A listener says, “Eventually, one spouse will pass before the other, which will often catapult the survivor into a significantly higher tax bracket. Shouldn’t a Roth strategy take this into account?”
James explores several factors that could positively and negatively impact a survivor’s tax liability and what to consider when creating a Roth conversion strategy.
Questions Answered:
How can Roth conversions benefit married couples beyond tax savings?
What factors should be considered when determining the optimal strategy for Roth conversions to protect a surviving spouse?
Timestamps:
0:00 - Steve’s question
3:40 - An example
6:41 - 3 changes
12:32 - Positive impacts
15:22 - RMD calculations
16:45 - Widows tax penalty
19:46 - When to do Roth conversions
23:40 - Big age gap
28:45 - Start with a good reason
29:57 - The bottom line
Create Your Custom Strategy ⬇️
A listener says, “Eventually, one spouse will pass before the other, which will often catapult the survivor into a significantly higher tax bracket. Shouldn’t a Roth strategy take this into account?”
James explores several factors that could positively and negatively impact a survivor’s tax liability and what to consider when creating a Roth conversion strategy.
Questions Answered:
How can Roth conversions benefit married couples beyond tax savings?
What factors should be considered when determining the optimal strategy for Roth conversions to protect a surviving spouse?
Timestamps:
0:00 - Steve’s question
3:40 - An example
6:41 - 3 changes
12:32 - Positive impacts
15:22 - RMD calculations
16:45 - Widows tax penalty
19:46 - When to do Roth conversions
23:40 - Big age gap
28:45 - Start with a good reason
29:57 - The bottom line
Create Your Custom Strategy ⬇️
Most people think of Roth conversions from the standpoint of how do we save the most amount of money and taxes over the course of our lifetime. This is absolutely correct. This is the first way that you should be thinking about Roth conversions, but it's also good to take this a step further. If you're married, you can also think of Roth conversions as being a way to protect a surviving spouse, and the reason for that is when one spouse passes away, tax brackets change for the surviving spouse. So that's the topic of today's episode of Ready for Retirement, and it's based upon a question that Steve submitted. This is another episode of Ready for Retirement. I'm your host, james Cannell, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. Steve said this. He said I'm addicted to your podcasts and I find them highly instructive.
Speaker 1:You've addressed the potential value of performing Roth conversions in numerous episodes. In these, you have discussed taking into consideration current and future anticipated tax brackets and the ability to reduce RMDs when deciding on whether to perform Roth conversions or not. Beyond these factors, there are a couple of additional dimensions that you haven't addressed. One is that, even if a person expects to be in the same tax bracket in the future, there could still be value in performing a conversion based upon the tax-free withdrawals in the future, which, after passing a break-even point in time, will be favorable even after taking into account the opportunity cost associated with using money to pay taxes at the time of the conversion if the same funds were instead invested. It would be interesting for you to go through such an analysis, though clearly it will depend upon the tax bracket for the investor. Perhaps you could do so for the 24% bracket. The other consideration is that, for married investors filing jointly, eventually one will pass before the other, which will often catapult the surviving investor into a significantly higher tax bracket. Performing a Roth conversion, even if one expects to be in the same tax bracket in the future, would mitigate this risk as well. It would be great to hear you talk through these topics, steve. Thank you for the question. You're exactly right.
Speaker 1:I do talk a lot about how Roth conversions can be beneficial and that the typical consideration is what tax bracket are you in today versus what tax bracket are you likely to be in in the future? That being said, there are other considerations to take into account, two of which Steve outlined in his question today. The one that I'm going to focus on is his second one, and that's the consideration for married investors of look, you don't want to just look at your tax bracket today versus your combined tax bracket in the future, but what happens if one of you passes away and, like I said, there's now different tax brackets that the surviving spouse has to deal with? So that's exactly what we're going to walk through today. So, as we jump into this, let's just quickly make sure that we're on the same page with normal Roth conversion procedures, the normal things that you're looking at, and it's really just what I said it's will I be in a higher tax bracket now or will I be in a higher tax bracket in the future? If you're going to be in a higher tax bracket in the future which to some extent, is just a guessing game, or at least an informed guessing game you don't exactly know, but you try to shift your tax liability to the years in which you're in a lower tax bracket. If you're in a 12% bracket today and expect to be in a 24% bracket in the future, well, it makes sense maybe to do some conversions today to pay taxes at the 12% rate, as opposed to waiting until the future and paying them at the 24% rate. Well, there's nuances to this, but that's the general analysis. One of the factors, though one of the nuances can be and is one spouse potentially passing away this was one of the factors that Steve mentioned or even if you're not projected to save any money on Roth conversions. When you look at married tax brackets so you're married finally joining a tax bracket today versus married finally joining a tax bracket in the future that equation, or that analysis, may change when you compare your married finally and jointly bracket today versus what potentially might be a single tax bracket in the future, if which is probable that one spouse predestines the other by some number of years. So let's take a look at an example here so I can clearly illustrate what I mean.
Speaker 1:Steve asked to maybe use 24% tax bracket or the 24% tax bracket as an example here. So, all that's being equal, what tax bracket would you be in with $250,000 of income if you're married finally jointly or if you were filing taxes as single? Well, if you're married finally jointly, you'd be in the 24% marginal tax bracket. And remember when I'm saying $250,000 of taxable income, that is taking your actual adjusted gross income and then backing out the deduction and at $250,000, you're in the 24% tax bracket if you are married. But what if you're not married? What if you're single? And to Steve's point, this is maybe what if it was 250, but then one spouse passes away, but income stays at $250,000. Well, if you're single, earning that amount of income, taxable income, it's no longer the 24% tax bracket, it's not even a 32% federal tax bracket. You're now jumping up into the 35% federal marginal tax bracket.
Speaker 1:Let's use another example, because $250,000 is a pretty high taxable income amount for someone in retirement. Even if someone's actually spending that amount, it's most likely not all taxable income. Some of it even may be taxable income, but it's taxed at long-term capital gain rates. So let's maybe use something more reasonable that makes sense to a wider portion of the population. What if, in retirement, you have $60,000 of taxable income and I'm specifically saying retirement because that's for the most part where people are doing Roth conversions.
Speaker 1:Well, if you have $60,000 of taxable income and you're married, finally and jointly, you're in the 12% marginal tax bracket. If you have that same $60,000 of taxable income and you're single, your federal tax bracket is almost double, you're now paying 22% or you're in the 22% marginal tax bracket. And just to make sure I'm clearing up any potential confusion, it doesn't necessarily mean you're paying double taxes. It means you might be in the almost double marginal tax bracket. Marginal tax bracket tells you, if you earn one more dollar, what will that marginal dollar be taxed? At what marginal rate will that dollar be taxed at? That's different than what you might call your effective tax bracket. Your effective tax bracket says divide the total taxes paid by your taxable income. So your effective tax bracket is saying how much are you actually paying taxes in total, whereas marginal is telling you what's the impact of one more dollar earned. So, as I go back to my initial statement, to repeat what I said, I said all else being equal.
Speaker 1:There is a pretty significant difference between tax brackets if you are married finally jointly, and tax brackets if you are single. However and this is starting to go to Steve's point all else isn't necessarily typically equal. It's not as if, if one spouse passes away, everything stays the same between income, between expenses, between tax brackets. All those things are typically changing and so it's not enough just to say, oh, you should convert more because one of you is likely to pass away before the other if you're a married couple, but that's potentially something that you want to look at. Here's the three things that you want to understand, though. Here's the three things that will change. The three things will at least impact this analysis. That will change.
Speaker 1:It's gonna be your expenses, your income and your taxes, and let's understand how each of those is going to work. Number one expenses. So let's assume you have Steven Sally and Steven Sally are retired couple and one of them passes away before the other. What does that necessarily mean? That whatever they were spending as a married couple is gonna continue to be spent as a single, with one of them being single because other one passes away? Probably not.
Speaker 1:Now you have some expenses that will probably stay the same. Maybe that's property taxes. Maybe that's mortgage, if they're still a mortgage. Maybe that's rent, if you're paying rent and you don't move to a different place. Maybe there's subscriptions, some streaming services, some utilities. Some of these things are gonna stay the same whether there's two of you or there's one of you, but a lot of expenses will be cut. Your grocery budgets probably not the same. Your entertainment budgets probably not the same. Your gas budget, your gym budget, your travel budget, a Lot of these things. You're not necessarily gonna be paying the same amount if one of you passes away, but you would be if both of you were living. So there's no perfect answer for what exactly will your expenses look like if one of you passes away before the other Because, like I said, some of these expenses will stay the same, some will be different, but in general, 60 to 80 percent is kind of a maybe a simple way of thinking about this, where, if you're both spending, say, a hundred thousand dollars per year In one of you passes away, maybe 60 to 80 thousand is what the surviving spouse might spend.
Speaker 1:Don't use that as a perfect number. You look through your actual expenses, maybe even estimate what that might look like if you want to do a full analysis. But that's just a general way of thinking about it. If one spouse passes away, surviving spouse expenses won't be the exact same. Now I know it probably starts to seem like I'm going away from the question.
Speaker 1:The question is, james, what about Roth conversions? We're not talking about expenses. We're talking about Roth conversions. We're talking about taxes. These are some details. I'm trying to paint the picture of what context you need to understand so that we can ultimately go back and answer that question about how much we do in Roth conversions. So expenses will change. Number two income will change. How will income change? Well, if you're both collecting social security, one of those benefits will go away. Whatever the higher benefit is, you'll keep that lower benefit will go away.
Speaker 1:Was there a pension and did the spouse pass away? Did they have a pension? If yes, was there a survivor benefit? Maybe there was, maybe there wasn't. If there wasn't, that pension completely goes away. If there was a survivor benefit, but maybe it was only 50% or 75% of the pension amount, then the income doesn't go away, but it certainly gets cut. What about any annuities? Were those annuities joint and survivor annuities where they continue even after one spouse passes away? Or is that annuity go away or at least get cut?
Speaker 1:It's important to know these things because all these income sources are taxable. So to Steve's point all of a sudden you're surviving. Spouse is in a higher tax bracket, so do you do some Roth conversions to protect against that? But you also have to understand there's some competing factors that are driving the taxable income down. Not necessarily good competing factors, but factors of? Are you losing a social security benefit? Are you losing a pension? Are you losing an annuity benefit? Some of these things certainly can and will be impacted.
Speaker 1:And then taxes. That's a third thing that's going to change. So the three things that go into this equation are income, expenses and taxes. How do taxes change? Well, for one, your standard deduction gets cut in half For 2024, if you are married finally, jointly, and I'm assuming you're under age 65, your standard deduction is $29,200. If you are single in 2024, your standard deduction is $14,600. If you're over 65, you get an additional $1,550 added to your standard deduction. If you're married in both of you are over 65, then you both add that on. But those numbers, as you can see, the standard deduction for a single filer is exactly half the married filer. So if you have income, if you hypothetically had the same exact income coming in when you're married as you did when you were single, all of a sudden that income is going to be taxed a whole lot more because you have less of a deduction to write off against that. And then also tax brackets are going to be compressed, so to speak. But if you still have the same 10%, 12%, 22%, 24%, so on and so forth.
Speaker 1:But for a single filer, the numbers, the thresholds at which you reach that next tax bracket are cut exactly in half. For example, if you want to know where do I cross into the 12% bracket if I'm married, finally jointly, well, that's at $23,200 of taxable income. Once you're above that, you're now paying taxes at the 12% federal tax bracket. Well, if you're single and you want to know where do you cross into the 12% tax bracket, it's at exactly half of that. Above $11,600 of taxable income, you're now jumping up into the 12% tax bracket. So, same amount of income, but your tax brackets are cut in half in terms of the dollar amount needed to jump up into the next tax bracket. So, for every tax bracket that you are in up until you reach the 35% federal tax bracket, which is the second highest, you have 35 and the 37% up until then, the taxable income for married, finally jointly, is exactly double the taxable income for single filers needed to get into the 12% or 22% or 24% bracket, so on and so forth. So not a ton of people in their retirement years are going to be the 35 or 37% tax brackets, which are those tax brackets where it's not exactly double. In fact those numbers are a lot more similar at that point. But for anything below that you have double the taxable income or you can have double the taxable income before you go into the same tax bracket you otherwise would have.
Speaker 1:So those are some negative aspects. Of course, negative financial aspects of one spouse passing away there are and I know it sounds kind of funny to say and of course there's no positive benefit to one spouse passing away. But from a planning standpoint we're saying what are the impacts? How does that actually impact our financial planning? Well, some of the positive impacts of that are step-up and basis. So a step-up and basis says look, what if you bought a bunch of investments together when you were married and you're hesitant to sell them because it's going to push you into a much higher tax bracket? This is somewhat state specific of how does your state handle step-up and basis, whether it's a full step-up or partial step-up. But I'll use California as an example, where I am. If you buy $250,000 of assets, to use a round number, and those assets appreciate to a million dollars over the course of your lifetime and you want to spend that, but you're married and saying, hey, it's going to cost us a bunch of money. By the way, does that mean anything to do with you being married? That's going to cost you a bunch of money, but it's just going to cost us taxes to sell that. If one spouse passes away, there's a step-up and basis. So now all of a sudden, okay, we have a million dollars that the surviving spouse can freely sell without any tax impact. Now, as that money keeps appreciating above a million dollars after one spouse passing away, you'll pay taxes on any of those gains, but there is a step-up to the value of the account on the date of death.
Speaker 1:Where this really has an impact on a lot of people is with their home. So say, for example, you and a spouse bought a home in California 30 years ago and you bought that home for $200,000. And now all of a sudden, that home is worth $1.8 million, which sounds absurd to say in a lot of the parts of the country, but in California, in certain parts, that's not absurd at all, it's a very real thing. And you're saying, gosh, we're kind of tight on funds of. We have some money in our IRAs and 401ks and other accounts, but a lot of our equity is in our home and on top of that we don't really want to sell our home because we're going to pay a couple, few hundred thousand dollars in taxes and broker fees to have to do that. Well, if one of you passes away in the home not necessarily physically in the home, but if one of you passes away while you're both living in that home that asset also has a step-up and basis. So now, all of a sudden, if you want to sell that home for, say, $1.8 million and you ran the numbers and said, oh geez, after selling we'd only walk away with, say, $1.4 to $1.5, not the full $1.8. Well, if one of you passes away and you have the full step-up and basis, now the surviving spouse, that's a few hundred thousand dollars of taxes that they would save money on because they now won't pay those same capital gain taxes that you otherwise would have as a married couple. So I still know that I haven't exactly answered Steve's question, but I'm trying to build the scenario here, paint the picture here of what are the competing factors, positive and negative that will impact a surviving spouse, and how do we use that information to determine if doing extra Roth conversions is worth it.
Speaker 1:Then the final thing from a tax standpoint that might potentially change is those RMD calculations, those required minimum distribution calculations If you are both the same age. So say we have Joe and Sally and Joe and Sally are both 75, and Joe passes away. Well, sally's going to have Joe's IRA and her IRA and whatever they would have taken and required distributions with their own separate IRAs. Both of those accounts are now just going to merge into Sally's IRA. Most likely it doesn't have to, but that's probably going to make the most sense. So it's going to be the same account value and because Sally and Joe are the same age, she's still going to have the same required distributions that she's forced to take each year that she otherwise would have if Joe was still living. So that doesn't actually change. What would change is if Joe's 75 and Sally's 70 and Joe passes away, well, now Sally would inherit that account. She wouldn't have any required distributions for the next three years until she turns 73. And then her required distribution would be a little less than Joe's would have been each year because she's a younger age. So, based upon the IRS life expectancy tables, she would be forced to take out a little less each year than Joe would have if that money was still in his account.
Speaker 1:So something else to keep in mind as I start to move into actually addressing Steve's question about what are some of the factors that indicate whether you should convert more to protect the surviving spouse versus under what conditions. Shouldn't you necessarily take that too much into account? So as we start to move forward to that, let's start to summarize what we've talked about so far. As we have this picture now built out, as Steve is asking, this question we're essentially asking is how do we avoid or how do we mitigate the risk of this tax penalty that exists when it comes to widows, the widow tax penalty. So it generally does exist.
Speaker 1:And if you could just cut income in half and cut expenses in half and say, oh, it doesn't really matter from a financial standpoint whether both spouses are living or if one passes away early, that doesn't matter, you know, if income gets cut in half, so to do expenses and so to do the tax brackets, all else is going to be equal. The problem with that is that's not going to be the case. As we started with, expenses probably aren't going to be cut perfectly in half. Expenses might be 60 to 80% of what they were when both spouses were living. They're probably not cut exactly in half. Income sources those may get cut in half, probably won't be. Depends on social security benefits, any potential pensions or rental income. That may look different. And then finally, tax brackets those do get cut in half and so that's kind of the problem is, income might stay higher or expenses might stay higher, but tax brackets, those thresholds are now lower and so that's where the issue is.
Speaker 1:Here's a basic example. Here's a simple example to show that. Assume John and Sally are married and they're living $100,000 per year and assume 40,000 of this is their combined social security benefit. Let's assume one of them has 25,000 per year, one is 15,000 per year and then 60,000 per year is coming from required distributions from their IRAs. And let's just assume both of them are the same age. Well then, john passes away. Sally is then going to collect the higher of the two social security benefits, which in this case would be $25,000. Sally, again, assuming she's still the same age as John, she's still going to have the same required distributions, required minimum distributions from the IRA account. So that's still going to be $60,000.
Speaker 1:So now, all of a sudden, sally has $85,000 of income, 60 from the IRA RMD, in 25,000 from social security. So expenses went from 100,000 to 85,000, I shouldn't say expenses income went from 100,000 to 85,000. But tax brackets have been cut in half. So previously there would have been one tax bracket, but because of this RMD, this required distribution that she must take from her IRA, she's been pushed up into a tax bracket that she otherwise wouldn't have been in if she was still married, if her husband hadn't passed away there. And the hard part about this, or the challenge about this, is maybe Sally didn't need that full $85,000 to live. Maybe she said, hey, I would have been perfectly content with only $60,000 and could have done everything that I wanted to do. But it's this required distribution that's pushing me up into a higher income threshold, into a higher tax threshold, and that really becomes the issue. And so this is really now where we start to actually address Steve's question.
Speaker 1:So I went through that because it's not automatically the case that you should convert more just to protect a surviving spouse. So the bottom line, steve, is you're absolutely correct. This is something that you should consider. You should absolutely look at what would be the impact of one spouse predestines and the other, but it doesn't automatically mean you should do more in conversions. Here are the actual specific things I would look at that would help me to determine should we do more of a Roth conversion for this client Number one. The first thing that I would look at is how big, how significant is the IRA balance? Talked about this before in other podcasts.
Speaker 1:Roth conversions, tax planning required minimum distributions. These become increasingly important as the size of your IRA or pre-tax investment account gets bigger and bigger and bigger. If you have a $4 million IRA, you're going to be in a significantly different position than someone with a $40,000 IRA. Even if all else is equal in some hypothetical world, even if you want to live on the same amount of income in retirement that the person with $40,000 does, if you have a $4 million IRA, you're going to be forced to take out a lot more money than you otherwise would have. So if the IRA balance isn't that significant, I don't know how much weight I would put into over converting just to protect the surviving spouse.
Speaker 1:So say, one spouse has a hundred thousand and the other spouse has a hundred thousand and one dies. Well, now that surviving spouse has the $200,000. And depending on the age let's assume mid to late 70s the required distribution on that might be $8,000 to $9,000, somewhere in that neighborhood, give or take. Now that's not probably a big enough tax bill to warrant doing any serious tax planning to avoid that. It's probably not even enough money to push you into a higher tax bracket, because the assumption I'm going to make is you're going to want to pull some money out of the IRA anyways, just to live. So $8,000 to $9,000 probably isn't a huge excess amount that's going to force you into a difficult spot.
Speaker 1:So that's the first thing that I would look at is project out if one of you did pass away, what would the required minimum distribution be for the surviving spouse and would that push them into an unwanted tax bracket? A required distribution by itself isn't bad If you're going to take that money anyways. Who cares whether it was required that you take it or it was discretionary withdrawal that you took? The bottom line is you're taking that money out and it's taxable. The issue becomes when the amount you're required to take is significantly more, even just a little bit more, than what you wanted to take. But the real issue is if that's pushing you into an unwanted tax bracket Another case where I probably wouldn't push for extra conversions just to protect the surviving spouse is what if the spouse that passes away first has a pretty significant pension or has maybe a single life annuity?
Speaker 1:Well, why does that matter? That matters because when they pass away, that's a significant source of taxable income that's passing with them, that's going away with them. So not necessarily a good thing, because just that's something that's going away and that's being taken out of the tax picture. So now, yes, you do have more required distributions, or even the same amount of required distributions, but that's somewhat being offset by the loss of this other taxable income source. That's probably seems a little vague. So this is where it's actually important to run the numbers of what would the actual projected tax bracket be for the surviving spouse where, if we use this example now, there's more or there's the same RMDs at a lower tax bracket, but that's somewhat offset by the fact that the spouse that passed away had a pension that passed with them or an annuity that passed with them or some income source that passed with them. With that, that's not being taken out of their taxable income and maybe doesn't increase the tax situation of the surviving spouse. Again, that's this weird case where that's actually a negative thing if that passes with them. But if we're looking at tax strategy, that thing passing with them, that pension or that annuity, that's not going to push the surviving spouse into as much of an unwanted tax bracket as it otherwise would have.
Speaker 1:Another factor I would look at is whether or not there's a big age difference. So let's assume we got John and Sally again and in this time John is 80 and Sally is 60. And right now John is already taking fairly significant required distributions. Well, if John dies today, sally could actually take his IRA balance and make it her own. Sally at age 60, now has 15 years until she needs to begin taking required distributions. So while they are both living, John was already taking those required distributions or may not have been as much quote unquote room within their tax brackets to convert more than they were already taking out. Maybe that conversion would have pushed them into a much higher tax bracket. Well, when John passes away and Sally now fully owns that IRA, she can start to do conversions because she's not going to simultaneous to be forced to take those required distributions because she could just make that account her own. So there's other RMD rules on top of that, of the way in which you can take required distributions based upon spouse's age, age gaps, other things like that, what life expectancy tables that you're using. But this is just one other thing I would take into account before deciding to do extra conversions to protect a surviving spouse.
Speaker 1:Then another question that I would ask before deciding to do extra conversions is when will the first spouse die? And obviously this is one of those big challenges of planning because we don't know the future, we don't know how long we're going to live, we don't know how long our spouse is going to live. So that makes it nearly impossible, if not impossible, to dial in the exact, perfect strategy because there are so many unknowns. But let's at least walk through why this is important to have a general idea. There's a general idea because let's assume we have John and Sally again, and John and Sally today are both 65. There would be a pretty significant difference between what if John lives to 70 and Sally lives until 92, versus what if John lives till 91 and Sally lives until 92. In the first scenario, where John passes away at 70 and Sally goes on to live for another 22 years, well, in that scenario you would have been better off converting a whole bunch more because they're only together for five more years and then Sally's got 22 years on her own at her condensed tax brackets. So it's more likely going to make sense to say how do we expedite conversions so that Sally isn't stuck with 22 years of higher tax brackets, versus the alternative of what if John lives until 91 and Sally lives until 92. And what if the plan was to say John, as long as you're going to be living, we're going to convert extra amounts every year to protect Sally in the event that you pass away or flip it Sally, every year that you're living, we're going to convert extra amounts to protect John in the case that he outlives you.
Speaker 1:Regardless of who it is, tax brackets are going to be the same. Well, in this case, one lives in 91, one lives in 92. That's a lot of years of excess conversions. And when I say excess conversion, what I want you to hear is paying more money in taxes than you otherwise would have. And what was the benefit of that? Well, one year of a lower tax bracket where the surviving spouse didn't have to pay as much in taxes. So you can start to get the picture there of. The longer there's going to be one spouse living without the other, the more it would make sense to take advantage of your higher tax brackets when you're married to convert more. But we just don't know.
Speaker 1:If that's going to be the case, there's a lot of instances where, if you are too conversion happy, you're converting too much, you're converting more than you should have. It ends up both costing the two of you during both of your lifetimes, because you paid more in taxes than you need to and it could and this is the real kicker for people actually really hurt the surviving spouse. Because think of this if you're converting too much, every time you do a conversion, you are writing an extra check to the IRS. You're potentially writing an extra check to your state. If you live in a state that taxes income or conversions or just taxable income, that hurts the surviving spouse.
Speaker 1:If you're, every single year, you are spending more money than you need to, not on cool things but on taxes. And if you do that for too long, you're dwindling your combined portfolio so that, even if you do pass away before your spouse, your spouse now has fewer dollars to live on. Sure, more of those dollars are in Roth accounts so it's easier for your surviving spouse to pull them out without going into higher tax brackets. But there's a lower combined balance, lower pool of those dollars to spend in the first place. So these are just the things that you have to balance and this is the hard thing. We don't know how long we have. So to some extent it's what's the health history of both of you, what's longevity like with both of you, what's the risk of not converting enough and then the surviving spouse being in a higher tax bracket, versus what's the risk of over converting and hurting both of you and also hurting the surviving spouse, because they then have fewer dollars to live on when the first house passes away. So you can start to see the challenge here of yes, there's absolutely times when you should convert more and there are also absolute times when you should not convert more. Part of the reason why is we just don't know exactly what the future is going to hold.
Speaker 1:Now you might notice, as we're going through this, all I've really done is given reasons not to do excess conversions, and that's really kind of my philosophy towards Roth conversions in general. Let's start by saying is there a good reason not to do this? Because when you hear Roth conversions, it sounds great. It sounds like, oh, you're doing great planning and in many cases you are, but I again want you to also hear. Roth conversions means writing a bigger check to the IRS this year, instead of having that be something that's kicked down the road, instead of that potential being something that didn't need to happen, depending on how you're doing it.
Speaker 1:So I'm trying to see are there good reasons not to pay the IRS more money today? One good reason is you can pay significantly less to the IRS in the future, which that's a good reason to do it. But start with a good reason. Start from the standpoint of I prefer not to do this unless there's a really compelling reason to do it. In many cases there's a really compelling reason, but I'm taking that same philosophy here of should you convert more money to protect a surviving spouse? Yes, in many cases there's a real compelling reason to do that, but can we find a good compelling reason not to first? If we can't find a good reason, that probably leads us to believe this is something that we should really consider doing.
Speaker 1:Here's the bottom line, though the widow penalty, this widow tax penalty that we're discussing it's going to apply and it's going to be most painful to surviving spouses that have large IRA balances and when I say surviving spouses who have that, I mean kind of married couples who have large combined IRA balances because when one passes away, the surviving spouse will inherit all of that. The reason that exists is because tax brackets get compressed when one spouse passes away, but the required distribution assuming spouses are at the same age or similar age that required minimum distribution is going to stay the same or similar, so it's forcing out the same amount of income, but you have lower tax brackets to use, which means you're going to be paying more taxes on that distribution. Here's the most important thing, I'd say, or one of the most important things is understand the real risk. People hear this and they have thoughts of their widow ending up on the streets if something happens to them. They have these horrible thoughts of oh my gosh, we don't convert enough money, my surviving spouse is going to end up destitute on the streets, all these really horrible things, which that would be horrible if that was the case. That's not really the risk we're talking about here.
Speaker 1:The risk we're talking about is paying more in taxes than you need to, which is a risk, which is something, but you are not going to be destitute. You're not going to be living on the streets because of paying money in taxes. You're going to be living on the streets for other reasons Overspending, being under-saved, a horrible downturn in the market and you're not being invested correctly. Those are real risks. The risk of not converting enough means your surviving spouse is going to have really significant required distributions and pay more on taxes than those distributions, and maybe they otherwise needed to. But real risk is not having an IRA. Real risk is that IRA balance dwindling and then, all of a sudden, that balance used to be a million dollars, is now $500,000, is now $200,000, is now $100,000, and then $50,000. Well, the thing is, is each of those things happen, the required distribution gets smaller and smaller, which means this tax risk gets lower and lower, and the real risk of running out of money. That's what now becomes the thing that we're most concerned about.
Speaker 1:So I just want to make sure I'm framing it correctly. You don't run out of money by paying too much in taxes. Paying too much in taxes is certainly a real issue and it's not an issue you want to stick your surviving spouse with, but this is not an issue of destitution or not. This is an issue of what's the right thing to do to minimize our tax liability. So that's just something that I wanted to start to close on, because sometimes people get this in their mind of I cannot leave my spouse's desk, I cannot leave them high and dry. Therefore, I'm going to do all these conversions today to protect against that, and what they don't realize is they end up paying more money in taxes than they need to For a risk. That is certainly a risk, but maybe not to the degree that they thought it was in their mind. So that's a big part of planning is properly framing what risk is, properly framing the impact of making a certain decision or not making that certain decision, and I think this is certainly one of those areas that is worth a lot of thought, because there are some unknowns, there are some variables that are going to impact this.
Speaker 1:But, steve, I really appreciate you spending this question of how can we not just think of Roth conversions in the really simple way of pay taxes now, pay tax later, understand the various nuances that exist in that, one of which is how does this whole equation change if one spouse predeceses the other. So, steve, thank you for the question. I hope that was helpful. I know we kind of bounced around a little bit and sometimes I can get confusing, so my apologies if that was the case, but really appreciate all of you tuning in and listening. If this is something that's helpful, I would really appreciate you supporting the show by leaving a thumbs up and subscribing if you're listening here on YouTube, leaving a review if you're listening on Apple Podcasts, leaving a review if you're listening on Spotify and, most importantly, if you know someone that can benefit from a friend, a family member, a co-worker please share this podcast with them. Want to make sure that people have good information, go and end the retirement so they can really make that one the best seasons of their life.
Speaker 1:That is it for today. Appreciate listening, as always, and I'll see you next time. If you enjoyed this podcast, then go to rootfinancialpartnerscom and click start here, where you can schedule a call to one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.