Should I Convert Everything To a Roth IRA Now?
Highlights:
1. The idea of a “100% Roth retirement portfolio” as a “holy grail” lacks nuance; all-or-nothing approaches are rarely optimal for retirement planning.
2. Both pre-tax and Roth accounts have different advantages: pre-tax provides immediate tax deductions but requires paying taxes upon withdrawal, while Roth uses post-tax dollars but offers tax-free growth and withdrawals.
3. Having a mix of pre-tax, Roth, and brokerage accounts provides flexibility and options for managing taxes in retirement rather than committing solely to one strategy.
4. Roth conversions during market downturns may offer incremental benefits but are often overstated; more important factors include your current income level and future tax expectations.
5. Retirement planning should be personalized based on individual circumstances rather than following generalized advice; taxes can’t be eliminated, only transformed or deferred.
Should I Convert Everything To a Roth IRA Now? Timestamps
00:45 The Myth of the “100% Roth Portfolio” as a Holy Grail
02:40 Understanding Retirement Account Types: Pre-Tax vs. Roth
03:45 Tax Considerations and Strategies for Retirement Planning
04:38 Roth Conversion Logistics and Timing Considerations
05:40 Creating a Balanced Approach to Retirement Account Diversification
Should I Convert Everything To a Roth IRA Now? Links
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Should I Convert Everything To a Roth IRA Now? Transcript
There are some people out there chasing what they call “the holy grail” of a 100% Roth retirement portfolio.
Some people in America today believe a lot of – or all of – your retirement investment portfolio should be in Roth dollars, if possible. So they’re doing everything they can to put money into these accounts and convert it to Roth if it’s not already in Roth.
When the article was written, the market was down. They were outlining how they thought that a downturn in the market presents a better opportunity to do Roth conversions.
I’m curious on your guys’ take where you stand or your thoughts on fully 100% Roth portfolios or the balance between pre-tax and Roth brokerage assets. How do you kind of think about that split?
I feel like anything just, for starters, that gets referred to as “the holy grail” is lacking nuance and probably not entirely correct.
But it gets people to click, so I get it.
I’m thinking of the line from Star Wars, “Revenge of the Sith,” like “Only a Sith deals in absolutes.” The idea that your retirement savings should be 100% in any bucket or just kind of like the fact of life that 100% into anything is probably not going to be right.
Just by default – because you’re being more specific when you don’t need to be.
I think it’s cool that people have been banging the drum for Roth because like in the big picture of retirement accounts, they’re relatively new – in comparison to standard pre-tax 401k. People have found out that if you follow all the rules, this can be tax-free retirement income down the line, tax-free compounding, that’s sweet, that’s awesome, do it.
But just give consideration to what your goals are and like where money should be.
It doesn’t all need to be in one bucket.
All or nothing is hardly ever the way to approach stuff, is kind of my (high-level) take on it.
To button down something Brendan just said, the Roth IRA has only been around since 1998. It’s barely 25 years old.
They created section 401K in 1977, and the IRA really went public in 1981, so they’ve got a long head start on a Roth IRA.
We usually have the opposite problem…
Or we sometimes have the opposite problem, when we’re dealing with folks, and all of their money as they’re getting ready to retire is all in pre-tax buckets.
Kind of a different set of circumstances.
For the viewers and listeners the benefits of pre-tax versus Roth: pre-tax, the money goes in pre-tax. So you’re not paying tax on it on the way in. And you can take a tax deduction. It lowers your taxable income for that year when you contribute to the accounts.
But then when the money comes out in retirement, you’re paying tax on it.
The idea ideally being, in retirement, if you have lower income, you’re gonna be paying tax at a lower tax bracket than you are currently as you’re working.
So that’s kind of the idea of a benefit behind pre-tax.
But the opposite is true for Roth: you’re paying the tax now. Every dollar that goes into the Roth account is going in post-tax.
But then, like Brendan said, tax free as you take it out, in retirement.
It grows tax free and you can take the money out in retirement. I guess in that scenario, you’re kind of saying you think…
…taxes will “only ever be higher in the future” is like the “meme version” of why you should do a Roth IRA.
The traditional IRA is like what you already said, (people believe) “your tax rates will be lower in retirement.”
Both of those, I think, make a lot of assumptions. And assumption is just a fancy word for “guesses” that people in finance use.
Unless you know – for sure – what your tax situation is going to look in retirement, I think you could probably come up with a plan to fill up both of those buckets.
And get some tax advantage now in terms of reducing your income. But also set yourself up nicely to have that flexibility of tax-free income in retirement. It doesn’t need to be “an either / or” it can be an “and” both.
In the article too, as you read further down, it shed some light on the people that are in these financial situations where they can afford to do things like conversions before 59.5. Because if you dig a little deeper into it, it might not make a ton of sense for a lot of people to do that. Because you have to pay tax in that year that you do the conversion.
And if you’re prior to retirement age, or 59.5, when you could take the money out, you can’t pay the tax with the money that you’re doing the conversion with. You have to have the tax money available in savings or in another type of maybe just a brokerage account or something, to pay the tax that year.
I think the people that are considering these fully Roth or doing a big conversion to get to mostly Roth, they’re in a certain situation that might not apply to a lot of people. They have the financial ability to do this that other people might not have.
If we’re talking about Roth versus traditional retirement accounts, the first thing that gets you 90% of the way there, we’re talking about optimizing. We should just be talking first and foremost about the savings happening at all.
Once you’ve set the bar of “I can afford to do this savings,” then:
How do you do it most efficiently?
How do you optimize it?
How do you give yourself optionality for the future?
I think that’s when Roth conversions in a big way enter the conversation. But you’re absolutely right. You either need to have cash on hand to do it if you’re under 59.5% or perhaps it reduces some of the benefit if you do it after 59.5 and you want to withhold tax from the transaction.
You’re still ending up with less in the Roth bucket, which is kind of counterproductive to the point of doing it. It doesn’t mean it’s entirely off the table, but it’s probably preferable to do it from cash, as you said.
You have to think through some of the logistics of it that are just beyond the idea that having tax-free income sounds good.
One of the other exercises that a lot of people may go through: you go through enough of these different exercises and you start to ask yourself, “why am I doing this in the first place?”
Because you say, “all right, I put money pre-tax into this pre-tax account, 401k…” let’s say.
So you did get your tax savings on that end. Then, you take it out – at whatever bracket you’re in, pay the tax on the conversion.
I wonder how many people when they go through this exercise, they actually sit down and say:
“What if I never made that deduction into my 401k in the first place?”
“What if I just saved the money instead?”
And now, if I want to tap into this money, I may have short (or long term) capital gains. Which may be lower than what I’m looking at anyway.
You could do that in addition to Roth and in addition to pre-tax, because neither of them are the answer. It’s just like you don’t need to do just one of these things.
Because all of them have different tax advantages in terms of when you go to take the money out.
What are your thoughts on the fact that a market downturn makes it a better opportunity to do a Roth conversion?
It’s incremental. It’s super overstated because basically what you’re saying is have less to convert anyway. If you convert when the market’s down, let’s assume we’re doing this in kind, so you have a traditional IRA with index funds in it, reasonable investments that we can assume will come back when the market comes back.
If the market’s down temporarily and you’re hitting the convert button to send it over to your Roth in kind, it’s picking up the shares while they’re down, generating a 1099R that will get sent out to you at tax time to reconcile the process and then dumping the shares into your Roth.
If the market does like what it did over the last several weeks here, maybe you converted on that first week of April and then by the end of the month, the investments have already gone up in value from the conversion date. So maybe there’s an incremental bit to be gained there by saying I’m gonna convert at the bottom.
But if you know it’s the bottom, I think there are cooler things you could do with that sort of information.
None of us ever know when it’s the bottom. If that’s all you’re doing with your crystal ball knowledge, then have more fun is I guess what I would say to you.
That’s I think where there was a little bit of disconnect when I read that. But what you said logistically, like just X’s and O’s, that does make sense. But usually overstated, people are looking to maximize and yes, theoretically there should be some benefit to be derived.
It’s a good way to make lemonade with the lemons you’ve been dealt with the market’s down, it’s a reasonable thing to do that. I would rather have somebody talk about, “hey, let’s Roth convert” or “let’s over rebalance into stocks, when they’re down” as opposed to “get me out, I’m freaking out.”
There are more productive conversations – even if they’re not going to make or break somebody’s retirement plan.
Typically we’ll be talking to someone about possibly doing a Roth conversion in a year where they retire, or where they sell a business. And they do it in January or February, early enough in the year where they haven’t booked a lot of income.
That’s an opportunity to take advantage of it, not necessarily what the market’s doing.
I think when it comes to Roth conversions that taking a year where you wouldn’t typically have a lot of income and recognizing potentially a lot of income, it could impact some other things too that people consider like healthcare premiums and stuff like that. So it’s not always a cut and dry answer.
People think “oh, I need to do a Roth conversion” and it’s like, well, let’s look at all the different possibilities or different consequences or benefits of doing it. It’s not always a slam dunk like some people might think.
I think in general, when you’re considering where to put money like this, it’s important to probably just think about tax in a way. I think this is a quote about something else, but I’m just gonna use it for this: taxes cannot be destroyed or eliminated, they can be transformed.
If you’re sending money into a pre-tax retirement account, it’s actually just a deferral. You haven’t saved the money, you’ve just deferred taxes. Likewise, if you’re gonna do a Roth conversion, you’re just transforming tax that you might have paid in the future on pre-tax dollars, you’re just pulling them forward to the present and recognizing them now.
It’s not like there’s a right or wrong answer. Which is often how these discussions are presented. It’s more about what’s going to be right for you and your future plans and how you kind of want to have things set up – for when you ultimately need the money.
A lot to consider there with Roth versus pre-tax versus brokerage assets, a combination of all three. It’s kind of different for everybody to see how you can kind of put your puzzle together, but important to consider all the different options before you make some decisions.
