“Is it too late for me to do Roth Conversions?” 

I get this question..A LOT. 

The premise is a retiree who is taking RMDs, which means he or she is over 70 years old. He/she doesn’t think they’ll have enough time left on this earth to benefit from the tax-free growth potential of Roth’s.  But they figure they’d ask “just in case I’m missing something.”  Well, they are missing something.  They’re missing a lot.

The Scenario

We have a married couple, the husband is 70, wife is 66.  They will both live until 90.  Husband has $500,000 in an IRA invested solely in VFINX, the Vanguard S&P 500 fund.  Expected returns on the S&P 500 are 7.4% with a Standard Deviation of 16%. Husband gets $30,000 in pension with a 100% survivor benefit. 

Husband’s Primary Insurance Amount is $2900 and he took his benefit at Full Retirement Age.  Wife’s PIA is $1000 but she took a reduced benefit at 62 and thus her Spousal Benefit will also be reduced. 

Their monthly expenses are $4000, which is ALL INCLUSIVE. I’m not breaking down the individual components for spending. We’re just saying $4k a month is what they need to live on. We are increasing spending each year by 3%. So let’s dive into this with the Right Capital software.

Before Roth Conversions

First thing, as is ALWAYS the priority when I do financial plans, is to ensure the client is not running out of money.  As you can see below, that’s not going to happen. 

Not one time, in the thousands of scenarios run, did they run out of money. In fact, they left a median liquid net wealth of over $3 million to their heirs too.   Not too shabby. 

But there are taxes to be paid

Almost half a million in taxes as a matter of fact. Of course, the widows tax trap exists as well. In 2039, while Hub was alive, total taxes were “only” $26,264.  The year after he dies, in 2040, Ms. has to pay $36,18 in taxes on $20,000 less income. 

Here’s a visual of the effective tax rates. 

Of course one of the main drawbacks to not doing Roth conversions is that a significant amount of assets left to the heirs in IRAs will be taxable as ordinary income.  The next graph shows how their legacy is broken down by account type.  

Taxable Accounts are Inherited Tax Free

The heirs inherit TAXABLE account TAX-FREE but the Traditional IRA is not. The heirs will have to pay tax on distributions from this account as ordinary income.  

Now, be advised, while the taxable account IS tax free upon inheritance, the husband and wife did have to pay tax on any distributions they received each year while they were alive.   The following 1040 shows an example of taxable distributions in the year 2039 in the form of dividends. 

See line 3B? There are $39,286 of dividends that this couple must pay tax on in the year 2039, to show an example of how this works.  There will certainly be capital gains and potentially interest income too. So, the drawback of having this much money in a taxable investment account is all the income that the account distributes each year is potentially taxable. 

With Roth Conversions

Let’s now turn to what the situation looks like when we convert $50,000 a year to a Roth IRA.

First thing to see is the probability of success hasn’t changed, still 100%.  The median LIQUID net worth has increased a tad…by $5,000.

Total Taxes Paid

Let’s look at the total taxes paid, shall we?

By doing Roth conversions this couple pays $115,000 LESS in taxes over their lives. That is a 25% decrease in total taxes paid.

But notice something else..under the Planned Distribution column there are big, fat goose eggs starting in 2032.  Planned distributions are RMDs. No IRA balances, no RMDs. No RMDs, less income tax to pay, less potential for higher Medicare premiums, less Social Security being taxed, as well as not having to pay taxes on Qualified Dividends and Long Term Capital gains which may be tax free, depending on tax bracket. 

So, there is a LOT to be said for Roth conversions even if the entirety of the benefit isn’t seen on the tax return. 

Pensions Put a Floor on Income Tax

One of the drawbacks to having a pension is there will always be an income tax floor which you can never go under.  As I stated previously, the pension essentially wipes out your standard deduction and thus ANY income you receive above that number will automatically be subject to income tax. 

A small problem to have, mind you, but it still needs to be understood. 

Lastly, let’s compare the 1040 from the year 2039 with the Roth conversion vs. what it was without. 

Below notice the amount in line 3B is 50% LESS than what it was when we did no Roth conversions.  The amount of line 15, the Total Tax, is about ¼ of what it was before. 

In this scenario only around 55% of Social Security is taxable whereas before 85% was. 

Finally, as you can see above the total net worth at death is ALL Tax-Free to the heirs.  $2.1 million in Roth, and $1.5 million in a taxable account. 

So, to answer the question stated before “Is it too late for me to do Roth Conversions?”  Well if paying 25% LESS in tax over your life, leaving MORE to your heirs, and leaving them with no taxes, is important, I think we can confidently answer NO!  It’s NEVER too late to at least consider Roth Conversions!