ABOUT HOSTS

Joe Anderson
ABOUT Joseph

As CEO and President, Joe Anderson has created a unique, ambitious business model utilizing advanced service, training, sales, and marketing strategies to grow Pure Financial Advisors into the trustworthy, client-focused company it is today. Pure Financial, a Registered Investment Advisor (RIA), was ranked 153 out of 715 RIA’s nationwide by total assets under management by [...]

Alan Clopine
ABOUT Alan

Alan Clopine is the CFO & Chairman of the Board of Pure Financial Advisors. He has been an executive leader of the Company for over a decade. As CFO he is responsible for the financial operations of the company as well as investor relations. Alan joined the firm in 2008, about one year after it [...]

Andi Last
ABOUT Andi

Andi Last brings nearly 30 years of broadcasting, media, and marketing experience to Pure Financial Advisors. She is the producer of the Your Money, Your Wealth® podcast and radio show, and moderator for the firm's digital events. Prior to joining Pure, Andi was Media Operations Manager for a San Diego-based financial services firm with a [...]

Published On
March 29, 2022

When do you have to pay the taxes on a Roth IRA conversion to avoid any IRS penalties? Was it a mistake to convert to Roth IRA? What percentage of your assets should be in tax-free, tax-deferred, and taxable accounts to give maximum flexibility in retirement? Do Roth conversions count as income toward your eligibility to contribute to a Roth, and finally, how will a pension be taxed?

Subscribe to the YMYW podcast Subscribe to the YMYW newsletter

Free Financial Assessment

Show Notes

  • (00:50) When Do You Have to Pay Roth Conversion Taxes to Avoid IRS Penalty? (John, Atlanta voice message)
  • (05:05) When to Pay Roth Conversion Taxes? (Luis, Plant City, FL)
  • (10:38) What Percentage in Tax-Free, Tax-Deferred and Taxable Accounts Gives Max Flexibility? (Benjamin, Fargo, ND)
  • (18:28) Was Our Roth Conversion a Mistake? (David, California)
  • (26:36) Do Roth Conversions Count Toward the Roth Contribution Eligibility Income Limit? (Steve, Seattle, WA)
  • (31:41) How Will a Utah Pension Be Taxed? (Douglas)

Free financial resources:

WATCH Joe and Big Al answer questions from the YMYW podcast – on video! 

Free Download: The Ultimate Guide to Roth IRAs

Listen to today’s podcast episode on YouTube:

Transcription

Today on Your Money, Your Wealth® podcast 371, when do you pay the taxes on a Roth IRA conversion to avoid any penalties? Was it a mistake to convert to Roth IRA? What percentage of your assets should be in tax-free, tax-deferred, and taxable accounts to give maximum flexibility? And finally, do Roth conversions count as income toward your eligibility to contribute to a Roth, and how will a pension be taxed? Those will be with a special guest, so stick around. In the meantime, I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

When Do You Have to Pay Roth Conversion Taxes to Avoid IRS Penalty? (John, Atlanta voice message)

John: “Hi, Andi, Joe and Big Al. I’m John from Atlanta. I’m 62 years old and I love listening to your broadcasts and podcasts. Thank you very much for educating so many folks. And my question today is regarding paying the taxes on Roth conversions. I am retired and I intend to do annual Roth conversions to the top of the 24% bracket. And for me, that’s going to be a couple hundred thousand a year. And I hear different financial planners talking about the timing of paying the taxes, whether those need to be paid immediately, paid in the quarter in which you take the conversion, paid in the calendar year. And now lately, I’ve heard a few financial planners say it’s okay to wait until April 15th of the following year to pay the taxes. So I’m just trying to figure out whether there would be a penalty if you don’t pay the taxes in the calendar year that you do the conversion. Thanks.”

Joe: Cool. Thanks, John. Appreciate the phone call or phone message.
Al: Yeah. Yeah, good question. And it relates to- we all know that when doing a Roth conversion, you’re taking money out of an IRA, you’re converting it to a Roth, you have to pay tax on what you convert. That’s the bad news. The good news is it grows tax-free forever. So interest income, dividends, principal is tax-free forever. Growth is tax-free for you, your spouse, your future beneficiaries, kids, grandkids, whatever. So, but then there’s the question of when do you pay the tax? And so there’s two simple rules I’ll go over quickly and then I’ll get into it a little bit more. There’s two ways to avoid penalty when you owe taxes. One is to have paid in 100% of last year’s tax. So you look at your tax on the last year and have you paid in enough through withholding to cover that or 110% if you’re over $150,000. So that’s one way-

Joe: $150,000 of income or $150,000 tax?

Al: $150,000 of income.

Joe: Got it.

Al: And then but the other way, which is probably more relevant for most people that are retired and doing Roth conversions, is you have to make estimated payments in the current year. And you have to make enough estimated payments to cover 90% of your tax by the time April 15th rolls around. So the standard rule is you pay those quarterly. You pay the first quarter in April, April 15th then June 15th then September 15th then January 15th of the following year. You pay 1/4 of the tax each time. Now then there’s a question, well, what if I do the Roth conversion in November, December? How did I know what the tax was? And so here, the way that you do it, there’s something called the anualization method, which basically says that you have to start paying the tax in the quarter where you have the income. So maybe you made your normal estimated payments in the first quarter, in second quarter and third quarter. In the fourth quarter you did a Roth conversion, your income goes way up. Then you have to pay that extra tax, or at least 90% of it by the fourth quarter estimate, which is January 15th. So for most people that are retired, you’re already paying estimated payments. Or if you haven’t, you’re going to have to when you have extra income like this. If you do your Roth conversion in January, February, March, then you just have to pay 1/4 of the tax payment one, two, three and four.

Joe: Sounds good. Great question, John. Get that quite a bit. No one likes to-

Al: And there’s a lot of confusion because if- now if you had enough withholding, like, let’s say you’re working and you’re retired. So you had a whole bunch of withholding or maybe you retired during the year, you had a whole bunch of withholding that covered last year’s tax. And then you do a Roth conversion at year-end. You might not have to pay until April 15th as long as you had 100% of last year’s tax paid in. But when you’re retired, that seems less likely.

When to Pay Roth Conversion Taxes? (Luis, Plant City, FL)

Joe: I just got really tired.

Andi: You might want to skip the next question then because it’s basically the same question.

Al: Well, I’m hot. Let’s go for it.

Joe: It’s so boring. “I converted $100,000 from my traditional IRA to a Roth IRA on 10th of January 2022. The conversion falls in my 24% tax bracket so I owe Uncle Sam $24,000 in taxes. I’ve yet to pay these taxes and want to avoid any penalties since I’m going to pay the taxes from the traditional IRA funds and the market is currently not doing so well. I prefer to wait until later in the year before I pay them, but I’m concerned about potential penalties for late payments of taxes. Can I pay the $24,000 plus the tax from the additional withdrawal to pay them on December 31st, 2022? Do I have to make quarterly payments or do I have to pay the $24,000 right now?” That’s Luis from Plant City, Florida.

Andi: I looked that up to see if it was true. And it is actually a place and it’s outside of Tampa.

Joe: Plant City. It’s a great place.

Al: You know about it? You used to live in Florida.

Joe: I know, love Plant City.

Al: Yeah. So, Luis, the answer is, since you did the conversion in January, you got to pay 1/4 of the tax, just like we talked about in your first estimate and your second estimate, you do one quarter. So in other words, $6,000 a quarter, $6000 April 15th, $6000 June 15th and September 15th and January 15th of 2023. That’s what you’re supposed to do. If you don’t do that, then you get charged interest and the IRS charges a 3% interest rate, which isn’t all that bad. So let’s say, what if you didn’t do the April payment and you waited all the way until you filed your return the following year? Well, that’s $6,000 at 3% for one year. That’s $180 bucks. So it’s not nothing, but it’s also not- it’s not a game changer. So I wouldn’t worry too much about it. The second payment in June, if you don’t pay that one on time, then it’s 10 months at 3%. So maybe that’s $150 or $160 something like that.

Joe: I guess a couple of things, is that what concerns me about his question is he must be 100% equities, right?

Al: Yes.

Joe: And he’s converting up to the 24% tax bracket. And he’s also taking money out of his retirement account to pay the tax.

Al: That concerns me, too.

Joe: So there’s a few red flags here that Luis is doing.

Al: Usually when you convert, you need to have money set aside outside of your retirement plans accounts because you want to use that to get the maximum amount of the Roth. A better way to do this would have been to convert, let’s say, $75,000. If you had to pay the tax out of your IRA and the other $25,000 goes to the government, so you’ve already done it.

Joe: So a few things to look at here is so he converts $100,000, the market tanks and he’s like, well, I don’t want to sell any shares and take the distribution and pay the tax on shares that are lower price because it’s a double whammy. So he’s down, let’s say, 10% on the stock price. Then he takes it out and he’s got to pay 24% tax on that. I mean, if you add all of this up, this conversion cost him lot more than the 24% tax bracket.

Al: Yes. Agreed.

Joe: Because just the tax on the $24,000 that he has to take out is, what, $6000 bucks? You add that to the $24,000-

Al: – and that’ll be taxed at 33% – next bracket.

Joe: So be careful when you’re doing this, you want to make sure that you understand, if he has no other assets and he has millions of dollars in a retirement account, then it might make sense. Because you have to look at what your effective tax rate is, because pulling money out of a retirement account to pay the tax on the conversion could be a great idea. Or it could be an awful idea if you don’t really understand the numbers.

Al: Right. And I would say for the majority of people, do not pay the tax out of your IRA. It’s not- it’s generally a pretty poor idea.

Joe: Yes, I would say the majority-

Al: There are there are exceptions, yeah, the majority is right.

Joe: Because look at it like this. If I pay- simple math, $100,000. 24% of that. So I owe $24,000. So I pull another $24,000 assuming that $24,000 stays in that bracket. So then I pay 24% on that $24,000. So what is that?

Al: Another $6000.

Joe: Yeah, $6000. So he’s paying $30,000. So then the $100,000 conversion cost him $30,000 in tax. So if he’s assuming he’s in the 24% tax bracket, he’s actually paying at a 30% rate.

Al: But then he has to pay 24% of the $6000 that he withdrew to pay the tax on the $24,000.

Joe: Exactly. So he’s got to pay tax on the tax that you withdraw to pay the tax that you withdraw.

Al: And actually it’s the 33% bracket now.

Joe: So. Right. The tax man will getcha. So we congratulate you for trying to do some proactive planning to put yourself in a lot better position. But sometimes the planning that people are doing actually hurts them then that helps them. Ask your money questions right here. Go to YourMoneyYourWealth.com. Click on Ask Joe and Al on the Air and we will answer them – when we get around to them.

Is this the right time for you to do a Roth conversion? Go to the podcast show notes at YourMoneyYourWealth.com and click “get an Assessment” to schedule a free financial assessment with one of the experienced financial professionals on Joe and Big Al’s team at Pure financial Advisors. Pure Financial is a fee only fiduciary. They won’t sell you investment products. They will give you a professional assessment of your entire financial picture, and they will help you make decisions that can have a huge impact on your retirement future. Click the link in the description of today’s episode in your podcast app, then click “Get an Assessment” to schedule your one-on-one video meeting at a date and time that works for you. 

What Percentage in Tax-Free, Tax-Deferred and Taxable Accounts Gives Max Flexibility? (Benjamin, Fargo, ND)

Joe: So we got ”Hey Joe and Big Al. I drive a 2020 Nissan Altima and drink Busch Lite.” Ah Busch Lite. “Not at the same time.” Of course not.

Al: I’m glad he clarified.

Joe: Yeah. Benjamin writes in from Fargo, North Dakota. Knew it was Midwest.

Andi: Because of the Busch Lite?

Joe: Yeah.

Al: I don’t even know where you get that. I guess in the Midwest.

Joe: Oh, my God. I went to my aunt’s funeral.

Al: That’s what they had?

Joe: Oh yeah. A parking lot full of coolers of Busch Lite. In the parking lot of a church of the funeral. That’s my family.

Al: Got it.

Joe: So I’m all too familiar with-

Al: You like Busch Lite?

Joe: Yeah, it’s like Coors Lite.

Al: Similar, huh?

Joe: Somewhat cheap. It’ll fit in your budget.

Al: It fits the budget, huh?

Joe: Fits the budget just fine.

Al: Is that as good as Pabst Blue Ribbon or not as good?

Joe: It’s a lot lighter than Pabst. You could go Busch heavy.

Al: Got it.

Joe: Haven’t seen that in a while.

Al: Got it.

Joe: Or Hamm’s.

Al: Oh yeah. I remember Hamms. Yeah.

Joe: So, yeah, I would rather have a PBR than a Busch Lite.

Al: Got it.

Joe: “My wife and I are both 40 years old. We make between $215,000 and $235,000 a year and are always on the border being able to contribute to Roth IRAs because of our income. We save 13% of our income for retirement. Combined, we have $350,000 in traditional IRAs, $200,000 in Roth, $130,000 in a taxable brokerage account, $120,000 in my 401(k). I have the option to contribute to my 401(k) in a traditional or Roth. Couple of questions for you. Should I start contributing to my Roth 401(k) or to the traditional 401(k) or a combination? How do you calculate that? In an ideal situation, what percentage would be in Roth, traditional IRAs, and taxable accounts that give you the most flexibility in retirement? Love the show, wish it was more than once a week.” Thank you, Benjamin. Great questions here. Where do we start? I mean, we could get super scientific.

Al: The real answer is kind of complicated.

Joe: It’s very complicated.

Al: Let’s try to make it simple if we can.

Joe: Okay. So the real simple terms is this, is here’s my real life suggestion. We’re just talking.

Al: Yeah. Talking points. This is what you would do.

Joe: This is what I would do. And I don’t make anywhere near the big bucks that Ben makes.

Al: Yeah, we’re just in radio. Doesn’t pay that well.

Joe: Not even that. It’s just junkie podcast. No offense Andi. Sorry.

Andi: Thanks.

Al: A great podcast. It’s just the two of us.

Joe: The two of us.

Al: Yeah. We’re still waiting for the new host to come in.

Al: Yeah, we are.

Joe: All right, so here’s what I would do, is that I would go 100% Roth. You’re 40 years old, you’re not going to miss the tax that you’re paying today. And what I mean by that is this, is that if you put money – real simple example- if you think of it like this and maybe hopefully this can clear it up once and for all. But you’re going to- but Alan, because he’s a CPA, he has a different opinion sometimes because he gets granular in the numbers. But I think we both agree that over time – you’re 40 years old and you’re saving a ton of money. And he’s saving 13% of his income. So what is that- 13%? So you’re saving like $26,000 a year. So he saves $25,000 a year. And let’s assume that he goes all pre-tax. And I’m just going to put a 25% tax bracket, even though that doesn’t exist, but I know the math. He owes around $6,000 in tax. I mean, he saved $6,000 in tax. You put $26,000 in-

Al: – in a traditional-

Joe: – in a traditional 401(k) plan. You get the tax deduction and boom, you save $6,000. So now let’s say that $26,000 grows to $260,000. And you pull that money out, you have to pay tax. And he’s a pretty good saver, right? Sounds like it. He’s got quite a bit of money saved at 40 years old. They make a couple of hundred thousand dollars a year. He’s got, what- $300,000, $400,000, $500,000, $600,000, $700,000? Almost $1,000,000 saved at 40. Pretty good.

Al: Very good.

Joe: So the $26,000 grows to $260,000, let’s say, over the next 20 some-odd years. And then he pulls the money out at the same exact tax bracket. So the $6500 savings that he got today, he’s going to have to pay that back to the IRS and he’s going to have to pay it in spades because every single dollar of growth is going to be taxed. So he pulls the $260,000 out. He’s going to owe $65,000 in taxes, assuming the same tax bracket. Is my math somewhat good?

Al: Yeah. That’s right. Although, it’s probably not going to be $260,000. That would be quite a –

Joe: Sure. I’m just-

Al: Call it $100,000.

Joe: Okay. Whatever. It doesn’t matter. He has to pay the tax deduction back.

Al: He does. He does.

Joe: So if you’re going to be in a lower tax bracket in retirement, which a lot of people are. Don’t get me wrong, most people are in a lower tax bracket in retirement, but not the people that listen to this show because they saved money. Most people don’t have a – I was going to say – they don’t have a dime. They don’t have a Busch Lite to drink.

Al: So I agree with you. And plus – and here’s maybe a little bit more color the way I think about it. So you’re in the 24% bracket. That’s actually a decent bracket. That’s probably lower than you will be potentially even in retirement. You’ll probably be in what will be the 25% bracket. So you’re not losing anything there. The fact that you’re 40, you have all this time for this to grow tax-free. And I do agree with you, Joe, when people get the tax deduction and save an extra $6000 or whatever the number is, they by and large spend it. And so if it’s out of sight, out of mind, growing tax-free, I think in most cases you’re going to be in a better spot for people that save. Now, completely opposite, if you don’t save-

Joe: If you need every dollar and every-

Al: – then do the tax deduction, you’re not going to be in that high bracket anyway because you’re not saving that much. So these are for people that are saving where the required minimum distributions is going to be high in the future.

Joe: Or their living expenses might be higher. Or maybe that they’re not really big spenders, but they’re big savers. So the technical answer to get to his other question is how much money should I have in Roth versus 401(k) versus blah, blah, blah, blah. To map this out, you would want to look at, okay, you still want to take advantage of the standard deduction or whatever your Schedule A is because all of that money coming out of a retirement account is going to be sheltered by that standard deduction. So you don’t want to have everything 100% in Roth IRAs or brokerage accounts. You still want to have money in a 401(k) or IRA to take that tax deduction, but you don’t want to overdo it. And without really spreadsheeting this whole thing out, it’s impossible to answer the question on like a show like this.

Al: It is because you’ve got to look at your fixed income and what your income brackets are. And ideally you would have enough in an IRA so that when you take your required minimum distributions, you stay in the lowest bracket. I mean, that would be ideal.

Joe: Perfect.

Was Our Roth Conversion a Mistake? (David, California)

Joe: We got David writes in from California. He says, “Thank you for such an informative and helpful show.” You’re welcome. Okay. Next question. “My question is about Roth conversions. My wife and I were fortunate to have converted all of our retirement accounts to Roths back in the financial crisis. Those are worth about $1,000,000 now. Since then, I switched jobs and rolled my 401(k) into a rollover IRA that is now worth $700,000. I also have $100,000 inherited IRA and my wife and I each have traditional IRAs made with non-deductible contributions worth $65,000 with a $45,000 of basis. Our accountant in early 2021 recommended a Roth conversion of our non-deductible IRAs ahead of possible higher tax rates. Was that a good idea? We are in the top bracket and will be there for at least the next 4 years. I had expected the taxable amount to be $20,000 for each of us based on our non-deductible contribution. Is that correct? Or does our $700,000 rollover IRA, all pre-tax, need to get factored in, which would boost the taxable amount? It turns out we never included that $700,000 rollover IRA in our form 8606. Was this a mistake? Thank you for your wisdom and advice. David.”

Al: There’s a lot here.

Joe: Yeah, there is. So they converted everything back in the financial crisis.

Al: Right. So that would have been 2008, 2009.

Joe: They were like we’re going to roll this into Roth IRAs. They got good advice back then.

Al: And good for them.

Joe: Yeah, awesome. So now they have $1,000,000 or so worth of Roth IRAs. He switches jobs, he rolls over his 401(k) into a $700,000- no that’s in an IRA, that’s worth $700,000. So he has non-deductible IRAs. So what a non-deductible IRA is, is that just how it sounds. You put money into retirement account, but you make too much money to take the tax deduction. So you have basis. That basis will never be taxed again. It’s not going to be double taxed. Most people that put money into an IRA or 401(k) received the tax deduction. So everything comes out 100% taxable. For those of you that listen to the show, you know all about the back door and the barn door and the garage door. You know, Roth conversion strategies. So that is a non-deductible IRA. So he had a non-deductible IRA. $45,000 is what his contributions were, $65,000 is what it’s worth. So if he would have converted that IRA, he would have paid taxes on $20,000 of income, even though $65,000 went into the Roth IRA. But he didn’t do that. And then he rolled over the $700,000 401(k) into an IRA. So he’s asking us, what the hell does this mean now? So now he’s got the pro-rata rules and aggregation and everything else.

Al: So what it means now is using your numbers, your IRAs are worth $765,000, and you have to aggregate them together. That’s the aggregation rule. Then you look at the basis of both of them. Together, that’s $45,000. So that’s about 7%, 8%, 6%, 6%. Okay, so 6%. So if you do a conversion right now of $100,000, let’s just say, only $6,000 will be tax-free. The other $94,000 will be fully taxable. So that’s not a great answer unless you’re in a real low bracket, but it says you’re in the highest bracket possible. So I think a better- if you have a company right now that has a 401(k), gosh, maybe you could take your $700,000 IRA, roll it into the IRA. Then you take your $65,000 IRA, try to roll that to the 401(k) and they won’t take after-tax money. You’ll be left with an IRA with $45,000 in it. Then you can convert it and there’s no tax to pay. That would be the smartest thing.

Joe: Right. And let me repeat that. So, David, if you have a job that has the 401(k), roll the IRA of $700,000, the rollover IRA that you did from your previous job of the 401(k), move that into a 401(k) because 401(k)s they don’t include in the pro-rata rule. So then if you converted your $65,000, you would only pay $20,000 of tax or $20,000 of taxable income. But Al said, you know what? There’s – do something better. Try to roll the whole $65,000 into your 401(k) plan at your new employer. 401(k) plans will not accept after-tax contributions. They will accept that $20,000 of growth. So then you can only move the $20,000 in and you’re left with an IRA of $45,000. That’s your basis. You take that $45,000 of basis, you convert it into the Roth and there’s zero tax paid. So instead of getting 6% tax-free, you could get 100% tax-free by doing two extra steps.

Al: And you’ve already got $1,000,000 in a Roth. And you’re going to be in a high bracket the next 4 years. I don’t know what happens out in 4 years. Are you retiring? Will you be in a lower bracket? Maybe that’s when you think about converting some of the money that will be in your 401(k).

Andi: So has David made any mistakes at this point?

Joe: Well, he rolled his 401(k) into an IRA and he didn’t convert the non-deductible. Well, he’s making non-deductible contributions. He’s filling out the 8606 form. And he already did conversions in the past. I’m like, David, what happened? You fell asleep at the wheel here. I mean, why wouldn’t you be converting those after-tax contributions?

Al: Yeah, they should happen immediately.

Joe: They should happen immediately. You should- he should have been doing that all along. But for some reason-

Al: Unless he’s had the $700,000 an IRA for a long time, but it doesn’t seem like it.

Joe: It doesn’t appear that way because it seems like, I rolled over my 401(k) into an IRA.

Al: So it’s not that big a deal, but it can be fixed if he’s got a current 401(k), meaning that he could roll his current IRAs into the 401(k), he’d be left with a $45,000 IRA with basis. He can convert that and pay no tax. That would be the smart thing to do currently. As far as whether you screwed up the form 8606, that’s the IRS form where you show your basis in IRAs. You know, theoretically you should have put $700,000 as part of your total IRAs. But it’s not that big a deal. I wouldn’t worry too much about that one.

Joe: They’re going to come and get David. All right. Thanks for the question.

Tax-free growth on your investments for life – that’s what a Roth IRA provides. Learn more about what Kiplinger calls one of the smartest money moves a young person can make. Download the Ultimate Guide to Roth IRAs for free from the podcast show notes at YourMoneyYourWealth.com, and subscribe to the YMYW newsletter there in the show notes as well so the latest podcast and TV episodes show up right in your inbox. Click the link in the description of today’s episode in your podcast app to download the Ultimate Guide to Roth IRAs, read the transcript of today’s episode, and subscribe to the YMYW newsletter. IT’s all free, all courtesy of Your Money, Your Wealth® and Pure Financial Advisors. Share this stuff and help us spread the YMYW word, won’t you please? Now, remember back in episode 368 we got a comment saying that YMYW would be better with different hosts? That works out well, since Joe is now on vacation. Next week we’re gonna see how Kyle Stacey, CFP® from Pure Financial Advisors does filling Joe’s shoes! First we’re gonna test the waters now and give Kyle a Roth conversion question.

Do Roth Conversions Count Toward the Roth Contribution Eligibility Income Limit? (Steve, Seattle, WA)

Andi: So our first question is from Steve in Seattle, Washington. He says, “Hello, Big Al, Joe and Andi. I have a question for you concerning Roth conversions.” It’s a favorite here on YMYW. “First, the important facts – ” Now, Kyle, I don’t know if you actually listen to the podcast or not, but we ask people to tell us what they drive and what they drink, and what kind of pet they have so that we can really fully understand their entire situation. So Steve says he “drives a 1971 Toyota FJ40 Land Cruiser and he likes to sip on Glenmorangie, the Quinta Ruban when he can find it. Here’s the background for my question, I turned 60 last year. Throughout my career, all of my retirement savings have been in traditional 401(k) and 457s. I also have an individual Roth which I normally fund with however much I can afford and fully funded last year. Late last year, I started running my retirement numbers and discovered that my RMDs will put me fully in the 24% tax bracket for the rest of my life, soon to be 28% or whatever else Congress decides on. I ran a number of scenarios and decided to convert all of my current traditional 457 to a Roth 457. I will leave my traditional 401k)s alone because they will leave me with small manageable RMDs. Last year I converted to the top of the 24% bracket. The conversions will continue to the top of the 24% bracket for 3 years. Then I’ll reevaluate and might convert more in a lower tax bracket in order to avoid IRMA limits after I turn 63. This January, I was using my favorite tax software which told me I was not eligible to contribute to an individual Roth because of the high income related to the conversion. I contacted my broker and had the 2021 contributions and earnings returned. Later, I needed some tax prep help for the Roth return in the tax software and posted a question on their forum. A quote/unquote “tax specialist” there told me that Roth conversions don’t count towards the income limit for individual Roth contributions. Can you enlighten me on this? If I convert to the top of the 24% bracket, can I still make individual Roth contributions or not? Thank you for your YMYW podcasts. I truly enjoy them. I may write up my whole plan for your spitball review at some point.” That’s Steve from Seattle, Washington.

Al: Wow, the whole plan. That could take a whole show, maybe.

Andi: Really. It’ll be a different type of show.

Al: Well, Steve, so these are good questions and maybe let’s kind of do a little bit of background here. So when people have a lot of money in an IRA or a 401(k), they got a tax deduction going in. But as they pull the money out in retirement, or they’re required to take it out at age 72, that’s the required minimum of distribution, they have to pay ordinary income on what they pull out. So sometimes people want to go ahead and do a conversion. They take some of that IRA money, 401(k) money, they convert it to a Roth IRA. They pay tax on the conversion, a one-time tax. But then any money they take out of the Roth IRA in the future is going to be tax-free, whether it’s principal, income, growth, whatever it may be, and it’s tax-free for the taxpayer, taxpayer spouse, taxpayer’s kids, beneficiaries. So when you’re in a low enough tax bracket currently relative to where you’re going to be in the future, you want to think about doing conversions. And Steve, I congratulate you on that. You converted up to the top of the 24% bracket, and you’ve already identified in 2026 the tax rates come back. You’ll probably be in the 25% or 28% bracket. In some cases- now you live in Washington, you don’t have any state taxes. If you lived in California, in that income level, you’d be subject to alternative minimum tax, which would be more like a 35% bracket. So, Kyle, the question was, is he eligible to do a Roth contribution because his income is too high because of the Roth conversion?

Kyle: It’s going to depend a little bit. The short answer is no. The Roth conversions don’t count toward your eligibility to make a Roth IRA contribution. But we also don’t know what his income was prior to the conversion.

Al: Correct.

Kyle: We didn’t know his adjusted gross income prior to that. So I would say it’s no overall, but it depends on your situation.

Al: So the takeaway here is that when you do a Roth conversion, it does not count as far as your modified adjusted gross income in determining whether you can do a Roth contribution. And if your tax software told you you were not eligible, it probably just means you didn’t click a certain box in the software so it knew it was a Roth conversion. Because you’d have to do that, otherwise it wouldn’t know that. So the tax specialist, as Andi said, the quote/unquote “tax specialist” is correct. In other words, you do not have to count that Roth conversion income in the modified adjusted gross income. And the limits I think this year are somewhere around $125,000 to $140,000 for a single and somewhere around $200,000 to $210,000, I might be off $1,000 here or there, but somewhere in that range for married.

Kyle: Yeah, you got it.

Al: It’s too bad you took it out because you probably could have left it in as long as your modified adjusted gross income was low enough to be able to qualify.

How Will a Utah Pension Be Taxed? (Douglas)

Al: Okay, Andi, do we have a quick question?

Andi: We do have a very short question. This is from Douglas. He said, “my wife is retiring at 58 from a Utah school district. How will her pension be taxed?”

Al: That is a short question. Very good. What do you think, Kyle?

Kyle: Oh, man. I guess I don’t know what pension system she’s coming from in Utah, but I would have to do some digging on that one. I don’t have an answer for that.

Al: Well, I’m going to spitball and guess. In general, when you’re getting a pension plan from an employer, government, school district, whatever it may be, generally it’s taxable as ordinary income. So it’s taxed in a similar manner as your salary, with one major exception and that is it’s not subject to Social Security taxes and other state disability should you have that. But generally a pension plan that you’re getting money from is taxable as ordinary income. Now, there could be some exceptions. Maybe if there was some money that you put into the pension plan where you didn’t get a tax break, maybe some of that could be tax-free.

Kyle: Yes, every once in a while there’s after-tax contributions that go into those pension systems and part of the pension is actually kind of bifurcated into tax-free money.

Al: And typically, if you have that situation upon retirement, the school district or whatever agency it is will tell you how much of your pension is taxable versus not. But in general, it’s fully taxable unless you have some basis. It does happen from time to time. It’s a little bit rare, but it does happen. So for planning purposes, I would say that it’s probably going to be taxable.

_______

Tune in next week to hear Big Al Clopine and Kyle Stacey, CFP® spitball on pension and Social Security, self employed retirement, police officer retirement, an employee stock ownership plan, emergency funds, and they’ll take on Ric Edelman and Dave Ramsey. Make sure you’re subscribed.

Subscribe to the YMYW podcast Subscribe to the YMYW newsletter

Listen on Apple Podcasts | Google Podcasts | Stitcher | Player FM

ASK JOE & AL ON AIR

Your Money, Your Wealth® is presented by Pure Financial Advisors. Sign up for your free financial assessment.

IMPORTANT DISCLOSURES:

Pure Financial Advisors is a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.

• Investment Advisory and Financial Planning Services are offered through Pure Financial Advisors, LLC, a Registered Investment Advisor.

• Pure Financial Advisors LLC does not offer tax or legal advice. Consult with your tax advisor or attorney regarding specific situations.

• Opinions expressed are not intended as investment advice or to predict future performance.

• Past performance does not guarantee future results.

• Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.

• All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.

• Intended for educational purposes only and are not intended as individualized advice or a guarantee that you will achieve a desired result. Before implementing any strategies discussed you should consult your tax and financial advisors.

CFP® – The CERTIFIED FINANCIAL PLANNER™ certification is by the Certified Financial Planner Board of Standards, Inc. To attain the right to use the CFP® designation, an individual must satisfactorily fulfill education, experience and ethics requirements as well as pass a comprehensive exam. Thirty hours of continuing education is required every two years to maintain the designation.

AIF® – Accredited Investment Fiduciary designation is administered by the Center for Fiduciary Studies fi360. To receive the AIF Designation, an individual must meet prerequisite criteria, complete a training program, and pass a comprehensive examination. Six hours of continuing education is required annually to maintain the designation.

CPA – Certified Public Accountant is a license set by the American Institute of Certified Public Accountants and administered by the National Association of State Boards of Accountancy. Eligibility to sit for the Uniform CPA Exam is determined by individual State Boards of Accountancy. Typically, the requirement is a U.S. bachelor’s degree which includes a minimum number of qualifying credit hours in accounting and business administration with an additional one-year study. All CPA candidates must pass the Uniform CPA Examination to qualify for a CPA certificate and license (i.e., permit to practice) to practice public accounting. CPAs are required to take continuing education courses to renew their license, and most states require CPAs to complete an ethics course during every renewal period.