All righty, so I get to introduce myself today. So hello. I am Mike. I am a CPA. And let's just get started. So as you can see from our title here, this is going to be a deep dive on the topic of Roth conversions. But before we do that, before we really dive deep, I want to take just a brief moment to make sure that everyone here is on the same page about one fundamental piece of information.

And that is, what is a Roth conversion? So a Roth conversion is when you move money from a tax-deferred account to a Roth account. So for instance, you could be moving money from a traditional IRA to a Roth IRA. And when you do that, the money that you move over-- so the money that you convert-- it's generally taxable as income in the year that you do the conversion.

So that's what a conversion is. And there are three primary things that we're going to be talking about today that all fall under the Roth conversion umbrella. The first one is, what are the effects? What are the pros and cons of a Roth conversion? In other words, how do we decide whether or not it makes sense for you to do a conversion in any given year?

Topic number two, what can we hope to achieve with a smart conversion plan? In other words, what are the metrics that we can realistically hope would be improved by doing conversions? And our third topic, which we're going to hit on more briefly, is, how does a Roth conversion plan fit into a broader overall retirement tax plan?

So digging right in here with the effects of a Roth conversion, in most cases, conversions are going to have up to three major effects. And these are the three things that you want to be looking at in any given year when trying to determine whether it does or does not make sense for you to do a conversion.

The first effect is that you will end up paying tax now instead of paying tax later. The second effect is that conversions will let you use taxable account dollars to essentially buy more Roth space. And the third effect is that Roth conversions will reduce your future required minimum distributions, your future RMDs.

And that can reduce the future tax drag on your portfolio. And we're going to go through these one by one. So pay tax now instead of later. The idea here is that when you do a conversion, the conversion is taxable. So you have to pay some tax right now, right?

But then the money is going to be in a Roth IRA going forward. So Roth IRAs are allowed to grow tax-free. So you won't have to pay tax later as it grows. And as long as you meet the appropriate requirements, you can take the money out tax-free as well.

Whereas, conversely, if you don't do a conversion, then you won't be paying any tax right now because you didn't do a conversion. But then the money is still in a traditional IRA or other tax deferred account. And so you most likely would have to pay tax at some point later whenever the money does come out of the account later.

And of the three effects shown on this slide, this first one, paying tax now instead of paying tax later, this is the one that gets almost all of the discussion. And in fact, it's very common to see this treated as if it is the entirety of the analysis. It's very common to see articles and bogleheads threads where this is the only thing that gets brought up.

But as we'll see in just a little bit, this is really only one piece of the picture. It's important to account for more than this. Now, this effect of paying tax now instead of paying tax later, it can be helpful or it can be harmful. So it can be a good thing or it can be a bad thing.

It can be a point in favor of doing a conversion or a point against. And that all depends on the current marginal tax rate. And by that, I mean the tax rate that you would pay on a conversion of a given size if you did do that conversion this year.

And how does that tax rate compare to the future marginal tax rate? And by that, we specifically mean the tax rate that would be paid on the dollars in question whenever they come out of the account later if you don't convert them. So we're comparing those two tax rates.

And whenever the current tax rate, so the tax rate on the conversion, is the lower of the two, then this effect is helpful. It's a point in favor of doing a conversion. And conversely, whenever the current tax rate is the higher of the two, then this effect is harmful because it means you're paying tax now at a higher tax rate when you could have waited and paid tax later at a lower tax rate.

So that's not a good thing. So this effect, it can be good or it can be bad. It just depends on the circumstances. Now, there are a number of caveats, complicating factors, that make this pay tax now or pay tax later thing more complicated than it might appear at first glance.

The first one is that when we're talking about marginal tax rates, your marginal tax rate might be different than just your tax bracket. We often treat those two terms as if they're synonyms, but they're not because there are a ton of different things in our tax code where as your income goes up, your income tax does go up as a result of your tax bracket, but something else also happens.

Like this additional taxable income causes you to become ineligible for a particular tax credit or something like that. And so when you account for that factor plus your tax bracket, your actual marginal tax rate can be considerably higher than just the tax bracket that you're in. And I wanna run through just a few things that can cause that type of effect that are most likely to be relevant in a Roth conversion analysis.

The first one is the premium tax credit. So that's the credit for anybody buying health insurance on the Affordable Care Act exchange. So that's most often gonna be relevant in a scenario where you retire before 65, so you're not yet on Medicare, but you've retired, so you don't have insurance through your previous employer, most likely, so you're probably buying insurance on the exchange.

And the way that credit works is that as your income goes up, the credit shrinks, and eventually it shrinks all the way to zero. And so let's say you're 63, and you're thinking about doing a conversion this year, and you're buying insurance on the exchange. Well, then this is something we have to account for.

Is this taxable income from the conversion going to be shrinking this tax credit? And if the answer is yes, that doesn't necessarily mean... (audience laughing) Can we get that light switch back on? Thank you. So if a conversion would be shrinking your premium tax credit, that's not a good thing, but it isn't necessarily enough to say that we shouldn't do a conversion.

It just is something we need to account for in the math in order to be doing it correctly. Then the way that Social Security benefits are taxed, that can also cause this type of effect. Basically, if your income is low enough, your benefits are not taxable, but then as your income proceeds upwards through a particular range, the portion of your benefits that are taxable, it goes up.

So as your income is proceeding upward through that range, the actual marginal tax rate is much higher than just the tax bracket that you're in. And Medicare IRMA, that's Income Related Monthly Adjustment Amount, and it is just a rule that says that if your income crosses a certain threshold or various thresholds in a particular year, then your Medicare premiums two years from now are going to be higher.

So if we're thinking about conversions in 2024, if you would be 65 or older in 2026, so two years from now, then we want to be thinking about, would this conversion push you over one of those thresholds? And again, if the answer is yes, that doesn't necessarily mean no conversions, it just means that's something we have to be accounting for in order to be getting the math right.

And one thing to point out about this idea that marginal tax rate and tax bracket are not necessarily the same is that we need to be thinking about that on both ends of this analysis, right? We're talking about pay tax now or pay tax later, and we're looking at the current tax rate and the future tax rate.

In both cases, we're concerned with your actual marginal tax rate, not just the tax bracket that you're in. Another important complicating factor that people often overlook is that for a married couple, one thing that often happens after either of the two people has died is that the surviving spouse is left with a higher marginal tax rate going forward.

And the reason for that is that the standard deduction for a single filer is only half the size that it is for a married couple filing jointly. And the tax brackets only have half as much space in them. But typically, when one of the two spouses dies, what happens is that the household's income falls, but it falls by less than half because it's usually the smaller of the two Social Security benefit amounts that goes away.

And the income from the portfolio usually doesn't change at all, or at least not very much, right? It's still there, paying interest and dividends and RMDs and so on. So the surviving spouse, they have half the standard deduction and half the space in the tax brackets but more than half as much income.

And so the result is that they're often left with a higher tax rate. And the takeaway with respect to Roth conversions is that this can be a compelling point in favor of doing conversions while both people are still alive. Another caveat, another complicating factor here is that when we're talking about that future tax rate, it might not be your future tax rate that we're talking about for a significant portion of these dollars.

It could be the tax rate that your heirs, your beneficiaries, would be paying on distributions from an inherited tax-deferred account. And so there's a couple of things we want to be thinking about there. Sorry, one moment. The first thing we want to be thinking about is how many beneficiaries will there be?

Because imagine you've got one adult child and they have no kids of their own and there's nobody else you're planning on leaving any of these assets to. Well, then it's pretty darn likely that the distributions themselves, as in the distributions that this beneficiary would have to take from an inherited traditional IRA, it's likely that those distributions would be pushing this person up into a higher tax rate.

And so that would be a compelling point in favor of doing conversions now. Pay tax at your current tax rate, whatever it happens to be, so your beneficiary doesn't have to pay a much higher tax rate later. But if you think about a different scenario, if you've got ten beneficiaries, four kids and six grandkids or something like that, and the accounts are going to be split up among all ten of those people, then it's a lot less likely that the distributions would be pushing them up into higher tax rates.

And so this wouldn't necessarily be a point in favor of conversions and could be a point against doing a conversion. So it all depends on the circumstances. We also want to be thinking about what are the careers, or just more broadly, what are the earnings levels of these beneficiaries?

The higher their level of earnings, the more likely it is that they're going to be paying very high tax rates on distributions from any inherited tax-deferred accounts. And so if all of these beneficiaries have high levels of earnings, that's a strong point in favor of doing conversions. Whereas if these beneficiaries have more modest levels of earnings, that could be a point against doing conversions.

So this all just depends on the circumstances. And then our last caveat here on this paying tax now versus paying tax later idea is that to the extent that you would use qualified charitable distributions, QCDs, or to the extent that you would leave tax-deferred dollars to charity at your death by naming a charity as the beneficiary of your IRA or something like that, well, then, to that extent, the future tax rate that we're talking about, it's actually zero because nonprofit organizations are tax-exempt.

They don't have to pay tax on dollars that they get from a traditional IRA or 401(k) or something like that. And so if you anticipate a large portion of your tax-deferred balances ultimately going to charity, well, then, that is a pretty compelling point against doing Roth conversions because it means you're paying tax now at whatever tax rate you pay on the conversion when ultimately a good chunk of these dollars could have come out of the account later at a 0% tax rate anyway.

And paying tax now to avoid zero taxes later is not helpful. So that's one thing to have in mind. And that is the first effect of a Roth conversion. You pay tax now instead of paying tax later, and it can be good or it can be bad. It just depends on all the circumstances.

The second effect of a Roth conversion is that conversions let you use taxable account dollars to essentially buy more Roth space. And before getting into how that works, I want to make sure we're all clear on a definition because I actually see this misunderstanding a lot on the Vogelheads forum.

Sometimes people think that a taxable account means a traditional IRA, meaning that it's taxable because you take the money out and it's taxable, but that's not what we're talking about. A taxable account is any account that doesn't have special tax treatment. So a taxable account is not a traditional IRA.

It's not a Roth IRA. It's not a 401(k) or a Roth 401(k). It's not a 403(b) or a Roth 403(b). It's not a 457 or a 529 or an HSA or an FSA. It's none of that stuff. It's basically a regular checking account or a regular savings account. Or if you went to Vanguard or Schwab or your favorite brokerage firm and opened up a new brokerage account that isn't an IRA, that's a taxable account.

Those are the types of accounts we're talking about here. And we call them taxable accounts because they're the types of accounts where you have to pay tax every year on the interest and dividends that you earn and so on. And the idea of effect number two here is that you can use money from a taxable account to pay the tax on the conversion.

And when you do that, what's happening essentially is that you're giving up money from a taxable account and you're getting more Roth money. And to illustrate how that works, I want to run through a very quick example of a Roth conversion. And as we'll see, this is actually an example of what not to do in most cases.

But we'll get to that in just a minute. And so we're going to keep the math easy. We're going to assume it's a 25% tax rate. And we're going to assume it's a $100,000 Roth conversion. Easy math. So we have $100,000 coming out of a traditional IRA. And when you do a conversion, you have a choice.

You can have taxes withheld if you want to at any percentage you want, including zero. So it's optional, but you can have taxes withheld. And so in this example, we're going to assume that you do choose to have taxes withheld. And you're anticipating a 25% tax rate. So again, easy math, 25% gets withheld.

And that means that $75,000 of this conversion, $75,000 is what actually ends up in the Roth. The other $25,000 gets withheld. It goes to the IRS. So that's one way you can do a conversion. Or instead of doing that, you can do this, what we have on this slide.

Here we have $100,000 coming out of the traditional IRA. Nothing gets withheld. So the whole $100,000 goes into the Roth account. But you still do have to pay the tax. And so we're just writing a check, essentially, to the IRS for $25,000. We're using money from a taxable account to pay that tax.

And so what has happened here is you gave up money from a taxable account, because that's what you used to pay the tax. But you got more Roth money. Because in this case, $100,000 made it into the Roth. The whole amount made it into the Roth instead of only $75,000.

Now, this effect of using taxable account money to pay the tax and therefore, essentially, buy more Roth space, one thing to point out is that it doesn't apply to everybody. If you don't have taxable account dollars that you could use, well, then who really cares? It's not relevant. You don't need to be thinking about it.

But in the cases where it is applicable, by definition, it's a point in favor of conversions. This one's never a point against conversions. The only two choices here are it does not apply or it's a point in favor of conversions. And the reason for that is that taxable accounts have what we call tax drag.

And Roth accounts don't have that. And what I mean by that is that in a taxable account every year, you have to pay tax on the interest that you earn. You have to pay tax on the dividends that you earn. You have to pay tax on the capital gains when you sell something.

And we call that tax drag because it's taxes dragging down your rate of return. And in Roth accounts, we don't have that. You don't have to pay those taxes. You get to keep the whole rate of return. And one thing that I know you all know, because this is one thing that we spend so much time talking about as Bogleheads, is that expense ratios of mutual funds, they're really important, right?

And the reason that they're so important, the reason we spend so much time talking about that is because even a small difference in the annual rate of return when you compound it over many years is a really big deal. And that same exact math applies to tax drag. Even a small difference in the annual rate of return when we compound it over many years can have a very big impact.

And so whenever you can give up taxable account money where you don't keep the whole rate of return and in exchange get more Roth money where you do keep the whole rate of return, that's a good thing. That's a point in favor of doing a conversion. Now, exactly how beneficial it turns out to be, in other words, how big of a point this is in favor of a conversion, it varies based on the circumstances.

And the most important factor here is how long will the money stay in the Roth account after you do the conversion. And the longer the money would be in the Roth account, the more beneficial this is, the bigger a point it is in favor of conversions. And that just, for the very simple reason that the longer the money is in the Roth, then the more years you had to take advantage of tax-free compounding.

And the length of time in question here, it could be from the date that you do the conversion until the date that you take the money out to spend it. Or it could be from the date that you do the conversion until the date that the dollars are distributed at some point after your death to your beneficiaries.

And so under the current rules, if somebody inherits a Roth IRA from someone other than their spouse, they have to take the money out, but not right away. They're allowed to keep the money in the Roth for up to 10 years beyond the date of death. So for some retirees here, we could be talking about from the date you do the conversion through the rest of your life plus 10 more years.

And so your age and your health are really important factors in this analysis. The younger you are and the better health you're in, the more likely it is that we're talking about a really long time here. And for some retirees, particularly those early in retirement and who are in good health, the rest of their life plus 10 years, it's not out of the question that we could be talking about 40 years, maybe even 50 years.

And 40 or 50 years of tax-free compounding in a Roth is a big deal. This is just a very quick back-of-an-envelope-style math example. If you imagine $1 invested today at a 4% rate of return for 40 years, at the end of those 40 years, it has turned into $4.80.

If you instead assume a 3.5% rate of return, so in other words, we're modeling a half-percentage point of tax drag, then it only turns into $3.96. In other words, it would have been 21% more money in the Roth account. If we keep all of those inputs the same but crank it up to 50 years, now it's 27% more money in the Roth account.

And I know that the people in this room, most of you could do this math in a spreadsheet or using your favorite calculator. So the reason I took a minute to put this in here is just to illustrate that this is a big deal. It can be very impactful.

And in some cases, this is actually a bigger deal than the pay tax now or pay tax later thing, even though that pay tax now or pay tax later thing gets all of the discussion. In some cases, this is a bigger deal. And frankly, what ends up happening a lot of times if I'm doing a Roth conversion analysis for somebody is when we're doing that first part, we're looking at pay tax now or pay tax later, and we're looking at the current tax rate and the future tax rate.

The current tax rate, we can calculate, right? We have at least pretty darn close. We have the inputs that we need to figure out what tax rate you would pay on a conversion of a given size this year. That's easy. We've got software that does that very quickly for us.

No big deal. But the future tax rate, that is extremely uncertain because we don't know what investment returns you're going to get. So we don't know how big your tax-deferred accounts will be, and so we don't know how big the RMDs will be. And we don't know how long anyone's gonna live, so we don't know how long this filing status or that filing status applies, and we don't know at what point it'll be your beneficiaries taking money out rather than you, and we don't know exactly how much you're gonna spend.

So that also compounds our uncertainty about how big the accounts will be and how big the RMDs will be. And the big one, we don't know what tax legislation we're going to see. So that future tax rate that we're trying to compare, you know, current tax rate versus future tax rate, the future tax rate is, we don't know, is the short answer.

It's extremely uncertain. It's a big question mark. And so in a lot of cases, if you're comparing this known future tax rate to an extremely uncertain, or known current tax rate to an extremely uncertain future tax rate, if that's the only part of the analysis that you look at, that can make a Roth conversion look like a wash, right?

How would we possibly know? Is this good? Is it bad? Really hard to say. But if we account for this other factor, the one on the slide, where you can use money from a taxable account to pay the tax on the conversion, and when you do that, you're giving up your, essentially your less tax-efficient dollars from a taxable account where you don't keep the whole rate of return, but you get more Roth dollars where you do get to keep the whole rate of return.

And when you account for that as well, in many cases, that's enough to take this analysis that at first glance looks like a who-knows and let us see that, oh, yeah, actually, in these circumstances, conversions probably are a good idea. That's how it ends up panning out a lot of the time.

So that's our second effect of a Roth conversion. They let you use taxable account money to pay the tax, and when you do that, you're giving up taxable account money and you're getting more Roth money, and that is a good thing. Our third effect of a Roth conversion is that they will reduce your future required minimum distributions, your future RMDs, and that can reduce the future tax drag on the portfolio, and the reason that conversions reduce your future RMDs is very straightforward.

It's that Roth accounts don't have RMDs while the original owner is still alive, so when you do a conversion, you're moving money out of tax-deferred and into Roth, so you're just reducing the portion of your portfolio that is subject to RMDs, so your RMDs go down. Now, when I say that reducing the RMDs can reduce the future tax drag on the portfolio, I want to make a distinction here because this is the least obvious thing that we're going to talk about today.

When I say this, I'm not actually talking about the taxes that you would pay on the RMDs themselves. We're not talking about that, and the reason we're not talking about that is because we already talked about it. When we talked about the pay tax now or pay tax later, the pay tax later chunk of that, to a significant extent, that's the taxes you would pay on RMDs, so we've already talked about that.

We already accounted for it. What we're talking about here is something completely separate. What we're talking about here is what happens to any unspent RMD dollars. In other words, your RMDs kick in. You take out however much you're forced to take out in a given year. You spend, let's say, half of it or whatever amount.

What do you do with the rest of it? In a lot of cases, the answer is that the money is going to end up getting reinvested in a taxable brokerage account, and guess what happens in taxable brokerage accounts? The same thing that we were just talking about. You have tax drag.

You have to pay tax on the interest and dividends and capital gains when you sell stuff, whereas, conversely, if you do the conversion, then the RMD never happens, and so the tax drag from being in a taxable account also never happens. The money is just allowed to stay in the Roth for up to the rest of your life plus up to 10 years.

Now, this is another one that isn't necessarily applicable because if you would spend your entire RMD every year or if you would donate any portion that you don't spend, if you would have it sent directly from your traditional IRA to charity as what's called a qualified charitable distribution, then you don't need to be worrying about this third effect.

It doesn't apply to you. This effect is only applicable in the cases where you expect that you'd be taking out your RMD and then ultimately reinvesting a portion of it. That's what we're concerned with here, but if this does apply, if you do expect you would be reinvesting a portion of your RMD, this is another one where, by definition, it's a point in favor of doing conversions.

It's never a point against doing a conversion, but just like with effect number two, here, same thing where how beneficial it turns out to be, in other words, how strong a point it is in favor of doing a conversion depends on the circumstances and specifically it depends on how long the money would be in the Roth account.

Now, in this case, the, oh, and again, the longer it's in the Roth account, the more beneficial this is, but in this case, the length of time that we're concerned with, it's essentially how long would the money be in a taxable account, incurring tax drag, if you don't do the conversion, whereas it instead would have been in the Roth account if you did do the conversion.

So essentially, it starts when your RMDs start, which is some point in your 70s, depending on when you're born, and it goes through potentially the rest of your life plus up to 10 years, and so this is another one where your health is really important. The better health you're in, the more likely it is that this is a long time, and for a lot of retirees, from the date that RMD starts, 73, 75, through the rest of their life plus up to 10 years, likely to be multiple decades, and multiple decades of compounding in a Roth tax-free can be a big deal.

So those are our three effects of a Roth conversion. Number one, you pay tax now instead of later. That can be good or it can be bad. It just depends on the tax rate you pay on the conversion, how that compares to the tax rate that would have been paid on the dollars later whenever they come out of the account later if you don't convert them.

Second effect is that conversions let you use money from a taxable account to pay the tax on the conversion, and when you do that, you're giving up your least tax-efficient money where you don't keep the whole rate of return and you're getting Roth money, which is your most tax-efficient money, and the third effect is that conversions are gonna reduce your RMDs, and that can reduce the future tax drag on your portfolio if you expect that you would be reinvesting your excess RMDs every year.

So moving on to primary topic number two, what are the goals that we can hope to achieve with a smart conversion plan? Or another way to say this would be what are the metrics that we can realistically expect would be improved by doing conversions? And to back up just a step, one thing that I have found in doing retirement tax planning for a lot of people is that a tax-efficient spending plan usually improves financial security in retirement, and what I mean by that is that it improves two metrics.

Number one, makes it less likely you're gonna run out of money during your lifetime. Number two is that it makes it so that in the unlucky scenarios, like if we're doing Monte Carlo simulations, in the unlucky scenarios where you still do run out of money, at least it happens later in life.

So that's still an improvement at least. And so when you improve both of those two things together, in my head I just think of that as, okay, you're now safer, more financially secure. Now one thing that honestly surprised me when I started digging into this is from modeling Roth conversions for a lot of clients in a very, very broad range of financial circumstances and using a bunch of different assumptions for all of the various inputs, is that Roth conversions don't usually have those effects.

They don't usually improve financial security in retirement. And I know that surprises a lot of people, and in fact you're probably thinking, well, why the heck not? Because we just spent all that time talking about the three effects of a conversion and how they can be helpful. So how can that be true and this can also be true?

It's not very intuitive. And the way I've come to think of it is, if you think about the problems that Roth conversions solve, number one is RMDs, right? They make your RMDs smaller and that has various beneficial effects. And number two is the tax drag that occurs in taxable accounts.

Basically the two things I've spent the last half hour talking about. Those are the problems Roth conversions solve. But if we make a list, what are the things that are likely to cause portfolio depletion in retirement? Those two things aren't on that list, right? RMDs, they don't cause people to run out of money.

If you haven't run into that math yet, they just don't. In fact, RMDs are often recommended as a retirement spending strategy with the idea being look up whatever the RMD percentage would be for somebody your age and then spend that percent of your whole portfolio. And they're recommended as a spending strategy precisely because they're so unlikely to cause portfolio depletion.

And that second factor there, the tax drag that occurs in a taxable account. If you think about how an unlucky retirement scenario is likely to look, that problem solves itself most of the time because as we'll get to in just a minute, the first dollars that you usually spend in retirement are the taxable account dollars.

And so if we're thinking about an unlucky retirement scenario where the portfolio is getting depleted and you're spending it down rapidly, that's the first thing that gets spent down. And remember, the tax drag is a small percentage. It's only a big deal when we're compounding that small percentage over 30, 40 years of having a taxable account.

If you're talking about maybe a half percentage point of cost on an account that's only a part of your portfolio and that account is going to disappear within the first maybe four or five or six years, half a percent on a part of the portfolio for a handful of years wasn't really the big thing that caused the depletion, right?

So the tax drag in taxable accounts, it doesn't cause portfolio depletion. And so Roth conversions are solving problems. They're just not the things that cause people to run out of money. Now, if we think, what are the things that cause people to run out of money? The first one that comes to mind for me is sequence of returns risk.

And I know many of you have heard that term. The idea is if you get bad investment returns in your early retirement years, you can have this situation where the portfolio, if it's just getting smashed in the stock market, right, and you're spending from it at the same time, it can end up getting severely depleted really quickly.

And so even if you get good returns going forward from there, it might not save the day. And then the second thing that comes to mind for me is the term spending shocks. This is a term that came from the late Dirk Cotton. He was one of my favorite retirement writers.

If you ever get a chance, look him up. And the idea of a spending shock is it is an unexpected but unavoidable big expense or a series of expenses. So it could be a healthcare cost that wasn't covered by insurance or major house repairs or whatever it is. And the reason those are so problematic is exactly the same reason as sequence of returns risk, actually.

If that happens early in retirement, you get hit with this big expense that you hadn't planned on and you can't avoid it, it can result in the portfolio getting depleted too severely, too rapidly. And then even if you get good returns after that, it might not save the day.

So those, in my head, those are the two things that are the biggest problems, the biggest risks, things that are likely to cause portfolio depletion. But if we think of both of those things and think about Roth conversions, Roth conversions don't solve those. They don't make sequence of returns risk go away.

They don't make unavoidable healthcare expenses go away. That's just not what Roth conversions do. So they're helpful, but they're just not helpful in this way. And so that might lead somebody to ask, "Why would I bother with a Roth conversion if it's not improving my financial security? What can I hope to get out of it?" And the answer is that in a case of a smart conversion plan, and I specify smart conversion plan because this is something that we need to be putting thought into, right?

We don't just want to start willy-nilly Roth conversions because in most years for most people, conversions aren't a good idea. It's just in the years where they are a good idea, the things that we can typically hope to see from it is that it's going to be increasing, improving the after-tax bequest that is likely to be left to heirs.

And they do that without changing financial security in either direction. So one way to think of that would be conversions don't make the bad scenarios any better, but they also don't make them worse in a smart conversion plan. But they do make the medium-to-good scenarios better. That's typically what we can hope to get out of conversions.

And moving on to our last topic, topic number three, of how does a Roth conversion plan fit into a broader overall retirement tax plan? We're going to move through this a little more quickly. And the question here is, which dollars do we want to spend every year? We can spend tax-deferred, Roth, or taxable dollars in every year of retirement.

And the plan that we want to follow -- and again, this is the very brief summary -- is that every year the first dollars we want to spend are the checking account dollars. So what I mean by that is everything in the checking account and all the stuff that automatically shows up in the checking account.

So earned income while you still have it, Social Security once that kicks in, RMDs, pension or annuity income if you have either of those, all those things. After that, we go to the savings accounts next. And then after that, we go to the taxable brokerage accounts, specifically the investments in those accounts where you would not have to pay any tax costs from selling them.

So things that have unrealized losses and money market funds where your basis is equal to the market value, so you can just spend it. That's the first stuff we want to spend every year. And it's actually only when we've already spent all of those dollars and then still need to spend more, that's when we have to start making some hard decisions, making judgment calls where we weigh the pros and cons of our options.

And in most cases, the first dollars to go after next are actually just the other dollars in a taxable account. In other words, the investments in a taxable account where you would have to pay tax if you sold them. And the exception there is if you expect that you would be donating or bequeathing those assets soon.

In that case, you want to leave them alone. And the example I always give here is imagine a 98-year-old retiree. And let's say she's the only person in her household. No matter how old we get, we obviously don't know how many years we have left. But at age 98, probably fair to say that her heirs will be inheriting these dollars roughly soonish, right?

Like, we don't know exactly what that means, but soonish. And so let's say she has a mutual fund in a taxable account and she bought this mutual fund like 30 or 40 years ago. And so it has a cost basis that's way down here and market value way up here.

Well, for her, if she sold that, she'd have to pay a capital gains tax. And so what probably makes sense for her is to leave that appreciated taxable asset alone, spend from her retirement accounts, and then when her heirs do inherit these dollars, which, again, is likely to be not the terribly distant future, they'll get a step up in cost basis.

And so that appreciated taxable asset, no one had to pay tax on all of that appreciation. But then if you flip the example around, now think about a couple who are early in retirement, age 60 and 62 or something like that. Statistically, they have a lot of years of retirement ahead of them, right?

So for them, if they have a mutual fund in a taxable account that has a basis way down here and market value way up here, for them it probably does actually make sense to just bite the bullet and sell that when they need it for spending in order to preserve their retirement accounts.

Because for them, the step up in cost basis is probably not coming anytime soon to save the day. So for them, we're probably selling that taxable asset first and preserving the retirement accounts. So again, just a brief summary there is the younger you are, the more likely it is to make sense to go after the appreciated taxable assets to preserve the retirement accounts.

And the older you are, the more likely it is to make sense to spend from their retirement accounts to preserve the appreciated taxable assets for the step up in cost basis. Now, whenever we do have to spend from retirement accounts, whether we're spending from tax deferred or from Roth is actually just the same question that we're always talking about with Roth conversions.

It's current marginal tax rate, future marginal tax rate, how do they compare? And whenever your current tax rate is the lower of the two, then we want to spend from tax deferred, right? Take advantage of the low tax rate. And whenever your current tax rate is the higher of the two, then we spend from Roth.

Now, as you can see, this last point here, what we're actually getting at is how does a Roth conversion plan fit into this? And the idea here is that when you're following a plan like this, most likely in the early years of retirement, you're going to be spending those taxable assets.

And so you won't be spending or maybe not spending very much from the tax deferred accounts. And so what that's going to mean is that, right, you've retired, so your income has gone down. We're not spending from tax deferred yet. Social Security probably hasn't started yet. So you've got some years with low taxable income and low tax rate space available to you.

And so what we're going to do is fill up that low tax rate space with Roth conversions. These two ideas, they fit hand in hand. It's the tax-smart spending plan that creates the space for the Roth conversions. They fit together. It's one broad, integrated retirement tax plan. And that's it.

So, yeah, we have about 10 minutes for questions. All right, when can it be worth it to donate appreciated taxable assets to a donor-advised fund to reduce your tax bracket to enable more traditional IRA, 401(k) conversions to Roth? OK, so that's an interesting question. And I wouldn't-- that's a very interesting question.

And there's a lot going on here. So donating appreciated taxable assets, that is usually the second best way to donate once you've reached age 70 and 1/2. Once you've reached 70 and 1/2, that's when QCDs, Qualified Charitable Distributions, kick in. Most of the time, QCDs are our best way to be donating once you're eligible for them.

But before 70 and 1/2, your best way to be doing charitable giving is by donating appreciated taxable assets. And the reason that's such a good idea is that you get an itemized deduction for the current market value. And you don't have to pay tax on that appreciation, as long as you owned the investment for longer than one year.

So don't forget that bit. But I wouldn't necessarily say that we want to be donating just to reduce the tax bracket so that you can be doing Roth conversions. Because in my mind, if you've got significant charitable intent-- we want to be doing some donating-- that itself is a strong point against the Roth conversions.

Because we can be listing the charity as the beneficiary of the IRA to begin with, or just waiting a little bit and then using QCDs. So donating appreciated taxable assets makes a lot of sense. But I wouldn't think that that's a great motivation to be doing it. Because if you have a lot of charitable intent, we probably don't necessarily want to be doing conversions anyway.

If you max out your employer 401(k) contributions in pre-tax, can you still execute a backdoor Roth IRA contribution? Yeah, potentially. So the big hang up there doesn't have anything-- so backdoor Roth IRA. That is when you earn too much to contribute to a Roth IRA in the normal way.

So you make a non-deductible traditional IRA contribution, and then do an immediate conversion. The big caveat, the thing you need to look out for, is if you have other money in a traditional IRA-- and it doesn't even have to be this traditional IRA. The IRS considers them all to be one IRA for this purpose.

So even if you've got some other traditional IRA, some other brokerage firm, that's still a problem. Basically, in order to be doing backdoor Roth, we need to make sure that the only money in traditional IRAs for you-- we don't count your spouse, but for you-- is this non-deductible contribution that you just made.

That's what we're looking to do. So a lot of times, if you have traditional IRA money-- and in this case, we have a 401(k) also, so that's our out-- what we're going to do is take the traditional IRA that exists and has tax-deferred dollars, roll it into the 401(k).

So now we don't have any traditional IRA anymore, and that frees us up to be doing non-deductible IRA contributions and then immediately converting them. If I have more money in my traditional IRA than my Roth IRA, do you advocate chunking a portion from traditional to Roth over a period of several years?

So it's not necessarily a function of exactly how big this account is relative to another account. That's not usually the number one thing we're looking at. But because, again, we're usually looking at exactly the stuff we talked about-- current tax rate, future tax rate. And so how big the traditional IRA is certainly plays into that future tax rate.

But we're not necessarily looking to get-- we're not trying to say, you should have 50/50 tax-deferred and Roth. There's not a tax-deferred Roth allocation that is the best. But with conversions in general, yes, chunking them is usually a good idea. We don't, in most cases, want to just go whole ham and hit the whole IRA in one year.

Most of the time we're spreading it out over several years so that we can do it at lower tax rates over time. Let's see. How do you decide the amount to convert in a specific year, for example, up to amount when next tax bracket kicks in? Yeah, exactly. So in any given year when you're doing a conversion, we're picking an income threshold.

And then we're going to try to stay right below that threshold. So often, it will be we're going to the top of this tax bracket. Or it could be right below an IRMA threshold. Or it could be right below the phase-out for some tax credit or whatever. And there isn't a rule of thumb, because there isn't the sort of thing where you can-- I use software for this.

Trying to manually do it out in a spreadsheet is going to be bordering on impossible. Turn this mic? Yeah, all right. So there isn't-- I'm just going to keep saying this. There aren't rules of thumb for a lot of this. So we are usually going to be picking some particular threshold.

And usually that's-- a part of that is we're looking at the current tax rate, future tax rate idea, trying to get some ballpark of that future tax rate. But sometimes, whatever we might very roughly ballpark that future tax rate at, it still often makes sense to do conversions slightly beyond that point.

Again, if we're using taxable account money to pay the tax and all that stuff. Because that's what we're getting at here, is that there's other benefits to conversions other than just reducing that future tax rate. There was another piece of this question. Oh, one other point, by the way, is that sometimes it's nice, if you can, to pick a threshold that is not a Medicare IRMA threshold.

Because if we're picking a tax bracket threshold and you end up, oops, I went $1,000 over, not that big of a deal. It means $1,000 got taxed at a couple higher percent. Not-- who cares? But accidentally going $1 over an IRMA threshold really is not ideal. So IRMA thresholds are less forgiving.

So that in itself is a reason to pick a different threshold. Because then if you mess up by a little bit, which does happen, because when we're doing the conversion, we're not usually doing it December 31st. We're usually doing it at some point somewhat earlier in the year. So we don't know exactly, precisely, all of the inputs.

So it can be hard to nail it exactly. So picking tax brackets rather than IRMA brackets often makes sense just because it's more forgiving. If it makes sense to do a conversion from IRA to Roth, is the goal to reduce the IRA to zero or to some other value target?

No. There is no rule of thumb. Sorry. Sometimes we want to be reducing the IRA to zero. That's almost exclusively in cases where there is a big taxable account. Because if we're reducing the IRA to zero, we're getting to the point where we're probably making that future tax rate pretty darn low.

And the only reason that we would have kept converting all the way to that point, probably paying taxes at a higher rate than whatever we're anticipating that future tax rate to be, the only reason we would be doing that is because we're just trying to get maximum value out of these taxable account dollars by just using them to pay this tax.

So some cases, yep, it makes sense to go all the way to zero. But that would specifically be if we're really trying to maximize that, get the value out of the taxable account sort of thing. Most of the time, we're not going to be converting the IRAs all the way to zero.

We're usually going to be picking some particular threshold, hitting that threshold every year. And then often what ends up happening is Social Security kicks in, and then RMDs kick in shortly thereafter. And there's just no more space for conversions at that point. So that's typically how it goes. Should you do the conversion all in one year or over time?

Generally over time. Again, it usually makes sense to break it up to keep your taxable income relatively lower than doing one big chunk and paying a huge tax bite all at once. If you do a conversion on January 1, when do you have to pay the tax? So if you have taxes withheld, the advantage of that is that whenever you do the conversion, any withholding, just as a rule, whether it's withholding from wages or withholding from a conversion or anything, withholding is always treated as having been paid on time.

Whereas if you're paying taxes separately, making estimated tax payments, there are specific deadlines for that. So if you choose to have taxes withheld, no matter when you do the conversion, you're good. But again, we don't usually want to have taxes withheld. Because that means we're using the IRA money.

And most of the time, we want to be using, if we have it, taxable account money to pay the tax. And so in that case, we're going to be making an estimated tax payment. And estimated tax payments, there's four over the course of the year. But they're not quarterly.

They don't happen every three months. If you think it's every three months, you're going to get one of them late. So you just make estimated tax payments on time, is basically how it works. Just look up the regular rules for estimated tax payments. And it looks like we've got 20 seconds left.

Let's see what this is. Oof, that's not a 20 second one. Oh, OK. I'm 62 with a number of dormant old 401(k)s kicking around from past employers. Convert or no? Well, so likely, it makes sense to be moving those, just for simplicity's sake, all into one account, whether that's into an IRA or into your current 401(k).

That's usually what makes sense. That's separate from the conversion idea. This factor, having a whole bunch of different 401(k)s, not really a factor in the Roth conversion analysis, right? All the things we talked about-- current tax rate, future tax rate-- they're based on dollar amounts rather than number of accounts.

So all the same stuff we said, it's the same, even if you have a bunch of old 401(k)s. But if you do have a bunch of old 401(k)s, it's probably time to do something about that. So I think that's it, right? We're over time by a minute and a half now.

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