In today’s episode, you’ll learn more about:
- When to complete a Roth conversion
- Whether to spread conversions throughout the year
- Tax bracket management and conversion timing
- Why recharacterizations no longer being available matters
- How to pay Roth conversion taxes efficiently
- Roth conversions before age 59½
- Estimated tax payments and withholding strategies
- Which investments may be best suited for Roth accounts
- Why higher-growth investments are often prioritized inside Roth IRAs
- Coordinating Roth conversions with investment management and rebalancing
Listen Now:
The Smart Take:
So you’ve decided to do a Roth conversion… now what?
Most Roth conversion conversations focus on whether you should do one. But the long-term value often comes from how the strategy is actually implemented.
In this episode, Tyler Emrick, CFA®, CFP® walks through the overlooked decisions that can materially impact the outcome of a Roth conversion strategy.
Tyler also explains why many Roth conversion mistakes have less to do with the conversion itself — and more to do with poor timing, tax management, and implementation decisions.
Go Inside the Episode:
0:00 – Intro
2:39 – Timing the Conversion
6:22 – Paying the Taxes
9:17 – What Should Be Converted?
11:49 – Final Thoughts
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The Hosts:
Kevin Kroskey, CFP®, MBA – About – Contact
Tyler Emrick, CFA®, CFP® – About – Contact
Episode Transcript:
Tyler Emrick:
A lot of people spend all their time deciding whether they should do a Roth conversion or not. But once you actually decide to move forward, the next question becomes, how do you do it well? Because timing, taxes, investment selection and even how to pay the taxes can have material impact on the outcome and the long-term strategy. So let’s talk about it. Today we’re talking about what happens after you decide, “I’m ready to do a Roth conversion.”
Walter Storholt:
It’s another episode of Retire Smarter. I’m Walter Storholt alongside Tyler Emrick. He’s a certified financial planner, a chartered financial analyst and a wealth advisor at True Wealth Design, based in Northeast Ohio, but serving clients all over the country. Check out truewealthdesign.com to schedule a time to visit for a review of your plan and a discovery call to see if you’re a good fit to work with one another. We’ve also got that linked in the description of today’s show.
I throw that out early today, Tyler, because of today’s topic. Often we talk about, we do this, a lot of other people on YouTube do this and podcasts. Should you do a Roth IRA? Very 101 material. Well, today’s going to be a little differently. We’re going to move past that and say, “All right, we’re…” or a Roth conversion. I’m sorry.
Tyler Emrick:
Roth conversion. You’re on. Same thing.
Walter Storholt:
“Should I do a Roth conversion?” We’re going to say the answer was yes. And now what’s next? Now what do we do? So I like that we’re driving the bus forward a little bit and because we’re now to the implementation step, that’s where you might want to reach out to Tyler and the True Wealth Design team. But we’ll tell you more about that later. Tyler, let’s get into it. Roth conversions we’ve decided on it, so now what?
Tyler Emrick:
You nailed it, but the planner in me, I have to have a-
Walter Storholt:
You have to give us context.
Tyler Emrick:
… quick disclosure, right? Have to give a quick disclosure. Hey, if you’ve planned to do your Roth, don’t fall in that trap of, “Oh, I’m just going to do a Roth conversion. I should. I’m going to pick a number.” Make sure that you’ve done the math and it’s done in conjunction with the plan. Hey, you know what your long-term tax rate is? You know what your tax rate is now. And you’re like, “Hey, I definitely want to do this. It makes sense for the family and I. We want to get this accomplished.” So I’m assuming that all that front-end work, well, we’re bypassing it. That’s all good fun stuff. That’s the planning piece of it. We’re assuming that is by the wayside and done and we’re there. [inaudible 00:02:21]
Walter Storholt:
The analysis just never stops. The analysis never stops, Tyler.
Tyler Emrick:
You got it. Watch out for IRMAA limits. Watch out for net investment income tax, all these other things that we got to be worried about when we’re starting to do these big Roth conversions. We’ve done all that, you’ve done your homework and we’re there. So now what do we got? We’re onto the Roth conversion. So the first thing, well, when I think about when it’s time to implement is, “Well, when do I actually complete the conversion? When do we do it within the year?” And a handful of years ago, there was an important law that got changed called Recharacterization. This whole idea of recharacterization was the idea that you could do a Roth conversion and then later in the year go, “Oops, I want to take that back. I changed my mind.”
Walter Storholt:
Interesting.
Tyler Emrick:
That is no longer applicable. We can’t do that anymore.
Walter Storholt:
Got it.
Tyler Emrick:
So it makes this decision even more important because, once we complete the conversion, it’s done. It’s in the books. You’re paying taxes on whatever that amount is so we want to make sure that we get it right. So that lends itself to us traditionally waiting until the end of the year to do those Roth conversions. Sometime maybe in Q4, we know exactly how much income you’ve had come in. We know how much portfolio income is hitting. We can really be deliberate about our income target, and boom, we got the number, we do it say in November, December, and everything is good to go. No surprise withdrawals from your IRA account that can perk up.
But oftentimes when we go down and do this though, for some individuals it might make sense to not do it at the end of the year. You’re sitting there in your situation where you’re like, Hey, my income is pretty standard. I have quite a bit in cash. I know I’m not going to have to dip into an IRA and I got a big, big gap. I got a $150,000 conversion that we want to do this year.” Well, in scenarios like this, we really might want to consider, why don’t we break up the Roth conversion? Why don’t we do part at the beginning of the year, leave ourselves a little bit of buffer and maybe finish it up towards the end? So when we think about, well, why would we want to do that? What does that do for us? Well, it just goes back to the old adage of what does the Roth do well?
Well, the Roth does well growth that’s tax-free. So when you do a Roth conversion earlier in the year, if the market or the investment that you have in your Roth appreciates in value, well, appreciating in the Roth is tax-free. Well, that’s great. Appreciating in value inside of your IRA account, well, you still got to pay taxes on all that money that you’ve earned. So depending on the investments, depending on market outlook, depending on how much room that you have and how much big of a conversion do you want to do, converting early in the year a big chunk might make sense because all that earnings and interest that you get throughout the year is all tax-free.
Walter Storholt:
Conversely, if it went the other way and you waited till the end of the year on a down year, you actually would pay less in taxes because of waiting to convert. So is doing the partial essentially diversification of Roth conversions?
Tyler Emrick:
It can, absolutely. Well, and I think it’s even more thoughtful is well, what are the underlying investments inside of your Roth? And we’ll touch on that a little bit later, but what is the return expectation? Do you want to take on that risk or do you maybe put it in an investment that’s maybe not in the stock market and is getting an interest rate that you’re not guaranteeing, but a much more likely chance that that interest would come to you and there would be some type of gains. Because you’re absolutely right, Walt, if you do the conversion, the investments drop in value. That’s where that recharacterization used to be great. No more. Can’t do that.
Walter Storholt:
I see. That was the oops rip cord.
Tyler Emrick:
Oh, it was. Absolutely, yes. So that’s what pushed most individuals to wait until the end of the year. And you’re not limited to just one conversion, right? That’s why we can split it up. We can do it. So you got quite a bit of flexibility there. But when you think about that timing, the other thing that needs to be on the top of your mind is, well, hey, Walt, we’re increasing your tax bill. How and when do you pay the taxes that you’re going to owe on that Roth conversion?
Walter Storholt:
Good point. Does somebody pay it for me? Do I have to just sit on the cash-
Tyler Emrick:
And that’d be nice, right?
Walter Storholt:
… to pay it at April 15th?
Tyler Emrick:
So you do have the capability, when you do Roth conversions, to withhold taxes on the conversion. So you can do it within the transaction, but what that does is it gets less money inside of your Roth because part of the Roth conversion would go to the IRS, part would go inside of your Roth. Obviously the money that goes in the IRS isn’t necessarily making it to the Roth account. So if you are in a great situation to where you have other assets outside of your retirement accounts that you can use to pay the actual tax bill on the conversion, well, this can work out really well. This means that you get more money inside of your Roth growing tax-free and you take money that is in less tax efficient accounts, like a taxable brokerage account or a savings account or whatnot, and then you go ahead and send that to the IRS.
You can do that in a multitude of ways. You can do it through estimated tax payments quarterly depending on timing and talk to your CPA, your tax account or your financial advisor should be giving you advice on this if you’re going to be paying with money outside. When do you complete that estimated tax payment? Do you wait until the end of the year? Do you have to do it quarterly? That has everything to do with how else are you sending money to the IRS? What does that timing look like? May even depend on what your taxable income was in the year prior, because there’s some safe harbor rules on pays and things like that that you might be able to take advantage of. So paying that tax liability with money that’s outside of the retirement accounts could be a wonderful way to start diversifying and get more money inside of the Roth.
The other caveat there that we want to think about too is those individuals that are maybe a bit younger here and are wanting to get a jumpstart on your Roth conversions, this could very well be the case, but you’re not 59 and a half, you’re really going to want to not pay your taxes on that conversion. Because if you’re under 59 and a half, 59 and a half is so important because that’s when you have a 10% early withdrawal penalty on withdrawals. The IRS will allow you to do a Roth conversion and not have to pay that 10% penalty. So that’s great. But if you end up sending some money to the IRS on that conversion to pay your federal or state taxes, well, that’s a distribution. Now that could be penalized. So for those individuals that are under 59 and a half, there might be a special caveat there you want to pay attention to and make sure that, outside of our retirement accounts, we’re going to make sure we get that tax liability covered to go from there.
So timing, how are we going to pay the taxes? I think the other thing that’s important is, well, what investments should be converted? A lot of times, Walt, what we’re doing is we’re not taking just cash out of our IRA account or our 401(k) and converting it over to the Roth. We’re just converting investments. We do shares of investments can be moved from one an account to another electronically in most cases. So it’s very nice and easy. You don’t have to sell investments, be out of the market, move cash and go over. You can just take the investments you already have, move them on over into that Roth electronically, as long as you’re doing it at the same custodian and it works out really, really well.
So the question becomes though is, what investment do you move over? As we think about our general guidelines for asset allocation, well, the Roth grows tax-free. So we do want our higher expected return assets, generally our stocks, to be mostly held inside of our Roth. Over time, certainly they can have some ups and down wall inevitably, but over time we want those highest expected return investments in there. So a lot of times we’re converting stock mutual funds or ETFs from an IRA over into the Roth. The one caveat or the one time where that might not be applicable is where you brought up earlier, right where maybe you’re not feeling comfortable about market outlook or one of the particular investments that you move over there. Certainly then that might be a case where you move and you’re in a different investment than maybe what your highest expected return is for a number of reasons, especially if you’re splitting it up and doing part at the beginning of the year and the end.
But again, the old caveat here, Walt, is it’s impossible to time the market in our opinion. So don’t get yourself caught up in that situation where you’re like, “Ooh, market is high. I’m going to move a bond investment,” and do that. Make sure you’re doing it for the right reasons. It’s almost impossible there for us to make sure and time it. So if you’re doing that split Roth conversion, keep that in mind.
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:
Makes a lot of sense, Tyler.
Tyler Emrick:
It does.
Walter Storholt:
So this gets into those are the three big questions, like thinking about, well, the analysis first, so four parts.
Tyler Emrick:
Analysis first. Analysis first. Absolutely. But the timing, how you’re paying the taxes and then which investment are you moving over are three great things to keep in mind as you’re thinking about the practical application of doing the Roth conversion. Certainly you got to figure out which account you’re going to do it from, because you can convert inside of your 401(k)s. A lot of plans can do that now. Not everyone check with your plan sponsor, but sometimes that can be an easy way to do it as well if you don’t maybe have individual retirement accounts that are afforded to you there. So obviously picking that account can be good. But those three things we discussed, I think are the biggest and easiest ways to add some value on top of, “Hey, we’ve already decided to do the conversion.”
Walter Storholt:
Because just something as simple as your age and being on one side or the other of that 59 and a half and then how you’re paying the taxes can dramatically change whether this was a good idea in the first place or not. So if you do those things incorrectly, then your original analysis no longer may make sense. So that’s why we’ve got to make sure that we’re implementing just as well as we did the initial research and decision making.
Tyler Emrick:
And there’s a reason why these Roth videos probably get some of the most views. They’re some of the most talked about things, the Roth conversion, is because most families should be looking at this every single year. Even in situations where you might not think, “Hey, I should do a Roth conversion. I’m working,” you might have room in the tax bracket that you’re in to do a conversion, especially if your expected tax rate down the road is not any lower than where you’re at now because you’ve done a good job saving. Maybe you have a lot of money inside of your IRA accounts, that type of thing. So I think it should be on everybody’s radar to review it no matter what stage in life that you’re at and what you’re thinking, how much in Roth conversion should we be thinking about each year?
Walter Storholt:
Do it thoughtfully, do it intentionally and you’ll be in great shape. So that is a great episode today to understand a little bit some of the execution part of doing those Roth conversions. Again, if the implementation of all of that does sound a little bit scary or you’re still not quite sure where to begin with the analysis portion of that, that’s what True Wealth Design does. Tyler and the team take you all the way from point A to point Z, I guess, right?
Tyler Emrick:
You got it.
Walter Storholt:
All the way through the decision points. A lot of times I would say point A to point B, but you guys are more thorough than A to B.
Tyler Emrick:
I like it. Nice.
Walter Storholt:
It’s A to Z I think is more realistic for how you put together plans for your clients, making sure no stone is left unturned. So if you’d like to interact with Tyler and the team, all you have to do is go to True Wealth Design and click the Let’s Talk button and you can schedule a quick discovery call with the team to see if you’re a good fit to work with one another and start talking about that plan. Or of course, you can just click the link that’s in the description of today’s show. If you’re watching on YouTube, just scroll down to that description section. You’ll find the link there and it’s also on all of the audio podcasting apps as well. So it should be easy to find for you. So check all that out, schedule that time to visit and see if you are a good fit. Tyler, thank you so much for the help today. This was a good one and we’ll talk again soon.
Tyler Emrick:
Absolutely.
Walter Storholt:
All right. Join us next time folks 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.