This video addresses the tax implications for individuals who are 60 years old and have all their retirement savings in pre-tax 401(k) accounts. Financial planner Jacob Duke discusses the potential tax problems that can arise in retirement, explores the benefits of Roth conversions, and outlines key considerations for deciding whether to pursue them. The video uses a case study of a couple named Mark and Julie to illustrate these points.
Here is the transcript for the video:
If you're 60 years old and all of your savings is in a pre-tax 401k and you're wondering what you can do to minimize taxes in retirement, then this video is for you. A couple recently asked me this exact question because they had saved to their 401ks throughout their careers. But as they're nearing retirement, they're starting to worry about the potential tax problems that this could present in the future. So, in this video, I'm going to walk through their situation, see if Roth conversions can help them, and also we're going to be discussing three big questions that you have to consider when deciding whether or not to do Roth conversions. But before we jump in, my name is Jacob Duke. I'm a certified financial planner and the owner of a retirement planning firm where we help people just like you plan smarter and retire better. So meet Mark and Julie. You can see that Mark is age 60 as of right now. Julie is retired, she's 57. Mark is previously retired as well, but he's back to work because he was like, "Man, I have a lot of time on my hands. I don't know what to do with myself. I need something to accomplish or a mission to to go out and do." And so he wanted to go back to work and he found a little bit of work to do that. And so right now he's making about $80,000. And for now he's saying I'm just going to keep working until about 62. So a couple of more years here of work. Uh once he is 67, his social security benefits would be about $3,800 uh at that point. And then for Julie, she would get about $3,200 at 67 as well. Now their net worth as it stands today, they have about $2 million in tax deferred accounts. And that's broken down between 1.2 there in Mark's 401k and then also Julie has an old 401k with 900. Now, here's the key. All of this is tax deferred. There's no Roth dollars. They don't have any brokerage accounts. The only after tax money they have is going to be their house, which is worth about 650 completely paid for. And they also have $75,000 in cash. Now, that house, the reason that that is paid for is because they were taking everything above their max of the 401ks in the later years of retirement to pay that house off. They didn't want to go into retirement with any debt, which is awesome. Now, what does retirement really look like for them? Let's look at what they're trying to accomplish. They said, "Jacob, we're pretty simple people. We don't require much. We just want to be able to spend about $7,000 per month throughout retirement. Adjusting that maybe for inflation over time. And that's all they're really asking for. We don't have any big extravagant trips or big purchases coming up. We just want to be able to spend 7,000 a month. And that can kind of accomplish all that we want daytoday, but then also add a few extras in along the way. So that's what we've got plugged in. And we also have uh Mark retiring at 62, which would be in a couple years in 2027. So that's their goals. Uh for retirement healthcare costs, they're currently on a work plan through Mark's job. So until he retires at 62, their healthc care is pretty much covered or already factored into their spending every single month. Once they get to 62, they might have obviously health care cost for premiums before 65. I plugged in $10,000 per year per person for that. So that could be an additional cost pre65. So let's look really quickly at their situation to see, hey, is their spending amount possible? And it definitely is. In fact, they're probably going to die with more money than they start with in retirement, uh, because of the fact that they're not spending enough. So, 100% chance of success, which is always good in terms of how it feels to us as we're going in retirement. We want to be certain of everything, but this really tells us they could be spending more. Now, I won't get into that today because their main objective or their big question was, Jacob, what can we do to minimize taxes? Now, what tax problems could they really have? If we look at the cash flow section of this, it's always really interesting to see that, you know, they're going to have income coming in here for a couple of years. They're going to have no income after Mark actually retires at 62 until, right now, we're saying they turn on their social security at 67. So, his would start here a partial year and then move forward until hers turned on here in 2035 or 36. Uh, kind of as that splits over. So, you can see that they're going to have income coming in. But really the big problem is if we keep going down the list here and we see in 2040 they're going to have a plan distribution. This is Mark's RMD, his first one at age 75 of $110,000. Now this is projecting forward based on how much money they would need to spend out of their IAS or their tax deferred 401ks and then how much their those accounts would be growing over time. So this is saying based on the expected potential growth rate and how much we think they're going to spend. There's a few assumptions obviously being made here, but we think that the RMDs are going to be this much starting at 75. So his first year RMD would be 110, but it doesn't just stop there. The problem actually grows because whenever Julie gets to 75 here in 2043, you can see $239,000 could potentially be their RMD amount at that point in time. Now, here's the kicker. They don't need that much money. They might not even need 173. This is inflate adjusting for inflation over time. So, who knows if they really need 173 to meet their normal needs at 78 and 75. I'd argue they probably won't. So, if you look at that and you say, man, 140 of extra tax dollars coming in, their taxes jump huge here. Minimal taxes throughout and then it starts jumping with those RMDs in the future. So, that's really the problem that we want to address. So, let's look at what we can do to solve that potentially. Again, you can see taxes going along here, Mark retires, it goes down. So his FICA goes away, his state income taxes drop off quite a bit. And now they just have a little bit of income from their portfolio. That's where they have to pull money from until they get to 67. That's when they flip on social security. Their tax rate goes down because uh social security taxation is more favorable. In fact, at most 85% of your benefits would ever be subject to taxation. And then we can see this jump right here. This is at 75. That's when Mark's first RMDs would start to kick in. We can see another jump here at 78. That's when he would be 78, but Julie would be 75 at this point. That's when her RMDs would kick in. And you can see this constant up and to the right, this rise over time because hypothetically those RMDs are increasing due to the percentage of how much you have to take out of your account increasing. And then finally, we see this final jump here. This is what's called the widow's tax draft. So, this is one of the important points that I want to make here as we think about should we do Roth conversions? Are they important or not? Whenever we're uh looking at a married couple, the widow's tax strap is whenever one person passes away, predeceasses the other, and then the surviving spouse is left with all of the tax deferred assets, but now they're having to take out those RMDs, but as a single tax filer. So, they have to take the same amount of money out of the accounts as if both of them were here because now they inherited uh the IRA and presume it as their own most likely. And then they have to start taking out those RMDs because they're above their RMD age, but as a single tax filer with compressed brackets. That's what this jump is here. This is saying that Mark is no longer here. Julie is now taking all the RMDs herself as a single filer. And because of that, her tax rate jumps. So, you can see that this potential tax problem just keeps escalating over time. Now, what can we do to solve it? Let's go and say that we do some Roth conversions. The first thing I want to look at is what if we just fill up the 12% tax bracket here? What if we just fill that one up? That's an easy one to fill up. I'd argue that almost anybody should be filling up that one. 12% is a really low federal tax rate overall historically. It's a really good one to fill up and target every single year. Regardless if you need money uh to fill up that bracket or not, you should be converting up to it. Let's refresh this and see how much that helps them. So, right away, a couple things. Number one, we could have this much or they could have this much more uh tax adjusted ending balance in the future. So after tax balances, so they'd have more Roth money is what this is kind of saying, but also you have more Roth growing over time as well. So that's one kicker. Now, the other thing here is that I like to point out is this is how much they'd be saving in taxes paid over their lifetimes by doing some conversions up to that 12% bracket every single year. So $36,000, that's a lot of money by doing a few conversions. Now, how much would they actually be doing in conversions? Let's look and say, okay, if we started next year in 2026, we can do 52,000 and 52,000. Now, I want to be clear here. What this is saying and what the system is assuming is that any additional money beyond the earned income that they need to meet their lifestyle needs of $7,000 a month, that would be taken from their $75,000 of cash. So, the system is assuming that we're spending the after tax bucket first and then we're going and buying or using money out of the uh tax deferred IAS and 401ks. So that's why year 1 they can technically convert 52,000 year 2 52 as well and then it drops off substantially here in 2028 because by this point he's no longer working. Mark's not working anymore and they have no after tax money to live on because we've spent that down in in the first two years 26 and 27. So just know that that's why it's higher in these years and lower beyond. Is that the right thing? I don't know. It changes year to year. This is why you need to evaluate this every single year to see what the right way to do a Roth conversion for you that particular year is. But I kind of I'm trying to tell you why the numbers look the way they look. From this point, the the conversion amount drops off because um up to fill up that 12% bracket, they're needing most of their income needs from their portfolio. So the only place they have to take money from is going to be that tax deferred IRA and then they have only just this much room to go to that top of the 12% bracket. And so you can see despite the fact that they're doing small Roth conversions every single year, going up slightly here once we get to social security age because now we have more room in the tax brackets because less of social security is taxable 85% at most. So we can actually convert more later on down the road. Now here's what that means. We're converting small amounts yearbyear over quite a few number of years here. But that's what actually gives us this much less in taxes paid over lifetime. So small, just chipping away, no major major conversions, right? Just filling up the 12% bracket. And let me actually go and fill up the 22% bracket and see how much that helps instead of just doing stopping at the 12. Okay, so what's interesting here is the tax adjusted ending balance actually went backwards. It didn't it didn't help as much in order for them to have more money, per se. But by converting more at that 22% bracket, they're actually paying this much less in taxes because they have this much less they have to actually pull from their IAS or their tax deferred accounts. So, it's an important point to consider and think about. A lot of people are doing Roth conversions to have taxfree income in retirement later on down the road or to have more money perhaps. But I would argue that sometimes Roth conversions don't help you have taxfree income for yourself or to have more money. Roth conversions sometimes are only to be able to pay less taxes. And maybe that's perfectly fine and maybe that's the right thing to do. But I want you to understand what you're trying to accomplish with Roth conversions. Is it to simply reduce your RMDs which in turn reduces how much your taxes would be or actually reduces what your IMAR charges would be or reduces the widow's tax trap risk that could be there for your spouse or reduces how much tax your heirs would pay on their inheritance one day if it's in a Roth compared to you know if it's in a tax deferred IRA. So, there's so many things that are adding up to the value here. And I want to pay attention to that because I don't want you to think that you're doing Roth conversions only for you to benefit. It's actually going to be better if you do it for others to benefit, your spouse, your heirs, whoever down the road. That's really the big benefit of doing these conversions is not so much to have taxfree income right now today. So, I just wanted to make that point really quickly. But filling up that 22% bracket, it saves them a lot of money in taxes over time. You can actually look at this and I want to go right here and say what if we did that. So this green section that blue that yellow line there that's the 22% bracket. So if we fill that up over time we can do a lot more in conversions. I'll go back to details. Remember how the first uh the first time we did it with that 12% is what we were targeting for the bracket. Man, we we had way less in conversions. We can convert hundreds of thousands of dollars every single year by filling up that 22% bracket. But here's a consideration to fill up that 22% bracket. We might be pushing ourselves into that first Irma searchcharge bracket. And I want to point that out really quickly. So we can see we're converting here. We come back. I'm going to change this graph to the Irma searchcharge bracket. If I zoom in, you can probably see it. But that blue line, that is going to be that first level of Irma searchcharges where your Medicare premiums actually increase because you earned too much money on paper. So, we can see that we're converting a little bit above that based on filling up the 22% bracket. Now, here's the here's the key thing to know. That blue line is a cliff. Meaning, if you have $1 over that in two years, two calendar years from now, you will definitely pay sir charges because you were you made too much money on paper. So, if we could do this optimally, maybe we should think about is not filling up the 22% bracket all the way. we can actually fill up a part of that 22% bracket up to that Irma searchcharge level right there so that we don't eclipse that level and then actually force ourselves to pay higher premiums on our Medicare in the future. So that's something to think about. Now as it relates also to Medicare search charges and Irma search charges moving forward. I want to point out something very important. Part of the benefit or the savings here is you know if we didn't do anything okay and we looked only at this graph right here. This is the blue line. No Roth conversions. This is our this is what we're looking at. If we didn't do anything, we immediately upon uh later on down the road once uh Julie takes her uh RMDs, she both of them are going to be paying sir charges moving forward. You see that line going up and up and up and we're actually crossing over to the higher and higher brackets based on the projection. Now, what's even worse is the widow's tax strap whenever um her brackets get cut in half and she also has the same amount or more of of RMDs later on down the road. So, she could be in ultra ultra high Irma searchcharge brackets. So that's without conversions. Once her RMDs start, they will be paying Irma charges the rest of their lives in perpetuity. That's something to be paying attention to. Now, the Roth conversions can help because if we fill up up to that Irma searchcharge bracket or the 22% bracket, somewhere in that range there, you can see that right here, this green section, we're not paying Irma search charges ever after they start. we're actually eliminating them entirely because now our primary source of income that's taxable is social security, meaning minimal taxes in the first place. We might have some Roth left over. I'm sorry, some tax deferred money left over, but we're not having to worry about Irma search charges in the future. So, a few things to know here about Irma and as it relates to Roth conversions. You got to be aware of how much you convert on the front end so that you don't eclipse that first Irma searchcharge bracket if you don't want to go above that. And on the back end, doing conversions actually helps you not pay Irma search charges in perpetuity because those RMDs very well could push you into those searchcharge brackets. So that's the second thing I wanted to mention here beyond the widow's tax trap as you're deciding whether or not to do Roth conversions in the first place. So if we look at this, we can see doing the conversions, you can do this much over time, right? Your taxable account balance goes down, but now you have this tax-free Roth money growing. you have this tax deferred balance going down because you're spending from it and you're also doing the conversions. This is what you could leave to heirs one day or leave to your spouse so that you have minimal issues around taxes later on down the road. And that's all at 22% or less. That's another key here. So, uh, as you're looking at this, there's a lot to consider. There's so many different variables and things to pay attention to, but in reality, if they can do Roth conversions yeartoear, assess what they should be doing at each time. you know, we could plan this out as far as we want, but every year it might be a different decision point. There's so many variables that go into that. So, we'd reassess it every single year. And the final thing that a lot of people are worried about with this Roth conversion decision-making process is going to be whether or not they should give up their ACA subsidies or their healthcare subsidies before 65 in order to do Roth conversions. And that's a big question. Should I try to get the subsidies, meaning lower my income, or should I do the Roth conversions and and not worry about the subsidies at all? And really what you've got to do there is just do an analysis and evaluate, is it worth it for me to pay a few thousand more dollars here at 62, 63, 64 in order to save hundreds of thousand dollars potentially on tax savings by doing the conversions? Which one is better or worse for me? It's a personal preference perhaps, but you can use the data. You can use the numbers to help evaluate your situation. So, I hope this is helpful as you evaluate your situation. If you're 60 or around 60 with all tax deferred money, Roth conversions can definitely be powerful in tax savings over time throughout your life. But you have to consider these different things in evaluating what is best for you and your situation. If you're looking for help with that, you can book a call with me directly uh using the link in the description below. Thanks for tuning in. We will see you in the next video. [Music]
The 12% and 22% tax brackets are significant because converting pre-tax 401(k) funds to Roth accounts during these periods can be advantageous.
IRMAA stands for the Income-Related Monthly Adjustment Amount. It refers to additional charges that may be applied to Medicare premiums if an individual's income exceeds certain thresholds. The video highlights that converting funds in a way that pushes taxable income above the IRMAA threshold can lead to higher Medicare premiums, creating a "cliff" effect where even a small increase in income can significantly impact costs. Therefore, when considering Roth conversions, it's crucial to be aware of these thresholds to avoid inadvertently increasing healthcare expenses.
