EP 18 – Roth IRA Conversions and Chunking Strategies
Roth IRAs and Roth 401(k)s grow and come out tax-free at retirement. Mark and Mat outline the steps to get to Roth (it’s for high-income earners too) from traditional IRA or 401(k)s and cover the sweet spots to keep the tax burden low when converting to Roth.
ark Kohler: Welcome, everybody, to this week’s episode of the directed IRA podcast. My name is Mark Kohler and I’m here with the man, the myth, the legend, the child prodigy. I’ve got to say that right, Mr. Mat Sorensen.
Mat Sorensen: I am 40. So, I mean,
Mark Kohler: Once you’re a child prodigy, you’re always a prodigy, aren’t you?
Mat Sorensen: Like, I mean, I don’t know my childhood, you know. You know, I don’t know if anyone was saying that back then. But, I’ll take it.
Mark Kohler: Bobby Fischer was a child prodigy with chess. Yeah. And he still retains that title.
Mat Sorensen: Yeah. I remember when Mark and I started working together, I was working for Mark and I was like the first associate and he was trying to get some clients to work with me. And he’d introduce me and be like because I, I mean, I was like twenty-five. I don’t know. I think people looked at me like this guy, like an intern who is he is a child prodigy. He’s a child prodigy. You’re good
Mark Kohler: Genius. Genius. Well yeah. We’re excited to be here today. I’ve got Mat Sorensen, of course, the CEO of Directed IRA and the author of the Self-directed IRA handbook. I’m holding a copy right here in front of me. We should give this away some time. We should give it away today. Yeah. Yeah. I don’t know how we do that. We’re going to give it away.
Mat Sorensen: Ok, we’ll figure out a way at the end of the day, we marinate. Yeah, we’ll marinate it and Mark will sign it for you.
Mark Kohler: Yeah. And I’ll sign it for you. It’ll be worth more in common than you shared and OK, Corey said, here’s the rule. If any of you share this podcast or it’s on YouTube or some method, we will go and look at all the shares in the next day or two is that OK? And then Corey’s going to randomly select two winners comments, comment to share, comment, share. OK, and then I want you to choose a male and a female. And that means any of you that have kind of a geronimus name your shot
Mat Sorensen: Or you can win twice.
Mark Kohler: That’s true you can win twice.
Mark Kohler: You know anybody out there. I’m in the country. So, Stacey, you can always have a Stacey guy or a Stacey girl. It’s kind of it’s kind of a farmer. Yeah, OK. OK. All right. Well, tell us about the topic, Mat.
Mat Sorensen: Yeah, we’re talking about Roth accounts, Roth IRAs and Roth 401ks. We don’t care what you have as long as it’s Roth because I mean, this make sure Roth equals tax-free, OK? That’s why Roths are so cool. It is the only way to make money from your investments, not pay taxes and stay out of jail. OK, that that you know, in this first piece, the Roth IRA is what’s key. So we’re going to talk about that. How you get to Roth for those, you’re like, oh, man, I’ve got traditional dollars. I’ve been taking tax deductions. I got hooked on the fun of all the tax deductions every year I went traditional. Now I want to swing back Roth. OK, we’ve got some strategies on how to get over to Roth.
Mark Kohler: And I think this is an important first statement to begin with. We’re going to talk about all the little tricks. We sometimes shot some videos called the sweet spot of the Roth conversion. There you’ll see other videos out there called the conversion ladder. There’s a trick. We call it chunking at times. But here’s the point. We really feel like the Roths a place to be, just like Mat said it, in the long run, the more you can get to Roth. The better in all the models, the financial models and I’m wins and I’m sick and tired of people going, well, you’re going to be a lower tax bracket when you retire. I don’t want that. That’s the last thing I want. And I want to be in the highest tax bracket of my life when I retire, essentially. But so people are like, well, you know. And so I think the Roth is where you want to be. And so if you will just live with us on that for this episode, just accept that proposition for a moment. It’s not a prepositional phrase. Sorry, it’s a proposition. Meaning I am presenting that to you is a valid fact. Live with it for a moment and then see what this episode does for you, because we’ve got there’s a lot of fun little rules and tricks and nuances that I think you’re really going to like. So, yeah, is that a good intro? Are we ready to go?
Mat Sorensen: Yeah. Yeah. So let’s start back in 2012. OK, this is where the story of the Roth conversions begin. OK, all right. We’ll have to go back to 2012.
Mark Kohler: Well, I feel like a story coming on. Let’s snuggle up on the couch. A little fireplace action and tell us a story.
Mat Sorensen: Ok, let me set the scene with George W. Bush is president.
Mark Kohler: Ok, Dad or son?
Mat Sorensen: I think this is second, this is this is w w w w w if you will. It’s all never a bush. Yeah. And here’s the here was what was going on at the time. If you were high income, you couldn’t convert to Roth in 2012, you know, before covid and Trump, you know, if you would have thought Trump’s going to be present back then, I mean, the world we live in different. But anyways, 2012. Is when the Roth conversion income restriction was lifted, so a lot of people, even your financial advisors and some accountants are still slow to this thinking now you can’t convert your high income. No, anyone can convert from traditional to Roth regardless of income. There are still an income restriction on regular Roth IRA contributions, and there’s a backdoor Roth IRA method around that. We have our content on that. But for converting, there is not been an income restriction since 2012. So don’t worry about that. Regardless of income, you’ll be able to convert to Roth. It’s for everyone now. Yeah, for everyone.
Mark Kohler: And it’s in it’s this is where OK, maybe point number two in this story. This is where the backdoor Roth evolved. I would like to say that Mr. Sorensen with me is a close second. We were at the forefront of that strategy. We were talking about it years ago, eight, nine years ago. We continue to talk about it. Some people play like it’s this newfound plutonium. You know, no it’s been around 10 years and we’ve been talking about it. And there’s still even financial advisors that have no clue about this. Clients bump into us all the time with legitimate accounting firms that have never talked about the backdoor Roth So we have another podcast on this topic. We’ve got Mat’s got a chapter in his book on it. We got videos on this. But I would just say this. Keep in mind, anybody at any income can have a Roth. If you’ve heard anything to the contrary, you’re getting bad advice. So just so put that aside as well.
Mat Sorensen: Yeah, OK. Yeah. So what we’re going to talk about today is converting to Roth. You have some traditional dollars that you got a tax deduction on to put it in. This could be your traditional IRA, your SEP IRA, your 401k at work where you got your day job, your solo 401k. All right. These are the traditional dollars, let’s call them that, that you got a tax deduction to put in. And when it comes out right now, it’s going to be taxed on the way out. And you’re like, no, no, no, no, I want to stop that madness. I want to pay all the tax now on what I want to convert and then I want it to come out later at retirement. Totally tax-free. OK, that’s the that’s what we’re shooting for here as we’re talking about converting to Roth.
Mark Kohler: Ok, now this is good. We’re hitting all these little these folks. This is like batting practice. We’re hitting all these little base hits. You got a
Mat Sorensen: Baby step and I’m stepping. Stepping. Yeah. What about Bob? What about Bob? I got that movie reference already. There you go. And what’s the doctor’s name was? Richard Dreyfus. What a shame, Doctor. He’s like he calls him by his first name. Doctor, I’m Baby Step and that’s the best. That’s a great show.
Mark Kohler: Remember, that is so good. I’ve got a couple movie references to throw in here, too, but here’s another little concept that we all have to come to grips with. And this is a political statement. Mat always says, Mark, be careful what you say. I’m the one that can stick his foot in his mouth with my drama and excitement for things. It is proposed by the Biden administration to increase the tax rates on anybody making more than four hundred and fifty thousand a year. We don’t know where that cut-off will be for singles, head of household or married. Right now, that 37% rate kicks in at five hundred and eighteen thousand if you’re single. Six hundred and twenty two thousand if you’re married. Biden wants to bring that threshold down and add another bracket, the 39% bracket. He also wants to increase capital gains rates for people over a certain bracket. So what this tells us is if you’re going to convert to a Roth and you’re already in the highest bracket, this could be the year to rip the Band-Aid off. Let’s just get it done. And we’ve had clients that are like, I’m going to drain my savings account over here to pay the taxes and never pay the taxes again. Pretty cool.
Mat Sorensen: So, yeah. And I think, you know, when to converge, we’re going to get through here on this chunking strategy. You know, you have to pay tax on what amount you convert from traditional to Roth. I want to convert one hundred thousand dollars of traditional Roth. I’m going to pay tax on that one hundred thousand dollars. There’s strategies on how to minimize that. We’re going to go over that. But the rates on what you your regular income bracket is determines the rate you pay. So they’re going to go up here soon with the Biden administration if this is going to pass through Congress. You know, and who knows if it’s going to continue to keep going up. We just don’t know. So if you think taxes are going to go up in the future, if you think that’s a likelihood, your political instincts are just as good as Mark’s and I’s on that, you know, I think it’s probably. More likely than not, it’s going to go up and go down, then it’s more advantageous to start converting now. OK, now
Mark Kohler: Let’s talk about another important strategy here, Mat before we get to the brackets because we want to say when should we convert based on the bracket we’re in? So that’s going to be the climax of the show, if you will. And I’ve got a whiteboard here that I’ve drawn. In fact, Mat and I took almost a half an hour before the show started to really nail down the brackets and these sweet spots, if you will. Here’s another important point. Now, this is tricky, and I’m not suggesting anything fraudulent or deceptive with the IRS, but we could be strategic in the way that we choose. What asset and what value it might be now, anticipating what the value might be in the future. For example, if I’ve got a raw piece of land right here and I know there might be an overpass on a freeway coming into that area of where I have this raw land that’s worth nothing right now, it’s not insider trading because you’re not trying, you know, this is a SEC regulated public company. This is your land. Now, if the upraising world out there, you hire a bona fide appraiser to give an appraisal of this land and it’s worth 100 grand right now. But, you know, there’s a good chance some sort of overpass might come in. You can convert it at the hundred thousand dollar value now. And when the overpass is announced or built or whatever, it’s now worth five hundred grand. You pay tax on the hundred. I mean, you just get that swing. Maybe another example, Mat. Maybe a.
Mat Sorensen: I mean, yeah, we see I see clients come in quite a bit that if you have a deal that is going to be a homerun. OK, and this is the concept. Just big picture. You have a deal that you know is going to be a home run or you’re going to make, you know, double the money, five, whatever, 5x 10x, whatever. You’re insane to do that with a traditional account. Convert that smaller amount now before the huge gain to Roth. And then you’re going to have this war chest of such after that deal of Roth dollars to keep doing the same thing over and over. And what I’ve seen with clients to have our largest Roth accounts and we have hundreds of clients with million dollar Roth IRAs, many with 10 million and a couple with one hundred million plus. That’s how they did it. They did a few initial deals in there with a little pot of money that were home runs that got them to a million. And then once you’re at a million, it’s easier to get up to ten and then, you know, just keeps you just keep snowballing and it keeps growing. So but I’ve I mean, I’ve seen it on clients. I mean, I’ve seen on everything Real Estate is the common one because real estate’s one where you can find an opportunity and where you have a competitive advantage. It’s not like it’s on the marketplace. And one hundred people are looking, hundreds of millions of people are looking at the stock every day, decide whether to buy or sell it. It’s like, no, I found a unique deal, an opportunity where I saw there was value where no one else was. And so those are the things you can kind of hit home runs on. Grow the Roth. Yeah, I love it.
Mark Kohler: Well, OK. And when I was going to say the crypto example, if you have crypto in a traditional IRA, this could be a chance. Or even if you want to do a contribution of some amount through a backdoor Roth, you might be able to contribute something. But the point is, if you if the market’s down in a particular month or day and you have, again, some insight into a quite a risky market, we all admit that we’re not, you know, encouraging anyone to put their life savings in cryptocurrency. But there’s some I.T. people out there that a lot of times know what coin might be a home run before me Joe Schmo Mark Kohler figure it out. So that would be the one to convert to Roth at this low, low, low, low value and to do it to a Roth. Now, Mat, let’s talk about a self-directed format. If I want to do a Roth conversion, there’s a specific form directed IRA and I do need an appraisal. Could you walk us through the steps for a moment?
Mat Sorensen: Yeah. So you’ll have a Roth conversion form and an election. So you have to do it in writing, request it with your custodian of Directed IRA. You know we’ll process that for you. Now, cash is the easiest. I always tell clients you’re trying to convert simple with cash. Fill out the form. It’s one page, sign it. Tell us how much cash to convert. We’ll do it that day there tomorrow. You know, it’s pretty easy and I’m going to just take the value of your cash that we convert. And that’s what’s going to we’re going to report to the IRS as a Roth conversion and send you a 1099r for all right now. If you have an income, you have an asset. Let’s say let’s say it’s real estate. You already own in your IRA, in your traditional IRA? And you want to convert that to Roth? You can do what’s called an in kind Roth conversion. But we need an appraisal of the property or let’s say it’s an LLC within appraisal, the LLC. We know what the value is so we can convert that. So that does take some work if you are converting in kind, it’s a little more difficult because it requires an appraisal.
Mark Kohler: I would also encourage you to keep in mind as we start to get to really we’re almost to the chunking topic, you want to keep in mind what other gains and losses you might be able to harvest at the time you do the conversion. For example, let’s say you’re sitting on a piece of real estate in your personal name that’s at a loss right now, or you’ve got another loss from some depreciation or a cost segregation. Maybe you’re a real estate professional. Maybe you need to harvest a loss on a bad debt expense or something. Now, not all losses are created equally. So you got to talk to your accountant with this loss offset my Roth conversion. But this is a topic you want to think about because before December 31st, you have to do the conversion you used to the good old days. You could do a reclassification of how much you converted later. That’s gone. So December 31st, that’s D-Day. Whatever. I’m going to convert for 2021. That’s it. But before you do it, talk to your accountant, say, hey, I got this loss over here. I got this gain over here. I’ve got my W-2 here. I’ve got all this. If you want to get a really, really good picture in November, December is to what you think you’re going to have as income. As you make this decision to convert.
Mat Sorensen: Yeah, and we saw a lot of clients last year who were self-employed or business owners that got kind of pummeled by the pandemic financially, had some losses or had lower income than typical. That’s a perfect opportunity and time to convert to Roth. And so some of you were in that situation now again in 2021. Unfortunately, the silver lining is this could be a beneficial time in the long run, in the grand scheme of things to be converting to Roth. Now, keep in mind, when you convert you so let’s say you convert now this is going to be on your 2021 tax return, OK? It’s not up until April 15th. So if you’re trying to do a 2020 Roth conversion, you have to do that by December thirty first. So don’t think you can until April 15th like we do for contributions to do conversions. Oh, that’s not nice.
Mark Kohler: Did you hear that?
Mat Sorensen: Was that was a good snap
Mark Kohler: That right on the microphone. Because Rock star. Because I’m a tax attorney. Rock star. If I may be so bold, because I am trying to schmooze the corporate, you know, heads at PepsiCo to say, you know what, you need to sponsor Mark Kohler, the guy, he takes care of us every. Yeah, he cracks a Rockstar well Mat we need to do a commercial break here. OK, for all of you fans out there, I am holding a cold. Rock star recovery, noncarbonated lemonade. Only 10 calories, no sugar, only 10, only 10. Wow, add this to my my sweet mouth here and just enjoy a long, cool drink. That’s what rock stars do, they drink rock stars. So if you’re going to be a rock star accountant, a rock star tax attorney helping America, you’re going to drink rockstar. So you folks at PepsiCo, I got your back. OK, call me. All right. OK. All right. Back on track. OK, now here’s another important point. Before chunking Mat. Now this is one more clue. Yeah, I was going to come to you. Why don’t you do yours? Because I think you’re going to talk about the five year, right? Yep. OK, talk about that.
Mat Sorensen: One of them. OK. OK, so here’s one of the rules. When you convert, right. I want to know when can I get the money out? If I convert to Roth Mat, I got to pay the tax now. And so let’s take that one hundred grand example. I have a hundred thousand a traditional IRA. I want to convert to Roth. I want to get that money out if I want it. OK, well, you got to wait five years before that money is going to come out. Tax and penalty free and you want to hit fifty nine and a half, of course, to make sure you get the earnings and the principal amount, you converted out. So five years and fifty nine and a half once you’ve hit both of those markers, the whole Roth IRA is going to come out tax free. Now that five year rule is per conversion. So we get in here to the chunking strategies. You’re going have a five year rule every year you convert for that set of funds that you convert. You won’t have to wait five years before you can pull it out with no tax or penalty in the
Mark Kohler: Appreciation on that amount
Mat Sorensen: And the depreciation on that amount. Now, keep in mind the appreciation on that amount. You’ve got to wait till you’re fifty nine and a half to get out. Let’s say you’re forty-five and you convert twenty-five grand. Let’s say you’re in a chunk at over four years. We’ll get to this. But let’s say you take twenty five grand now. Or if I wait five years until I’m 50 I can at least get that. Twenty-five grand out. No tax, just like a Roth contribution. When you put the money in you can always take that back out. But the earnings, there’s no way I’m going to get that out until fifty nine and a half. OK.
Mark Kohler: Ok, now here’s a let’s add another variable. Let’s say I’m 57 and I do a Roth conversion. I have to wait five years to get the contribution amount out that I can get the appreciation amount out in two and a half years.
Mat Sorensen: No, no, that’s fine. The whole thing.
Mark Kohler: Ok, all right. Now, OK, now let’s do another nuance to this. This could get tricky, everybody. So if you’re driving down the road, I’ve got some good I’ve got the People magazine here. We’re going to give an update on Brad and Jen here in a minute. But on a technical note, for those that want to dive deep here, when you want to have a Roth IRA and you’re in your 40s or 50s, sometimes people go, well, am I too old to do a Roth? Oh, you’re never too old to do a Roth. You can do Roth at any age. And also that time value of money is a big deal because you want to get that money in there growing and it’ll come out tax free. Well, let’s say you have a traditional IRA. And you’re now 58 and you’re like, well, I’m going to open a Roth now. Well, whenever you open a Roth or convert a traditional to Roth. It’s the same point you have to wait five years or you’re fifty nine and a half, whichever is longer. So a lot of times I tell clients, hey, if you’re 54, just open a Roth account, get that Roth started so that you’ve got that five years ticking. But Mat, what about contributions to the Roth what I’m 58, does a contribution have to wait five years or when I open the account now?
Mat Sorensen: Yeah, the contribution. You’re fine. You’re going to have you must have a well, if you’re fifty-eight and barely starting a Roth. Yeah. You’re going to have a five-year rule still getting well. Now let me let me back up.
Mark Kohler: Yeah. See the opening to the commercials are different aren’t they.
Mat Sorensen: Yeah. And that’s why it’s there are two five year rules, there’s a five year Roth conversion rule that is five years from the time you convert so you can take it out without penalty. OK, now you got to hit fifty nine and a half too to gat the earnings out without no penalty. There’s a five year contribution rule that says you must have an IRA in existence for five years before you can pull the contributions out. Where they’re so let’s say you’re 58, you’re going have to wait till your in you’ve never had a Roth IRA before. You start at 58. You’re going to have to wait till you’re sixty three to pull the money out without tax or penalty. You can always take the contribution amount out. Let’s say you put in six grand, but the earnings will you’ll have to wait till five years hits.
Mark Kohler: Now I’m learning something here. This is really, really good. So I want to ask because that’s the book on this. And he said, Didn’t you read my book? And I said, Well, yeah, but I know I’m halfway through. Yeah.
Mat Sorensen: I mean, what a lot.
Mark Kohler: Ok, what happens if I opened the Roth account when I’m 54 and I only put it 100 bucks and then I put seven thousand dollars in what? I’m 58. Do I have to wait for the day I opened it or the day I contributed?
Mat Sorensen: So for the first five year rule, not the conversion rule, that just the five year contribution when you made your first contribution to the Roth IRA five years. So that hundred bucks you put in started the clock. OK, you’re done. You don’t need to worry about you. That’s the only time period you look at.
Mark Kohler: Ok, so any more money
Mat Sorensen: Conversions, you’ve got to look at everyone and wait five years. OK, look
Mark Kohler: Man, your stud Mat. I will point out for those watching on YouTube, I am wearing a tie today. Mat Sorensen looks like crap. This is much like Geena Davis telling Tom Hanks in the movie A League of their own, just gosh you look like crap, she said. But Tom Hanks is like, you’re going to win the Davis Cup. I’d love that scene. He said, we’re going to win when you tell pissy. OK, now here’s one of my points I wanted to make. OK, OK. When you want to start converting now, we’re going to get to the again, the chunking to the income levels is going to. That’s the grand finale here. But if you want to convert, here’s another rule you got to think about. You have to convert traditional IRA money first before you can do a back door Roth See some people are like, well, I want to put money in a Roth at any income level. You said I could do it. Yeah, but you got to convert all of your traditional money first to Roth. Oh, OK. Which is not a bad thing. I mean, the goal is to get as much Roth as we can, but you can’t do the back door Roth contribution in conversion until you convert everything else. Now, did I say that right? Mat.
Mat Sorensen: Yeah, for IRAs, for treacheries. Now you have traditional 401ks and stuff or employer plans. And that’s cool. You can still do a back for a Roth contribution. But just you know, this is only for people that want to do a backdoor Roth. In addition to this is you make sure you do the conversion part first of your traditional IRAs.
Mark Kohler: Ok, but here’s the loophole. And I had a call with a client two days ago on this. I was pretty excited about it, is that the client was already on it. He was like, I read Mat book. I listen to your podcast. I got it. I go, What are you doing? He goes, I’m moving my traditional IRA into my 401k at work because I’m going to roll it to traditional into the 401k so I could do the backdoor Roth individually. And then I could go back and convert. Inside my 401k to Roth, whatever the heck I want, because once you turn those IRA money, that IRA money traditional into a 401k traditional, the rule of converting first is out the window you don’t have to worry about it. So that’s the real tricky part if some of you have access to a 401K move that over to the 401K, hopefully you could self-direct it there and then do your back door right
Mat Sorensen: Now or even if you had a Solok, you know, for those have a business on the side of you, the Solok get those traditional IRA dollars over to a traditional Solok account too so. And again, this this piece here, I’m just making clear, if you just want to convert some traditional owners to Roth, don’t worry about that. That’s this is that’s you honors little tidbit here for those that also are trying to do the backdoor Roth.
Mark Kohler: Ok, can I ask this is technical again. Some of you geeks out there, you’re going to love this. This is why we did this podcast, the directed IRA podcast, because we’ve got our Main Street podcast. If any of you haven’t been to Main Street, we’re hitting base hits all day long, writing off auto right now for kids. We talk a little, IRA, we’re doing small business partnerships, legal issues, yada, yada, yada. But this podcast, this is for you, the honors level. I mean, yeah, that’s our goal. Now, if some of you are like a little overwhelmed, like going, wow, these guys are diving deep, go back and listen to our first 10 podcasts, because we really build a foundation there where this podcast is making sense for those folks that have done that. OK, here’s another honors level question. Let’s say you own a business and this is on the conversion topic, Mat. Yeah, you’re not going to see this one coming. You’re going to be like you, Mark. That was a good question. OK, ready? OK, let’s say I have a small doctor’s office or a construction company or a plumbing business or online marketing. But I have employees, full time employees, and I’d really like to have a solo 401k, but I can’t. And if I go do a group 401k, I’ve got to deal with cross testing and attribution rules and I can’t throw all this money into that I would in a solo for okay, I got to deal with the group. So you go down the safe harbor route, which we’re cool with, but you’re like, I don’t want to go to a group 401K and I got all this traditional IRA money over here, but I have a side business. Now, this is where we’ve debated a lot in our firm and we’re very cautious for our clients that if you’re the majority owner of a business with employees, it’s very difficult to go up a little, open up a little solo 401K on the side for another business, because the Arista rules IRS rules, they say, are you got to take care of your full-time employees before you go playing the solo. So a lot of times we don’t do the solo because you can’t contribute in the solo. Without taking care of your full-time employees are doing a group, but Mat, let’s say I do have a little real estate business, I create some management income. And I create a solo 401k, but I don’t contribute to it, I just create a solo 401k in order to roll my money over and then and then keep that traditional IRA money in a solo 401k. But I’m not I’m not converting. I’m not contributing. Do you think you could get around that or I see you smiling going up?
Mat Sorensen: No. Yeah, it ain’t going to work.
Mark Kohler: I’m not even contributing. Come on.
Mat Sorensen: I know it’s going to be considered a rollover contribution. It’s not going to work because you have employees in the other business and you’d have to give them the same opportunity to be able to do the same thing. And so it’s so, unfortunately, no I hate being the guy that shuts, you know, good ideas like that. I do. I mean, that’s the worst but better that I tell you now, you know. Yeah.
Mark Kohler: Yeah, OK, well,
Mat Sorensen: It’s not,
Mark Kohler: You know. All right, now we are to the unveiling of the brackets, the chunking strategy. We ready?
Mat Sorensen: I never thought there is so much excitement for the unveiling of a tax bracket. Yeah.
Mark Kohler: Yeah, it is March. You know, this is not our March Madness bracket.
Mat Sorensen: Yeah. That it’s a little more exciting actually.
Mark Kohler: Yeah. This is the tax bracket.
Mat Sorensen: But this bracket can save money. Yeah. Can you, can your NCAA bracket save you money. No, it cost you money because you put money in the pool with your friends or at work and your secretary wins and every time the guy at your work that just guesses that doesn’t even know, you know, what team is what.
Mark Kohler: I swear for years. And it’s no jab at. The females are secretaries. It’s just funny. Our secretary would always win. And all these guys are using these matrixes to do their bracketology watching ESPN until their eyes are, you know, a little bit by toothpicks. And then the secretary wins and we’re like, what was your strategy? Goes, Oh, I just chose my favorite color in each game.
Mat Sorensen: Yeah, I chose my favorite states. I pick all the states I’ve been to to win. I haven’t been to that state.
Mark Kohler: I’m not kidding. I’ve heard every one of them. Oh, my gosh. OK, so look at this bracket. This is the seven tax brackets for a single individual. OK, we’re going to do married. We’re going to go to single first. There are seven tax brackets currently. And as you see here on the left side, we see ten, twelve. You see that little jump. This is the premise of this principle from twelve percent. We have a ten percent jump up to 22%, then 24%, then another big jump up to 32%, then 35%, 37%. So there’s seven brackets. So for those of you that are listening, driving down the road, we’ve got a graph here that be the best way to. So the x-axis going top to bottom is 37% at the top then. 35. 52 little window. The 24. 22 that a window that twelve, 10%. That’s the x axis. They’re going left to right. We have our income levels so from zero to forty thousand a single individual is going to be in the ten to twelve percent bracket then from forty to one hundred and sixty thousand of adjusted gross income. Again this is after your standard itemized deductions from 40 to 162,000. You’re the 22 to 24% bracket and then from one hundred and sixty to two hundred seven thousand you’re 32. The two hundred seventy five hundred and eighteen thousand you’re 35 and then a five hundred and eighteen thousand. You’re 37 percent on now you’ll see here and I’ll let Mat explained the strategy here. I’m just describing the diagram you’re going to see this little I put the word trigger, this little trigger where a decision needs to be made and that is at the forty thousand dollar level, the one hundred and sixty thousand dollar level. And I would argue the two hundred seven thousand dollar level, because what we’re dealing with is an increase in taxes at that trigger point of 10%, then 8% and then 3%. So Mat explained the strategy, please.
Mat Sorensen: All right. So you can see there, as long as you keep increasing your income, let’s go to ten and twelve percent. Let’s do the married one up to 80. That’s easier track there
Mark Kohler: You want me to get the married one out there.
Mat Sorensen: Oh, you don’t have married. OK, you got sing, let’s go.
Mark Kohler: Ok, I’ll sign up for the married one here in a minute, ok.
Mat Sorensen: All right. Let’s say they’re married. Just gives you a little more runway to play with here. That’s a single you’re only going to. 40 knots, I’m talking about taxes. All right, I’m talking about taxes.
Mark Kohler: I need to point out here, I first buy YouTube video is titled The Sweet Spot for Roth Conversions and chunking, now, maybe I have the most views on this channel for this topic because I have the words sweet spot in the video, you know, someone’s up at night. So we started this one oh oh oh. It’s Roth conversion sweet spot. Not the sweet spot I was thinking of. But I will point out.
Mat Sorensen: That’s a good tip likes a good financial tip. Maybe.
Mark Kohler: Yeah, maybe. So for those that have kids listening, I’m just going to say this final point. Make sure when you search for this video on YouTube, you try to sweet spot Roth conversion or sweet spot Roth. Do not just search for the words sweet spot. Not liable for what you may find. OK, so there you go.
Mat Sorensen: Ok, OK. Well let’s case if you look at the price of course case single up to 40, let’s say you’ve made 30 grand that year. OK, if I convert ten thousand of money from traditional to Roth, I’m in the same tax bracket, I’m still up to 40. I’ve kind of hit the limit there. I’m not bumping up on any additional income or amount’s. I convert 10% to 22%. OK, so you, you want to find you. Where is your, where is your annual income? Typically every year. Look into this bracket here, maybe you’re in the next band here of the 22% to 24% that is up to $160,000. OK, and you’re going to jump another 8% once you go over 160. So you may want to find them out. This is the sweet spot, so to speak, that you can convert that keeps you in the same tax bracket.
Mark Kohler: Yeah, I love it. Oh, man, I was going to do that. I have an inside voice that was going to be a really good joke with I was going to do some indications here, but I that’s what my wife says. Inside voice do not say it. I’m like, OK, yes. I would be very disappointed in me with my some analogies here, but we’re going to leave now. Here’s another point on this rating. E for everyone, E for everyone. Ok, now here’s an important point. Some of you may go, Mark, I make a lot more than 40 grand or I make a lot more than 160 grand. This doesn’t help me. But slow down. Remember what I said earlier on. Look at your overall income based on maybe some losses from some real estate depreciation or some business ventures or some bad debt or who knows. What do you see? So you want to look at your Mat said what you’re where you normally. That’s first question, but where are you going to be this year or two? Are there some losses that might bring you down into a 24% bracket? And you’re like, oh, this is the this is the year where I can I could convert maybe 30 grand and still save stay in the 24% bracket would normally you may not be so now.
Mat Sorensen: Yeah. Now keep in mind when we talk about the brackets, let’s say you’re converting, let’s say you’re in, let’s say you make one hundred and fifty grand this year, OK? And this is like single people you can work on fifty grand. So you’re in the twenty two to twenty four percent range here. And let’s say that you convert another, let’s see, convert fifty grand. OK, it’s going to bump you up to two hundred of annual income. Now you get another ten thousand. That’s going to be at the twenty three to twenty four but the other 40 grand you convert is going to be at a thirty two percent rate. OK, now keep in mind, I just want to say it’s not like all of your income now goes to a thirty two percent rate. Right. It’s just the additional amount once you get outside of the bracket. So in that example there would be this 40 grand that I’ve gone over one hundred and sixty. So now I’ve got you know, so now that 40 grand is going to be at the higher thirty two percent rate.
Mark Kohler: Ok, now for some you that might have your brain spinning with Mat source comment, take a breath. I’m going to
Mat Sorensen: Look at the picture when I’m talking about it. Yeah.
Mark Kohler: For those driving down the road, let me make an important point. You may not know this. This is called a progressive tax bracket. So what this means is if you make 40 grand, you’re going to be taxed at 10% on the first. I don’t know what is it? I actually have it here. Let’s let’s be a little accurate here. OK, now. Yeah. OK, if you. So this is important, everybody. This is how it really works. And this is why Mat’s point is important. If I made 40 grand, I paid 10 percent on approximately, the first ten and that paid twelve percent on the next thirty. So I’m not paying 40 percent on 12 percent on everything, it’s a bracket, it goes up so 10 percent on the first 10, 12 percent on the next 30. Then Mat says, oh, I made one fifty. Oh, OK. Well, you did 10 percent on 10, 12 percent on 30. Now you’re twenty two percent on. Everything up to 85. And then 24 percent on the rest of it, up to 150. They hope that you convert Roth, OK? Well, I’ve got 10 grand I can keep at 24%. And so that’s so your effective rate might be the 20% range when you average all that together, but on the next dollar of income above 150, it’s still 24%. And then at 160, that next dollar is at 32%. So that that’s the principal for some you that may not have ever dealt with that. So yeah. So is that accounted for. We’re always running. What is your effective tax rate. What do you really pay in taxes on that 200 grand. Well it’s not going to be 32% is going to have all these little levels in between. OK, married Mat. There’s your diagram. Unmarried. So give us some new numbers here.
Mat Sorensen: Ok, so as I said earlier, marriage gives us a little more runway in the Roth conversion world and all that helps with that
Mark Kohler: Means I have no idea, but
Mat Sorensen: So take that for what you will. Married or single people out there, you know. I don’t know. So here’s what we mean by that. Of course. Just look in the brackets here. Now we’re up to 80 percent of the 10 to 12 percent, 80 grand. But there’s a difference anyway. But from 80 to three hundred and twenty six thousand, there’s a lot of people a lot. I mean, we’re talking about the majority of you probably listening are in this 22% to 24% rate on on your income that you’re making. So if you’re like $200,000, let’s say in an income for that year, going from two hundred to three hundred to one hundred thousand conversion, you’re still sitting at the same rate, you’re not bumping into the next rate, you’ve got a lot of runway there, so to speak, to be converting and staying in the same tax rate, not bumping into the next bracket, which again, the next bracket is 8% more.
Mark Kohler: Yeah, yeah, I love it. And so the trigger for those driving down the road, or if you’re able to watch this on YouTube, the trigger is at $326,000. That’s when you would say, oh, I better not go over that. I’m going to jump up eight percent on that next dollar. The trigger of course was at eighty and three twenty six. And look at that span. That’s a lot of money. You could be converting at a very lower, much lower rate that you might have in the future. OK, which brings us to the bad news. Again, not trying to be politically bent here, but Joe Biden has been very clear. I want to repeal everything Trump did. I hate it. What we’re hoping he’s going to pick and choose things he. People don’t like. The areas consist of constituents and then pound some other ones that some Trump voters may not like, but the point is he’s already said, I want to go to a 39% bracket. On income over $450,000, married or single or something, we don’t know again where that bracket break will be, but he wants to go to 39% at a much lower level right now. Thirty seven kicks in at six. Twenty two and thirty five kicks in at 414. Well, if he has his wish $400,000, you could go from thirty five to thirty nine in the 400 range somewhere. So this is now most experts and we tend to believe as well, tax policy is a forward effective date type thing. So if Biden gets a law passed this year, there’s a good chance they’re going to be beaten it up all summer long and it’ll go into effect January 1st. 2021, which is our hope. I mean, 2022. So January 1st, 2022, these new brackets would come into play. So again, this, this podcast and these videos we’ve prepared on YouTube are very, very important for 2021 because you could be looking down the barrel at a much higher bracket next year and this could be the year to clean house. Mm hmm. Do I say that politically correctly.
Mat Sorensen: Yeah. And I think we’ve seen this before. You know, the Republicans came in, they said they were going to decrease tax rates and they did these rates. If Biden just rolls back the Trump tax cuts and Trump tax cuts, as generous as you call the Republican tax cuts, but you’re going to see these same rates, but you’re going to see you get to the higher rate faster even without adding the thirty nine percent top at top end bracket. So so that’s going to push everyone into a little bit higher income tax bracket. And that’s how we you know, that’s the pay fors things that the government’s doing right now. So so we’ll see how that comes. And that’s you just got to deal with that. Whatever your political leanings are for tax policy right now, for those wanting to convert, it’s a tax hit now. We just want to take the lightest hit possible, OK? So if you wait a year, it might be a little more painful when the rates are higher. But again, this is where we get to Chunking, too. Yeah. To talk about chunking because we talk bracketed, which kind of
Mark Kohler: Where chunking comes in is. You would like if I may. Yeah. And I want you know what? Before I get chunky, let me hit another political point, though. That is more
Mat Sorensen: Like more politics.
Mark Kohler: Well, I’m sorry. This is more by side of the argument. Everybody out there, you may not know this with the Republicans. Let’s not call it Trump. I like what Mat said. He didn’t. Trump can do this on his own with all the without the Republicans on, you know, going off on this Paul Ryan being a big part of that. The Republicans said we’re going to do all these tax changes, but they’re going to phase out. They were all temporary. So a 2024. We’re going back to the old crappy rates anyway. And that’s why those that were really tuned in to the political arena last year with the everybody was voting. Whoever’s in the office right now, which is President Biden, is going to have a chance to either let those just automatically go back to the crappy rates or even make them worse. And so I don’t think that we were Trump, the Republicans didn’t make this permanent. So we were going to be kind of a crap fest anyway. So that’s Biden’s defense.
Mat Sorensen: Ok, that was the Republican, by the way, playing politics. This is the only political thing I’ll say, because this is the one that tick me off, that the whole reason the Republicans did that is to make you have to vote them back into office. Why would they not make it permanent? They made the corporate tax cuts permanent. Twenty one down from thirty five to twenty one that permanent forever. Individuals would decrease the rate on you guys like a couple percent each. And it’s only good for ten years. You’d have to vote us back if you want to keep that. It was that’s what it was.
Mark Kohler: It was very self-serving. And so for, you know, on the Biden side of things, like I said, that by the voters, you should know that, you know, that that was, you know, a crappy thing.
Mat Sorensen: I just want to make sure that we insulted Republicans and Democrats on the same podcast. Just about
Mark Kohler: Insulting everybody.
Mat Sorensen: Yeah, that’s what we call fair and balanced.
Mark Kohler: Oh, my gosh. All right. Now, here’s what chunking basically means. It’s really simple. Now you want to. OK, it’s kind of a two part issue you want to look at. How much do I have a traditional IRA money? Can I move it to a 401k could be a little more open the door to maybe a backdoor Roth contribution? Separate topic maybe. But you want to look at how much you have in traditional money and if the goal is which we would propose should be your goal is to get that to Roth money as quickly as possible. You want to start looking at two things. I would look at your asset allocation, what what’s in your traditional IRA that has the highest probability of going up in value quickly? That’s what we want to convert first. That’s part. And you want a chunk that you want to take that chunk. There’s different concepts here, but you want to take that chunk that’s going to appreciate most quickly and focus on that first. Then you want to choose that amount or that chunk that I could chop away at and get converted without going into a massive new bracket. That that’s how would you explain that? That’s kind of like kind of two chunks to look at what’s appreciating quickly and what’s to keep me in the lowest bracket without kicking me into a new one.
Mat Sorensen: Yeah, I just think about chunking it over time, you know, and not trying to, you know, eat the Roth conversion all in one year. So if you’re jumping up to this, let’s say the 22 to 24% range up to thirty two, which I think is a lot of people, that’s an eight percent jump if you like. All right. I got another hundred thousand I can convert this year and still stay in twenty, twenty two. But I have a two hundred thousand traditional IRA. I want to get to Roth. OK, do one hundred this year and one next year. Don’t do the next hundred and go up eight percent when you have that that range available next year. Even people like I always love clients converting at the end of the year because I’ll be like, let’s just convert half now on December 31st, the other half on January 1st, break it up into two tax years. That’s the easy, you know, just split up between two years. But get it all done kind of all in one swoop with two conversions or let’s see, you’ve got a large account. You’re trying to get to Roth. You might want to chunk it over five, three, six. I don’t know. Just that’s where you’re going to look at your sweet spot here, if you will. What what works for you and your income? You get to that higher bracket. It’s. All unique, everyone’s unique and
Mark Kohler: Communicate about, oh, boy, OK, now you’re here.
Mat Sorensen: I was going to add and.
Mark Kohler: You stepped right into that one. So I think that also this is about what your long-term goal is in your overall portfolio of assets, too. There is one last thing to say here is we meet financial advisers, too, that are like we got a client here with way too much money in their retirement account. Let’s get that into something that’s not in a retirement account. And Ed Slott, he’s probably the most pronounced retirement adviser over the last 20 years. He would say people get to a point where they have too much in a retirement account and it’s going to affect their family in it with inheritance tax possibly, or they’re going to have what’s called income in respect of a decedent. So I just want to address these naysayers out there, too, that go, well, I’ve got too much in a retirement account anyway. I need to go out, buy real estate or do some other things. Well, I, I would agree with that when it’s a traditional money, because your family that inherits that IRA or your spouse is going to have to pay income tax on it. But with the Roth, it’s tax-free forever. So don’t get don’t go down that rabbit hole of having too much in retirement, I just don’t think you can have too much in a Roth Mat can you?
Mat Sorensen: I agree. I mean, like, that’s a problem. I’ve got too much money in my Roth IRA. I mean, if those are the problems you’re dealing with in your life, it’s pretty good. All right. Here’s the cool thing about the Roth is if your kids or whoever inherits it, they get 10 years to keep investing the thing as Roth dollars tax free, that they can keep investing and try and it another 10 years to pull it out and get all the whole thing tax free. They might be able to double in 10 years from what you give them. So that’s pretty cool, too. There’s no other things they can inherit it from you that they could keep for another 10 years and keep trying to invest and it come back out tax free instead. So it’s as Mark and I have talked on prior shows, if you could be at the negotiating table with your family and there’s your family, let’s say your parents passed away. You have three assets each worth a million bucks, and you got three two siblings. There’s three of you. One of those assets is a Roth IRA. Let’s say the other one’s a piece of raw land worth a million bucks. The other one’s the family home. That’s a million bucks. Go take the Roth IRA. That’s a million bucks every time. And so much more valuable. You get ten years to keep playing with that thing to make it come out tax free. Can you do that with the land now? Can you deal with the family home? No, no, no.
Mark Kohler: Was well, everybody, we hope that you’re tolerant of our sometimes off-color jokes and our stupid humor as we try to keep these topics palatable. Interesting fun, but we want to thank you for spending an hour or so with us and on a topic that is very difficult to tackle. So we do try to have fun with it. So thanks so much, everybody. We wish you the best. Don’t give up. Keep working hard. Mat any final sage words of wisdom
Mat Sorensen: For now I you say Corey is going to be the one doing this, the free book. So yeah. So we’ll get that out there. And then on the tax brackets things. I think this is a pretty good sketch Mark. I like the tax bracket sketch. Well, you might want to sign that and we could probably turn that into an NFT and maybe auction it off.
Mark Kohler: Yeah, here we go. I’m going to sign it right now.
Mat Sorensen: Yeah. You and people, you know, I don’t know. Let’s go for sixty nine million, but maybe six to six point nine
Mark Kohler: Are are we will only give out two of these. So you’ll get a two people get a book and then I will send you an autographed bracket that you can use next year at March Madness. All right. Well, we’ll see everybody talk to you next week.
Mat Sorensen: Thanks.