Use Your RMD to Fund a Roth Conversion
You can’t convert a required minimum distribution into a Roth IRA. But you can use it to pay for a conversion. In this episode, we tell you how.
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Full Transcript below:
00;00;00;00 - 00;00;28;00
Unknown
Welcome back again to 30 Minute Money. It's the podcast that delivers action oriented, smart money ideas and bite sized pieces. Scott Fitzgerald here, along with Steve Wershing of Focused Wealth Advisors, and we are going to chat about things that you know better than I do. We're yeah. When I when I did the first outline of this, it was just like all jargon on the page.
00;00;28;00 - 00;00;48;14
Unknown
And we're going to try not to do that. We're going to try to talk in English. I'm reading it and I'm like. Like what? What are you talking about? Yes, exactly. Well, of course it's great information. Well it is. And what we're going to talk about is using required minimum distributions to minimize your required minimum distributions. So easy sets if that's not too circular.
00;00;48;16 - 00;01;09;24
Unknown
Yeah. Actually what we're going to talk about is using required minimum distributions to fund Roth conversions okay. So just to go back to sort of the beginning, one of the keys to managing the amount of tax you have to pay in retirement, managing what bracket you're in is to have a nice balance. between the three tax buckets.
00;01;09;24 - 00;01;29;11
Unknown
So having a nice distribution of money in taxable accounts, which is just accounts with your name on it, just a regular old account, no special label on it. And tax deferred accounts, which are things like traditional IRAs and 401 K's and 403 BS and that kind of stuff, and tax free accounts. And of course, the workhorse of the tax free accounts is the Roth IRA having money in.
00;01;29;11 - 00;01;49;00
Unknown
And they have a nice spread across those three buckets, enables you to take money out of the deferred accounts in retirement up until the point where you get to the top of a low bracket and then to shift to one of the other two sources of income so that it doesn't show up on your 1014, you can manage what bracket you're in by doing that.
00;01;49;06 - 00;02;24;17
Unknown
So now this may be a silly question, but it's me we're talking to. do people have people have like, is it common for people to have all of these different types of accounts? for A1K and a Roth IRA? And yeah, like each bucket they have accounts for each bucket. Well, so, the typical person who comes in to see me the first time, there are a few years before a retirement and the, the most typical case is they've got they've got some money in regular old investment accounts, their taxable accounts, they've got 85% of their net worth in tax deferred accounts.
00;02;24;20 - 00;02;47;20
Unknown
And with A401K, which is like A41K or an IRA. Okay. And practically nothing in tax free accounts. Okay. And the problem with that is that, you know, and a lot of these folks have have saved really well. And so they've got plenty of money for retirement, which is terrific. but when they get to be either 73 or 75, they kind of lose control over how much that turns into taxation.
00;02;47;20 - 00;03;09;15
Unknown
Because when you turn 73 or 75, depending on what year you're born, the government tells you have to take out at least this much. Right? And that's the RMD, that's the required, the required minimum distribution. And so at that point, like I said, you kind of lose control over some of how you manage taxes because the government is forcing you to take a certain amount out.
00;03;09;18 - 00;03;36;09
Unknown
Now there, they're actually a fair amount of, of people out. There are a lot of our clients who don't necessarily need to take all that money out. they might have they may have a pension, they have Social Security, they've saved, they've got a frugal lifestyle. And so they they go into retirement and, you know, they, they take they have to take out a little bit of their retirement accounts to live on, but they don't necessarily have to take out as much as the required minimum distribution would require them to.
00;03;36;12 - 00;04;04;20
Unknown
And so when they get to be to that age, all of a sudden they're realizing way more income than they really need to realize, because they don't need to take that much now. But there it is. Now. You're they're they're getting whacked with the RMD. Right. And they're going to have to pay a whole lot more tax. And there are there are a lot of cases where the required minimum is big enough that it actually pushes you up a tax bracket, sometimes two, and so it's really important that you have a nice distribution of stuff.
00;04;04;27 - 00;04;22;25
Unknown
But, you know, you may not have had the opportunity to do that. You may get up to the required minimum distribution age, and you've got a little bit in taxable, and you've got this big proportion of your savings in tax deferred accounts. And here comes the required minimum. And they require and they're forcing you to take out ten 2030, $40,000.
00;04;22;27 - 00;04;46;09
Unknown
And you really didn't need that much. And but you're going to have to pay tax on it. Well here's how you can leverage that. Do tell to to reduce that. the first thing that we that, that we should make explicit is that, you know, you're forced to take it out of our, tax deferred account, you're forced to take it out of, for example, your IRA, but you're not forced to spend it.
00;04;46;11 - 00;05;05;04
Unknown
Right. You can just put it into a regular taxable account, or you can do what you want with it. You don't necessarily have to increase spending. And if you're if you're getting enough income from the different sources that you don't need to spend it, what you can do is you can utilize that to pay tax on a Roth conversion.
00;05;05;06 - 00;05;26;20
Unknown
And so people may not have enough in the bank, or they may not want to take out enough to to do a big Roth conversion. But if you're being forced to take a required minimum distribution, hey, use that to pay for the tax on a Roth conversion. now let's let's talk a little bit about some of those, Roth IRA rules.
00;05;26;23 - 00;05;45;22
Unknown
The, some people think that you can't put money into a Roth after age 72. That's not true. you can't put money into a Roth IRA if you don't have earned income. That's a contribution. You can't contribute money to it. But you can convert. You can convert at any age you want to, and you can convert as much as you want.
00;05;45;24 - 00;06;07;15
Unknown
It's just taxable when you do. So. so you can so the, the name of the game. And you know, generally we can't get people to where they need to be using just contributions. Generally we have to convert traditional IRAs into Roth IRAs. And so the question is where do you come up with the money to pay the tax on that conversion?
00;06;07;15 - 00;06;30;03
Unknown
Well, if you're getting a required minimum distribution, let's say that do you have a big enough account that you're being forced to take $10,000 as a required minimum and you don't really need it? So you would just put it into an investment account, you know, and leave it there to earn interest or whatever. Well, what you could do instead is we could analyze how much you could convert from your traditional IRA into your Roth IRA.
00;06;30;03 - 00;06;55;10
Unknown
That would result in an additional $10,000 in taxes. And what you do is you convert that much and then you take that required minimum of 10,000 that you got and use it to pay the tax. so it's like it's kind of like you're not doing what you're supposed to be doing, but you are. It's kind of like, I got a little I had a little light bulb go on.
00;06;55;10 - 00;07;12;04
Unknown
But then it started to flicker. And when you're right, they're going to force you to take it right. So use it so that you're required minimums get smaller over the course of time. Okay. Right now one of the things, one of the, one of the twisted things about the tax code is they're going to force you to take this money out and it's going to be taxable, but you can't convert that into a Roth.
00;07;12;06 - 00;07;35;08
Unknown
A required minimum can't be used for conversion. So so you could pay the tax use it to pay the tax on a conversion. So let's say that if you're in the 22% bracket, well you could convert basically $50,000. And the tax bill on that would be about $10,000. So if you're getting a required minimum of $10,000, convert 50 and use the ten to pay the tax on it.
00;07;35;08 - 00;08;02;26
Unknown
Now, when they calculate next year's required minimum, you're using a $50,000 smaller balance, so you're required. Minimum distribution will probably be smaller. And again if you don't need it, you could do the same thing whatever they force you to take. Use that to pay the tax on another Roth conversion. And what you're doing is you're systematically reducing the size of your tax deferred accounts so that the required minimums go down and down and down and down.
00;08;02;28 - 00;08;29;07
Unknown
All right. So if you let's let's say you're 75 years old, so you're taking required minimum distributions. And you get this 10,000 you have to take. So you use that to pay the tax on a $50,000 conversion. What that means is next year you required minimum is probably going to be $2,000 less than it was this year because of how the factors work and how much how much lower your balance will be.
00;08;29;09 - 00;08;41;02
Unknown
Okay. So that's kind of one one way of using the tax code to your advantage, as opposed to just being a victim of it.
00;08;41;05 - 00;09;15;28
Unknown
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00;09;16;01 - 00;09;37;12
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00;09;37;12 - 00;10;07;07
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00;10;07;09 - 00;10;30;23
Unknown
All right. So I think I think I got most of that sort of kind of so what's your 30 minute action item? 30 minute action item is what is your required minimum distribution going to be next year? And let's try to make it smaller. That's another episode of 30 Minute Money three zero Minutes money. All the podcast platforms like share, subscribe and rate and Review and all of those good interactive things.
00;10;30;23 - 00;10;56;28
Unknown
You can find Steve at FocusedWealthadvisors.com. I'm Scott Fitzgerald from RocVox.com. We'll see you next time on 30 Minute Money.