Converting a Traditional IRA to a Roth IRA – Episode 138

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome to another edition of the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, we have bestselling financial author, Kim Butler with us today, and we’re going to be talking today about sort of a kind of a technical area, and that’s the ability to convert a traditional IRA to a Roth IRA. Now a lot of our clients are higher income earners, and they are not able to participate in the Roth IRA on an annual basis, but it’s important to know that there are no

[00:55] income requirements for converting a traditional IRA over to a Roth IRA. Now, the question that Kim is going to help us with today is the how and the why and the who this would be good for. Welcome, Kim. Well, thank you, Todd. I guess I better write that down. How and why and who the Roth IRA is great, is a good strategy for really. How, why, who? OK, yes, we can do this. That’ll be a fun conversation. So the Roth IRA conversion, I remember when it first came out, I thought, holy cow, why would anybody want to do that? But as we moved forward, so I think I’m going to answer these questions backwards. The who this is appropriate for is really important because it’s definitely not appropriate for everybody.

[01:50] And yet converting can be beneficial if you have the dollars to pay the tax that are going to be due because you’ve gone from essentially a pre-tax environment to an after-tax environment. And I have to admit that I have this conversation with a lot of people and they get all excited about it. The benefits are there, but then when it comes down to it, they don’t really want to pay the tax. So let’s just put some dollar figures on this real quick. You’ve got, say, a hundred thousand dollar IRA. You want to convert that to a Roth IRA. You’re essentially paying the income tax now to do that. And so depending on your tax bracket and very specifically this year’s tax bracket, that could be a hefty chunk of change.

[02:46] And so let’s just say it’s thirty thousand dollars for ease of today’s discussion. That thirty thousand cannot come from the hundred thousand dollar account. That needs to come from outside money. And so who this is appropriate for are people that believe that taxes are going up, people that want to access the Roth IRA tax law as opposed to regular IRA tax law, and people that have extra cash sitting around, whether it might be cash value of whole life insurance or cash in a savings account or a CD or a money market account that they can use to write a check for that tax bill. So that’s the who. Is that clear? We need a little more on that subject. Yep. The only one question I’d like to ask is that when you convert this IRA to a Roth IRA,

[03:37] do you have to do the entire thing or can you do a partial part of it? That’s a good question. To my knowledge, you can do a partial conversion. Do you have any research that answers that differently? My research is the same. So that, you know, say you have two hundred and fifty thousand dollars in an IRA and you can’t afford to pay the taxes on the two fifty. But yet you’ve had a lower income year this year where maybe fifty thousand or a hundred thousand could be converted because I think we’re all in agreement that taxes are going to be higher. And, you know, certainly the polls are telling us that Hillary Clinton is definitely in the lead. And her idea of helping the tax situation and the debt situation is to eliminate all loopholes.

[04:24] So getting your money from a traditional IRA environment to a Roth IRA environment, even if it’s only a piece of it, this may be one of your last chances to do it. Absolutely. And that really leads us to our second question, which is why? Why would you want to do this? And why would you pay taxes now on something that you could defer? And this is a really critical point. And even if you don’t feel like you fit into the who category, this why part of the question and answer session is so valuable because people are believing that taxes are going to go up. I think potentially, regardless of who wins the presidency, just because we’ve got so many promises out there of things that our tax dollars are supposed to pay.

[05:14] And so the reason you would say, I want to pay my taxes now, is if you felt that tax rates were going to go up and go up so substantially and so permanently, of course, nothing’s really permanent, but for a long time, in other words, the tax rates will stay high for a long time, it would behoove you to go ahead and pay the taxes now, get those dollars into a Roth IRA where your good investment growth could then go on and really grow that Roth. And you would not pay taxes on it in the future. Of course, if you don’t have a good investment and you’re not confident about your growth, then you might not want to do that. But obviously, we’re talking about this potential because we know where some good investments are.

[06:02] And that’ll be the how part in a minute. But let’s just, again, make sure that we’re covering the why clear enough. And that’s that you’ve got extra dollars available today that you’re willing to pay the tax with at today’s tax rates, which might mean, especially if you’re a business owner and you can dictate your income, it might actually behoove you to take a little less income this year, do a Roth IRA conversion. And because you’re in a lower tax bracket, even your marginal tax bracket, where this is going to have an impact because you’re in that lower bracket because of lower income, you are going to pay less tax on this Roth IRA conversion. Awesome. One caveat, I guess I would like to add, is that if you are getting ready to send your children

[06:50] to college next year and you have any potential of receiving financial aid, this is a big factor because the FAFSA looks at the income the year before the kids go to school. This adding additional income at that point in time could critically cost them financial aid for their full four or seven years of education. So this would be a case where you would probably not exercise this option. Yes, very good addition. I’m glad you brought that up because that’s going to be definitely relevant for a lot of our clients. And though you may be thinking, oh, my gosh, we’re not going to get any financial aid anyway, you never know. And you certainly don’t want to harm your potential for that. So super. Why don’t you talk about the advantages of the Roth?

[07:40] Why? Why would we? I know we get to pay taxes now. But what happens in the end that makes this so fantastic? Well, Roth IRA tax law says pay your taxes now and not in the future. It’s to use an old adage, it’s a paying tax on the seed and not on the harvest. And obviously, if you have an investment that’s going to grow, your harvest is going to be a lot more. And Roth IRA tax law says you’re not going to pay income taxes not only on the growth along the way, which, of course, all IRAs don’t pay tax on the growth along the way. A Roth IRA also does not pay tax at distribution as opposed to a regular IRA, which does pay tax at distribution. So it’s worth it if you can make a conversion from a regular IRA to a Roth IRA and then really get that thing to grow effectively and well.

[08:36] Then you have all those dollars in the future that will be available to you tax free. Got it. Which makes a heck of a lot of sense to me. OK, so we covered the who and we covered the why. I guess we just got to talk just a little bit about the how. Absolutely. So the how can play out in two different ways. And one would just be a simple conversion. It’s largely paperwork where you’re going to say, here’s my hundred thousand dollar IRA. I’m going to convert it to a Roth and you could even leave your dollars in the same investment depends on your investment provider. But most of the time, it’s just a retitling of an account. Again, you’re going to have to pay the thirty thousand or whatever the amount of money is in taxes with outside dollars.

[09:29] And that’s one of the reasons why oftentimes you can just leave your dollars in the investment that they are in. But I want to address something else that is available in this how category. And that is to get a discount for that conversion. So there is a couple different options around this area. And we work with investments that provide a discount. In other words, your hundred thousand dollar IRA, that’s going to be a hundred thousand dollar Roth. If you could get a discount for it, then though you would still have a hundred thousand dollars in the IRS’s eyes, maybe it only looks like sixty five thousand dollars. So then though you still have your hundred, you’re only going to get taxed on sixty five thousand.

[10:26] So maybe instead of paying thirty grand in tax round numbers, you’re paying closer to twenty thousand in tax round numbers. And again, you still have your hundred thousand dollars. So this discount is available for certain investments in certain circumstances. And if you have an IRA of this size, please reach out to us so that we can help you understand if this discount might be available to you. Super. And again, one thing I don’t think we quite addressed is that when we’re talking about paying taxes, you do not pay any penalties to you, do you? That’s correct. I’m sure glad you brought that up. No, no penalties for moving. This is even if you’re under fifty nine and a half, it’s an IRS approved conversion, if you will.

[11:17] And frankly, it benefits them because they’re getting your tax money now. The government’s as short sighted as a lot of our public companies are. They basically operate on a quarterly basis and not a whole lot of forethought beyond that time frame. So they’re more than happy to have your taxes now. And because of that, there’s no penalty for making that conversion. I just can’t stress enough how wonderful it is on the side of control and certainty. I don’t know what my taxes are going to be 10 years from now, but I know what they are today. And once that money is there, I don’t have to worry about how much of my future lifestyle is going to have to be sacrificed to pay taxes because it’s done.

[12:02] One hundred percent of that money is now mine, correct? That is correct. And then as we’ve talked about, if you can go out with a goal for investing and our goal is double digits, no loss of principle. If that can be your goal for investing and you can actually achieve that goal, then your Roth can really do some heavy lifting for you in terms of its investment capability and its forward momentum uninhibited ever again by the taxman. Super. And again, this is in an individual case by case basis. What’s a good way for them to get a hold of you to find out? So our special email for podcast listeners only is hello at partners, the number four prosperity dot com. And we pay close attention to those questions that come in off our podcasts.

[12:55] If you’re interested in getting information about this Roth IRA conversion and in particular, the discount idea, send us an email to hello at partners number four prosperity dot com. And we’ll send you a little white paper on the discount. Super. And Kim, I know we’re getting kind of close on time here, but I know you usually make an e-book available to our listeners. Always. That’s at partners, the number four prosperity dot com slash e-book. There’s an audio version there as well, since podcast listeners probably like to listen instead of read. And so, again, it’s partners number four prosperity dot com slash e-book. Super. Well, I encourage all of you to investigate this idea. Again, this is something that if you want to count it on this year’s income needs to be done by December 31st.

[13:49] But it’s really a relatively quick and painless transaction. As long as, like Kim said, you are prepared to have resource money to pay the taxes that are going to be coming due April 15th. So, Kim, thank you so much. This is a great subject. Take care, everybody, from No BS Money Guy at Prosperity Podcast. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partners for prosperity dot com. If you liked this episode, make sure you subscribe and leave a review.