How Much Can I Save in Taxes with Roth Conversions?
Learn how to maximize your retirement savings through strategic Roth IRA conversions. Discover how to thread the needle on conversions each year to minimize taxes over decades of retirement and avoid higher Medicare premiums down the road.
Sometimes people will just come up and say "Tim, we've heard about Roth conversions, but how much can we actually save in taxes if we implement them during our retirement?" That's what we're going to answer.
I'm going to show you the two different types of software that we use when we're determining whether or not people want to do Roth conversions, or if it would be advantageous, and maybe give them a ballpark estimate of how much they might be able to save over their lifetime.
Of course, as you can probably imagine, it's a little bit different for everybody. Everybody has different assets, different ages, starts doing different things, has different incomes, so there are lots of different variables that are going to go into it all.
I'm going to show you our high-level software that kind of shows us over a 20- or 30-year retirement what we might expect. Then I'm going to show you our down-in-the-weeds software that we use every single year to make sure that we're threading the needle on the appropriate amount of Roth conversions. Maybe we're bumping up to fill up brackets or IRMAA or Medicare thresholds, but we're not bumping over them.
How much can you save in lifetime tax liability using Roth Conversions?
So back to the original question: how much can you save in lifetime tax liability by using Roth conversions? What we typically see is if you have a few $100,000 in a traditional IRA or 401(k) or any pre-tax account, and if you can properly use your gap years between retirement and RMD age, then what we see is that you can usually save a few hundred thousand in lifetime tax liability.
If you have a tax deferred account that's over a million, maybe $1.7 million like our example of Charlie and Lucy Brown or 2 million or whatever amount it might be, then you can usually save into the millions of dollars in lifetime tax liability. Not to mention that you're also going to save in IRMAA or Medicare premiums because that's going to be determined by your AGI.
I have an example from a real life couple that we work with, but of course I've changed the names and some of the numbers and dates a little bit.
We can use our high level planning software to look at decades, but basically we're just going to keep it simple. This particular couple did some annual charitable giving, and they wanted us to plan for some travel money, but we don't really need that because we're just using this scenario to show you what we can possibly save over their retirement.
High-level software example
We put in their retirement expenses and then their ages. They're planning on spending about $7,000 a month in retirement. That's pretty typical; sometimes it's higher, sometimes it's lower.
Let's break down their blueprint. So we have Charlie and Lucy Brown, ages 65 and 63. They saved up a nice little nest egg for retirement. Charlie's got a decent 401(k) and then a Roth; they have some joint assets; and then Lucy has a pre-tax IRA and a Roth IRA.
So they are sitting on quite a bit of what we call a "tax bomb" because they have a large tax deferred account.
So their dashboard breaks it down further. Almost 81% of their assets are tax deferred, so somewhere between zero and 37%, since that's our top income tax bracket right now, is going to go to Uncle Sam.
So using Roth conversions over time, we want to make sure that we are getting rid of that tax bomb and mitigating our lifetime tax liability. Now our software shows us what if we were to fill up certain brackets in retirement. I have already kind of fooled around with it but if we take this back to zero, and what this means is we're filling up each one of these brackets to see what it'll do over time.
So let's say I bump up their income to fill up the 12% bracket, which is set to go to 15% at the end of 2025. It's saying what if we filled up the 12% bracket for a couple years, and then after that we fill up the 15%. In this scenario, over Charlie and Lucy's lifetime it will save them about $355,000 in taxes just converting up to that bracket.
Now let's go a little bit higher. Let's say we fill up the 22%/25% bracket. Our Medicare Parts B&D premium is going to be based on our adjusted gross income, and if we have really high RMDs, that's going to spike our AGI, and therefore Medicare premiums, as well. And you're probably going to pay a higher tax rate than was absolutely necessary.
But in this case, we're saving over a million dollars in taxes now by doing this over a 30-year retirement running the ages out to age 90 and we set up the growth rate to be about uh between 7% and 8%. So it does show growth over time but not super aggressive and not super conservative. So if we fill up the 22% bracket and the 25% bracket (starting in 2026) we're going to save quite a bit in taxes over time.
Now what if we say we want to fill up the 24% and then the 28% bracket. We're still saving a decent chunk but not quite as much as we would have saved with just the 22% bracket, and this is where we want to thread the needle. The software is saying we fill up the whole 22% bracket or the whole 24% bracket, but we don't have to do that. We can go up to the 22% bracket and note the 24% bracket is only two more points and it's a big bracket. We don't necessarily need to max that out, but if we do, then it's going to bring our average tax rate down.
What we want to pay attention to later is our Medicare tax bracket or our Medicare thresholds because you know down the road if we don't do anything we might be paying an extra $10,000 or $12,000 a year in Parts B and D premium. This is what people usually don't realize when they have to start paying RMDs is that it's going to affect their Parts B and D premium as well, not to mention being in a higher tax rate than was absolutely necessary.
We can see once we've moved all this money into a tax-free account, we can look at our total taxes to be paid if we do nothing, which in this scenario is about $2.4 million. Then if we do Roth conversions and fill up somewhere between the 22% and 24% bracket, we're potentially going to save about $1.4 million in taxes.
Then it's going to give recommendations on how much to convert. But as I was saying, we don't need to go all the way up to $328,000 because this is saying we have to max out that 24% bracket. In reality we don't, but this software is showing us that yes it's advantageous for you to still do that.
At the beginning of the plan, we might pay a little bit higher in Parts B & D premium, but then by the time RMDs kick in, we are going to be 75 and we'll have taken enough out of the tax deferred account that our income has dropped way back, and then we don't have to worry about affecting Parts B & D premium going into the future.
So that's a high-level view of what Roth conversions can do to help mitigate lifetime tax liability.
Down-in-the-weeds software example
Our next software, which is a down-in-the-weeds, year-to-year, line-by-line breakdown of what we do and how we go about threading needle to make sure that we're maximizing what we're doing.
For this example, we're starting with a 2021 tax return for Charlie and Lucy. It's obviously a couple of years old, but the principles are all the same. I built a hypothetical scenario for this year. It shows everything on the tax return line by line all the way down including total incomes and tax amounts. It's a great down-in-the-weeds software.
In this scenario, he's got a pension, they've got Social Security, they're going to have some qualified dividends and some capital gains, and so on and so forth. Let's say we don't need to do the $300,000 Roth conversion that the other software was recommending, but we can do a little bit more than just filling up the 22% bracket.
What if we do a $190,000 Roth conversion? You'll see why I picked that amount because obviously I've already played with the numbers a bit. We can generate a hypothetical tax report for that situation. The total income is still over $300,000. Their average tax rate is 17% even though they're in the 24% bracket, so not bad considering they have over $300,000 in adjusted gross income.
We could go all the way up to $383,000 in the 24% bracket, but we've gone about $76,000 or so over the 22% bracket. We can do that because we're threading the needle, but we don't really necessarily want to max this out because of what's going on with the Medicare Parts B and D premium.
I had initially done a $200,000 conversion, and bumped us over the parts B and D threshold that goes up to $322,000. It took us into the next one, but we don't need to do that because we're going to be able to thread that needle filling up more than the 22% tax bracket but not quite as much as the 24%. We're saying somewhere between the 22% and 24% brackets for Roth conversions is the sweep spot for this couple.
It's always different for everybody, so threading that needle is what we want to do is make sure that we're actually getting more savings in lifetime tax liability than you could have if you just filled out a certain bracket.
The software can show us another visual that shows how their Social Security is stacked on top of their ordinary income, an then capital gains and qualified dividends are going to get taxed at preferred rates, which also stack on top of ordinary income. As we move through the tax brackets, there are dotted lines to show the Medicare Parts B and D annual increases.
We leave a little bit of a buffer before the next Medicare threshold because if we go over that threshold by $1, we're going to end up paying a couple thousand dollars more in Parts B and D premium.
Bottom line
A lot of times people ask me how can Roth conversions work for them. Well this is a real scenario of how Charlie and Lucy Brown are going to save over $1 million in taxes over their life time just by doing Roth conversions.
And this says nothing to the legacy assets and what your heirs are going to save when they inherit the money. This is also going to help them mitigate their lifetime tax liability as well by doing Roth conversions and making sure they're not going to be inheriting a tax bomb from you. Because they're going to have to pay income tax rates at their ordinary income tax rates, not your rates that are probably lower in retirement.
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