Planning a Roth Conversion Before Dec. 31? Don’t Make These Mistakes

In today’s episode, you’ll learn more about:

💰 Tax Rates Matter: Compare today with the future

🧾 Pay Taxes Wisely: Outside cash can improve the outcome

👨‍👩‍👧 Think About Heirs: Inherited Roth assets can help

📈 Use Asset Location: Put growth where it matters most

📅 Review Annually: Roth decisions deserve a yearly checkup

Listen Now:

The Smart Take:

Go Inside the Episode: 

0:00 – Intro

3:55 – Tax-free growth isn’t always better

6:08 – What makes a Roth conversion more valuable

14:03 – Why investment returns matter

19:44 – What should you evaluate?

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The Hosts:

Kevin Kroskey, CFP®, MBA – About – Contact

Tyler Emrick, CFA®, CFP® – About – Contact

Episode Transcript:

Walter Storholt:

Well, the countdown is on. We’re nearing the end of the year, and that means it’s time to revisit one of the more popular retirement planning topics, especially when it comes to taxes. And that’s going to be the old Roth conversions, Tyler.

Tyler Emrick:

Absolutely. And if you haven’t started to evaluate Roth conversion, if it makes sense for you or not, it’s probably worth taking a look. And we’ve covered Roth conversions, how they work and why they might make sense on a ton of our podcasts. So today, we just want to take that discussion a little bit further.

Walter Storholt:

And this is because just moving money from a traditional IRA to a Roth IRA doesn’t automatically mean that you’re coming out ahead, right?

Tyler Emrick:

Exactly. In fact, I mean, here’s something that surprises many people, but if your tax rate’s the same today and in retirement and your investment return’s the same in the two accounts, then Roth conversions might not create all that much additional tax benefits.

Walter Storholt:

Even though, as we know, Roth grows tax-free.

Tyler Emrick:

It does. It does. It grows tax-free, but even then, right? So there’s important things that can change that equation. And well, that’s what we’re going to get into today, for sure.

Walter Storholt:

Welcome back to another episode of Retire Smarter. I’m Walter Storholt, as always joined by Tyler Emrick of True Wealth Design, where he is one of the wealth advisors on the team, a certified financial planner, and of course, a chartered financial analyst. I’m Walter Storholt, and we have to acknowledge, at least for our video viewers, Tyler, my cool background is gone and it’s just an empty room. We have made our move across the country and I’ve been in the thick of it for two weeks of trying to move, settle in with a baby. And so if things look a little haggard on this end of the screen, that’s why.

Tyler Emrick:

Don’t worry. We’ll cut you a little bit of slack for this one. We’ll give you a couple more weeks to get it up and running, but hey, we’re going to expect that room to look pretty nice like the last one once it’s all up and running, but yeah.

Walter Storholt:

That’s right. At least audio listeners, everything still sounds good on your end.

Tyler Emrick:

You got it. Well, hey, the good news is the first recording in the new house, you get to talk about Roth conversions and year end planning.

Walter Storholt:

What a better topic. I love it. It’s a good one to christen the new house in. So I’ll break the champagne bottle after we’re done on the air.

Tyler Emrick:

Yeah, no, it is. Well, and we try to get out a Roth episode, oh boy, Walt, every now and again, or at least a few times a year. It’s on a lot of families’ minds, a lot of clients’ minds. We talk about them quite a bit. I mean, as we’re coming up on our… Well, we’re in the thick of our year-end tax and investment review meetings right now. It’s on the docket for a lot of the families that we talk to. So it’s an important planning piece and certainly something that if you haven’t looked into it yet, it probably should be on the old to-do list here to see if it makes sense for you.

But today I think we want to take it maybe a little bit more granular, Walt. And as I was thinking about the podcast, there were two questions that came to mind that I kind of hope to answer today. And the first of which is what actually makes a Roth conversion worthwhile? And this idea of investment positioning and asset location, can it actually increase your Roth conversions value and add some after tax wealth to your situation? So most of the research that we pulled from today are from Journal of Financial Planning and some of our other good resources. So it should be a pretty good one for sure.

Walter Storholt:

And as you get ready to dive in, Tyler, I think this is one of those ones as well where you have to be very careful where you’re hearing the advice from because what may sound like a foregone conclusion of what you should do for someone in their 20s or 30s might be very different than what you should do if you’re approaching, let’s say, retirement or in the thick of your working years. So this is one I feel like that’s a really good one to make sure that you’re not just, “Well, so-and-so says that you should always do this.” Remember their audience, remember who they’re talking to or their personal experience, where they are in life, because this one is one of those ones that definitely varies.

Tyler Emrick:

Oh, 100%, because it doesn’t always… I mean, Roths are great, tax-free growth, but that doesn’t mean that it always pays off for your particular situation. Certainly as you think about Roths and comparing them to a traditional IRA, they’re different. That Roth grows tax-free. Generally speaking though, when we do Roth conversions and we take money from an IRA, you do need to pay taxes on it when you do that conversion. And then of course your traditional IRAs, you got a tax deduction for that money that went in there in most cases, and it just grows and then you got to pay taxes when you do pull it out or when you do do that Roth conversion. So tax deferred growth. So the idea that’s at play here, it’s like, well, hey, should we be paying more in taxes now to get the benefit of that tax-free growth?

And I think when we start out today, this whole idea of like, well, hey, the after tax outcomes can be very similar if we don’t dive down into the intricacies or the details here. And that’s what we want to certainly avoid because I alluded to it a little bit when we set up for today, but this whole idea, Walt, that if you have the same tax rate throughout the entirety of retirement and you get the same investment return inside of your Roth and in your IRA, then essentially you’re going to have the equivalent after tax outcomes. So whether you do the Roth conversion or you’re not, it’s going to work out to be essentially the same. So if you’re thinking about doing a $100,000 Roth conversion and you got to peel off 20% of that for taxes and you decide to do that and your account grows 10% for the next 20 years and you’re in the same 20% tax… Well, there’s not a tax bracket that’s 20%. So I picked a bad one there. 22%, let’s say federal tax bracket-

Walter Storholt:

But we’re 20 years in the future, so maybe by then there is.

Tyler Emrick:

Yeah. Who knows? Rates would have gone down a little bit, that wouldn’t be such a bad thing. And if that tax rate’s the same and you’ve gotten the same return, then doing a conversion or pulling money out of your traditional IRA would basically have that exact same outcome.

Walter Storholt:

It’s truly a pay me now or pay me later setup at that point.

Tyler Emrick:

You got it. But what makes the Roth so advantageous, Walt, are some of these intricacies and some of the uniqueness that can come into play here. Those are the variables that we want to spend some time talking about today. And the first variable that’s-

Walter Storholt:

Personal variables also then what tax rates will do themselves. So things we can’t control, but some things we can’t control.

Tyler Emrick:

You got it. 100%. 100%. Well, and your future tax bracket is probably this first big item that we need to take a look at. One of the reasons why we take so much time in working on a financial plan and kind of extrapolating out a long, happy, healthy retirement is, well, we want to get an idea of, well, what does your tax bracket look like throughout retirement? Certainly we don’t know what’s going to happen with the tax code, but let’s get an idea under current tax law, what that looks like. And essentially saying, well, hey, if you’re going to have some event down the road that bumps you up into a higher tax bracket than you’re in now, well, this can absolutely make Roth conversions a little bit more advantageous.

Some of the big ones or the biggest one we see is when you reach RMD age and the good old IRS starts making you pull money out of your retirement accounts, that can absolutely jump families and households up into a higher tax bracket. Certainly if you’re married and you’re currently filing joint and we plan for one of your spouse passing away, that’s another big one because then you go from filing joint at bigger tax brackets, larger tax brackets to filing single, that could be something or another event that kind of ratchets up your tax bracket down the road. So having a gauge or at least an idea of what that tax bracket looks like down the road, Walt, it will absolutely play into that decision on, hey, should I or should I not do that Roth conversion for the simple fact of, hey, I think my tax bracket’s going to go up down the road, so I want to kind of get some of those taxes out of the way.

Walter Storholt:

Yeah. Interesting though, the very first variable is starting off with some big ifs. So that’s where I think starts to trip people up. The more ifs we add, then it’s harder to nail down a good direction to take.

Tyler Emrick:

Oh, 100%. Well, I mean, we’re talking about tax rates, right? I mean, hey, I mean, in the last five years before the One Big Beautiful Bill, or last handful of years before The One Big Beautiful Bill, we were expecting tax rates to actually go up starting in 2026. Tax legislations came in, stopped that and continued us into lower rates. So just the uncertainty about what are tax rates going to do down the road and where are they going to be can kind of play a factor in here. We have these types of conversations all the time. We talked about some personal things that affect your tax bracket. Well, what if tax laws change completely and tax rates go up in the future? Does getting some of those taxes out of the way now and getting into that Roth provide you and your family some protection in case tax rates do go up, right?

There’s no shortage of headlines around our US debt situation and what some of the issues that are facing bringing that down. Hey, could we see tax rates going up in the future to kind of help curb that? Potentially, we’ll see, but that would be another one we’ll to have on our minds or have on our radar as we’re kind of evaluating should we or should we not start doing these conversions? So we talked about, hey, what your future tax rates look like? Are they higher? Are they lower? We talked about some things that are maybe out of your control, what the IRS does. Another consideration, let’s bring it back to your specific situation. And this would be, are we looking at these conversions through an estate planning or beneficiary lens?

Time and time again, we’ll go through these plans, Walt, and the fun ones are talking to families about, “Hey, you need to spend a little bit more. Hey, the plan results look great. Is there anything that you’re not doing that you want to be doing to make sure that you’re using that wealth to enrich your life and get enjoyment out of what retirement has to offer?” One of the considerations is if you do have a big safety margin left at the end of these plan results and we’re telling you or your advisor’s telling you, “Hey, you’re passing away with two million bucks, three million bucks, four million bucks inside your plan under your current spending assumptions,” well then we can start to potentially, should we start turning our attention to those heirs, right? Who is going to potentially inherit that wealth? What does their tax situation look like? And would the conversions actually start to help them and create more after tax wealth for your state and for your beneficiaries?

Obviously the SECURE Act a few years ago changed inheritor rules when we start looking at Roths and IRAs. Most beneficiaries, especially child beneficiaries, if they inherit an IRA, they’re going to have about 10 years to get that money out. Not all, there are some certain circumstances where they can stretch that out, but if they’ve got 10 years to distribute the entirety of your IRA, what does that look like from a tax standpoint to them? And is that going to jump them up into the higher tax brackets, maybe even higher than the bracket that you’re currently in? Obviously the Roth still has those 10 year rules, but the Roth, those distributions are not taxable to your heirs. So a big caveat there as we’re starting to think about estate planning and tying in some of the things that you’re doing in the here and now from a tax standpoint with the greater plan that you’ve created. So don’t want to forget about the estate planning and beneficiaries concept of it.

Speaker 3:

What would your life look like if you designed it around your true wealth? It’s a powerful question and one that True Wealth Design helps individuals, families and business owners answer every day. With a fully integrated approach to financial planning, tax strategy, investments and business advisory, their team can bring clarity and confidence to every part of your financial life. Take the first step toward a stronger financial future with a no cost, no obligation discovery meeting. Just click the link in today’s show description to get started.

Walter Storholt:

I suppose you could get to this point in the conversation and then start saying, okay, maybe all these variables, we think it does make sense to convert, but then all of a sudden you might be creating a big tax bill that then needs to get paid and that’s now the new thing to figure out, right?

Tyler Emrick:

It is, right? Because that’s the last thing that I wrote down here is these granular things to be considering here, which is how do you pay the taxes on the conversion, right? When I was talking about that scenario above where I said, Hey, $100,000 conversion, 20, not 22% tax withholding, we were assuming that those taxes would be paid when you do the conversion, right? So $100,000 comes out of your IRA, 20,000 gets sent to the IRS for taxes, 80 grand gets inside your IRA.

Well, one of the things that you can do from a logistical standpoint to make that Roth conversion even better is say, “Hey, I’m going to actually convert $100,000 over to my Roth. I know I’m creating a $20,000 tax bill, but I’m going to pay that with money that’s sitting outside of my IRAs and Roth. I’m going to pay it with what’s in my cash,” or whatever. And what that does, Walt, is that allows you to get more money in that Roth and hey, more money in that Roth, more we can gain inside that account from a return standpoint, the more beneficial that conversion is, right?

Walter Storholt:

Yeah.

Tyler Emrick:

So that’s getting down into that whole granularity of like, “Well, hey, where are my assets currently located and where’s going to be the best place to use to pay this tax bill that I’m creating for myself?” So that would absolutely [inaudible 00:13:36]-

Walter Storholt:

It’s a bit of an emotional angle to this too, right? Because when you’re making Roth contributions, if it’s a Roth IRA or a Roth 401k or 403 kind of thing, those feel a little bit different because they’re kind of automatic, they’re just coming out of the paycheck in smaller chunks. But in a conversion, you might have this big, very tangible bill to pay and that’s a very different kind of feeling, I guess.

Tyler Emrick:

Correct. Oh yeah, 100%. But those were what came up on things that I was like, “Hey, maybe a little less talked about items to keep in mind.” Obviously when we’re doing these, Walt, we need all the big items we talk about, “Hey, is this increasing your IRMA charges? Hey, is this increasing how much of your social security is taxed?” All that type of stuff needs to be included in there. So there’s a whole list of items that we can go on, but these are some of the ones that are a little bit more maybe second order effects that can kind of get you over the hump or maybe change that decision a little bit if you’re on the fence on those Roth conversions.

So we talked a little bit about, “Hey, what actually makes that Roth conversion potentially worthwhile?” The second question that I posed earlier was how can my investment positioning potentially increase doing a Roth conversion or make it a little bit more valuable? So now we’re getting even a little bit more granular Walt on like, well, hey, what happens after that conversion is complete and what do I do with the investments or the cash that actually comes over and is sitting inside of my Roth account?

And this gets back to what we’ve talked about before is just asset location, and this is making sure that you hold the right investment in the right account. So Walt, it’s not uncommon for families to have a multitude of different accounts that they’ve saved in over the years. Maybe there’s a 401k, an IRA, a Roth, maybe you got a taxable brokerage account, a savings account. I mean, there is a multitude of different accounts that you can have that can accumulate your net worth. All these accounts have pros and cons and things that are a little bit different.

Obviously, we’re zeroing in on two types of accounts today, right? Basically IRA accounts and Roth accounts. So when we look at those, the question becomes, is, how can I take advantage of that Roth growing tax-free? And asset location is one of the big ones.

When we look at a typical household or a typical client, most clients don’t have all their money in stock when we look at the makeup of their investments. Well, maybe they have some cash, maybe they have some bonds, maybe they have real estate, maybe they have a whole multitude of different asset classes that make up that mix. Well, I’m picturing those pie charts. Us financial advisors love pie charts, right? If you get your statement, generally this would be that pie chart that’s on the front of your statements that kind of gives you an idea of the makeup of the investments that you’re using.

Walter Storholt:

Where’s all your stuff? Here’s it is.

Tyler Emrick:

You got it. So if you look at that and your pie chart has many sleeves, well, this is an opportunity for you because what that means is that you have investments that maybe have very high expected return, but have a lot of volatility up and down. Maybe you have some investments that are a little safer and maybe they’re just interest bearing investments and you’re looking to get some type of interest from them. Well, when we think about what can make that Roth a little bit better is that if we can position your highest expected return, highest expected return investments, these would be typically your stocks, that doesn’t mean stocks always go up into the right, might feel that way over the last few years, Walt, but inevitably they’re going to have those ups and downs. But if we take a long, happy, healthy retirement of 30 years, we would generally expect to get paid for taking on that risk for a stock. So our return expectations would be higher over the long run, right?

So if stocks have a higher expected return than some of our safer investments like bonds or cash and Roth accounts grow tax free, well then it would be behoove you to say, “Hey, can I pick up a little bit of added value of my Roth conversion and make sure that I position my Roth account with my more aggressive or higher expected return assets?” Hey, that doesn’t mean you need to take on more risk with your allocation. It’s just saying, “Hey, hold a little bit more bonds inside of your IRA. You got to pay taxes on any of that growth anyway, and hold your higher expected return stuff inside of your Roth.” So this could add tremendous amount of value as we look at a long, happy, healthy retirement and how much growth can be accumulated inside of those Roth accounts. So very, very important nuance.

Walter Storholt:

Using your pie chart example, it’s like don’t look at one of your accounts and its pie chart. Think of your whole portfolio as a pie chart and strategically place the things that are supposed to get you the higher returns into the Roth section. That makes a lot of sense.

Tyler Emrick:

You got it. 100%. And it’s very important, here at True Wealth, I mean, even when we think about how we manage account assets, we do it at what’s called the household level, right? So what we’re doing is looking at all accounts from a particular household and trying to do this asset location and position the right type of investment for the right type of account. If you’ve talked to your advisor and you find that, “Hey, I have the same exact investments in my Roth as I do my IRA, as I do in my taxable brokerage account,” then you’ve got an advisor that kind of trades or looks at your accounts at the account level, not the household level. And when you do that, what happens is it’s very hard for you to take advantage of some of these more nuanced benefits as we think about how each account’s taxed, right?

So good conversations to have if you haven’t had one of them with your advisor. Certainly if you’re a client of True Wealth, we’re already doing that for you and you’re expected that we’re taking care of that and certainly we are, but we want to try to pick up anything that we can, Walt, to make sure that, hey, if we’re going to be doing a Roth conversion or we’re starting to build assets in there, are we doing everything that we possibly can to make sure that that outcome is going to be the best possible outcome for the family or household that we’re working with?

Walter Storholt:

Yeah. All great points to kind of consider and think through, Tyler. Anything else we should evaluate or think about before the year ends in thinking about these Roth conversions?

Tyler Emrick:

I don’t know. We could go on for probably another hour, but we better leave it there, Walt. I mean, certainly if anybody is very interested in a Roth conversions and how it fits in, I mean, look back, Walt. I mean, no less than a handful probably of podcasts this year on Roth conversions and last year. Dive into them, use them as a resource, maybe get on our calendar. I know the timeline’s getting pretty tight here as we’re coming up towards the end of the year. So if these decisions aren’t on your to-do list, certainly make sure that they are. Even if you are working, I have a number of families where we do Roth conversions even while they’re working because of the economics and some of the things that we touched on today still make sense to maybe fill up the tax bracket that they’re currently in. So don’t just assume that, “Hey, I’m working. I don’t need to worry about this until I’m retired.” No, this should be on pretty much everybody’s to-do list for good housekeeping at the end of each year.

Walter Storholt:

Yeah, makes a lot of sense. Well, very good. If you want to talk to Tyler and the team at True Wealth Design a little bit more about Roth conversions, do they make sense for you to do this year or in future years? We can certainly broaden that conversation out to the larger planning focus as well. Don’t hesitate to reach out. All you have to do is go to truewealthdesign.com, look for the let’s talk button, or very easily just check the description of today’s show, whether you’re on YouTube or an audio podcasting app. Look in the show notes or description section, you’ll find a link where you can also book that time to meet. It’s about a 20-minute discovery call with an experienced member of the team who’s going to walk through your situation, look at some of your goals, and see if you’re a good fit to work with one another and take next steps. It’s very easy to do that. Again, click the link in the description of today’s show or go to truewealthdesign.com. Tyler, thanks for all the details on Roth conversions today, and we’ll catch up again next week.

Tyler Emrick:

You got it.

Walter Storholt:

All right. Take care everybody. We’ll see you again next time right back here on Retire Smarter.

Speaker 4:

Information provided is for informational purposes only and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.