this was helpful. If you have questions on it, just let me know. Take care, talk soon.