Transcription
Every Roth conversion video seems to focus on something different. Some say fill up the 22% bracket. Others say watch those Irma thresholds. Some say convert as much as possible. Others say just don't convert at all. So, which one is right? Well, they're all pointing at the same objective from different angles.
Today, I want to show you a single framework that accounts for almost all those factors at once and simplifies the whole decision down to one number that you set every January. And later on in the video, I'm going to show you a year-end tax move that works really well with the framework I'm going to show you. One that's only available for retirees and allows you to collect interest instead of making quarterly tax payments. How's that for a tease?
Now, if you're new to the channel, my name is Ben Brandt. I've been a retirement planner for almost 20 years, and I want to help make your retirement even better.
All right, here's that core idea. At the end of every year, I want you to pick a target withdrawal percentage. Let's just say 6% for example, and that's the amount that we're going to pull out of our IRA that year. One way or another, that 6% is leaving our account based on the January 1st balance.
Now, here's where it gets interesting. There are two ways that money can leave your IRA. Option number one is we spend it. Option number two is that we convert to the Roth. And the order of priority really matters here because spending comes first. Roth conversion is just what we do with whatever's left over.
So, looking at a hypothetical example, let's say your IRA is $1.5 million. 6% of that, $90,000. Now, maybe you actually managed to spend $72,000 in that year. Well, we convert then what remains? The remaining $18,000 goes to your Roth. That's the whole system. Spend first, convert the rest.
Now, I know what some of you are already thinking. You're saying, "Ben, well, Roth IRA dollars, that's tax-free money forever. Should that not be my first priority?" And that's really the kind of misconception that I want to address in this video. Because for a lot of you watching this, especially what I call a super saver, the most important financial move that you might make is actually giving yourself permission to spend your money. And this framework is a significant step towards unlocking that because we're combining two things, spending and Roth conversions.
Super savers are people that have done an extraordinary job building wealth. If you if you've accumulated over a million dollars for retirement, you're in pretty rare company, honestly. You've outs saved probably 90% of your peers. And you got there through decades of discipline. You lived below your means. You maxed out your IAS where possible, your 401ks, and you just made smart decisions year-over-year. But that same discipline that built that wealth can work against you in retirement because super savers of course are wired to save. And when they discover Roth conversions, they often redirect all of that saving energy towards optimizing that conversion. Right? We want to maximize the Roth balance. We want to pay taxes from outside accounts. We want to squeeze every last dollar of efficiency out of that Roth conversion strategy. And here's what I want to say to that. You save this money for you, not for your IRA, not for some overoptimization for the IRS. You save this money for you.
Now, I know that's a mindset shift, but it is an important one. And the beautiful thing about this framework of a target percentage is that it gives you permission to do it because spending and converting really gets you the exact same place from a tax perspective. There's also a related year-end tax move that lets you earn extra interest on your tax payments as a part of the strategy. But I got to explain a little bit more about the framework before we get to that part because I need to be really clear about how super savers need to think differently about Roth conversions. We're not trying to maximize the Roth balance. We're trying to minimize the traditional IRA balance.
Now, that might sound like the same thing, but really they're not. When you are a super saver with modest income goals, meaning that your portfolio can generate a lot more income than you're used to spending, the real long-term threat isn't running out of money. That's kind of off the table if we manage this properly. The real threat is losing control of your income. If your traditional IRA grows unchecked through your 70s and 80s, the IRS is going to start forcing you to take required minimum distributions or RMDs. And those RMDs don't care about your retirement income budget. They don't care if you need $70,000 or $90,000 a year to live comfortably. If your RMD is 130,000, you're taking 130,000. You're paying taxes on all that income and you're potentially triggering some Medicare charges on top of that.
Now, when I tell people that, a lot of people in the comments say, "Well, Ben, that sounds like a pretty good problem to have." I have to tell you, I strongly disagree. And here's why. Because large RMDs in excess of your income needs present two failures. One, we could have spent more money sooner or maybe just retired sooner. And two, we're paying taxes on what could have been at least partially avoidable, right? We're paying unnecessary taxes. When we see a retirement plan with excess RMDs, we don't say, "Well, wouldn't that be nice?" We say, "That looks like a missed opportunity that I'm never going to get back."
So, the overall goal of the system is not to build the biggest Roth. It's to rightsize the traditional IRA so that when RMDs eventually kick in, they're not forcing you to take income that you don't want and you don't need.
Now, before I show you the specific numbers, I got to give you one more concept to think about before you pick your target percentage. And that's the difference between mile markers and cliffs. And once you understand that, I think this strategy is going to make a lot more sense.
Now, when it comes to income planning in retirement, there are some things that we should be generally aware of and some things that we need to pay specific attention to. We call those mile markers and cliffs. Now, when it comes to marginal tax brackets, think of them as mile markers. 10% 12% 22 24 all the way up. These are way points that we need to be generally aware of, but they're less consequential in the big picture. Going a dollar over the 22% bracket into the 24% bracket, that cost you 24 cents on that dollar. Far from a catastrophe, right? It's a mile marker. You just passed one and you're on the way to the next one, right? The rest of your income is not affected.
Irma, now Irma is totally different. Irma, the income related monthly adjustment amount, that's the extra amount of Medicare premium that you pay when your income is too high. Well, that is a cliff. And a cliff is something that we should specifically be aware of. $1 over our Irma threshold and you're paying the full search charge the same as if you're $50,000 over that level. For a married couple, crossing that first Irma threshold is going to be an additional charge of about $1,944 per year just for being a dollar over. So that's why we treat marginal brackets and Irma brackets very differently in the framework that we're going to talk about today. So mile markers don't stress out about being a dollar over cliffs we've got to be careful of. So we build a buffer of a few thousand under that and we never run it right up to the to the edge.
All right, so let's talk about how to calibrate that target percentage. The right number for you depends on where your income lands relative to these mile markers and cliffs. So I want to show you two sets of anchors and then you choose whichever one makes the most sense to you depending on your situation.
So option A for some of these targets are your marginal tax bracket. So for 2026, the top of the 22% bracket is $21,400 for a married couple filing jointly and $105,700 for single filers. So that's 22. The top of the 24% bracket is 403550 joint or $21,775 single. Now again, these are mile markers. So being $1 over is not a disaster, but they're still useful targets that we're trying to build a percentage around. I'll show you some specific numbers here in a moment.
Option B would be our Irma thresholds. So for your 2026 Irma premiums, if you're single, they're going to look back to your 2024 income. And our our free or our no additional premium is at 109,000 for a single filer. Then we move on to we want to be below 137 for a single filer. If we're below 137, we're going to pay an additional $81.20 for the single individual. Income dictates your 2026 premium. And so we want to stay under 218,000. If we don't want to pay anything additional, we still pay our standard $22.90 premium for part B. Then as a married person, we want to stay under $274,000. If we only want to pay $81.20 more per person. So for our second paid tier, if we're married filing jointly, 2024 income, again, dictating our 2026 premiums, we want to stay under $342,000. If we're able to do that, we have our standard part B premiums plus an additional $22.90 per person.
So again, when we're dealing with Irma, these are clips. So we want to leave a buffer of a few thousand below each line and we generally do our conversions in December so we know exactly where our income is going to land for the end of the year.
Now, a quick note on the first Irma bracket specifically. For most retired people, it's kind of a rounding error. If you retired before 65, you were probably paying $1,200 or $2,500 a month for health insurance from the marketplace if your income was too high for premium assistance. So moving to Medicare and paying essentially an extra $81 per person per month in premiums, you know, that's not that dramatic. You're still getting a dramatic reduction in health care costs even if you're paying the first tier of Irma. So not saying ignore it, but I'm not losing sleep over that first Irma bracket, especially if you are a healthy super saver. In fact, I really can't imagine a scenario even for these superstars where you're on your deathbed at 102 years old and you're still missing that $81.20 20 cents versus the memories that we're trying to make by trying to convince you to spend more money. So, first tier of Irma, not a big deal. That second paid Irma tier, that's where I start really paying attention.
All right, now let's finally pick our target percentage. I know people watching this video have all different account balances. I talk to folks every day through our retirey blueprint. Some have $800,000, some have $18 million, and everywhere in between. So, I'm going to give you a few examples of different portfolio sizes so that you can find one that looks the most like your situation to kind of picture what this target percentage might look like.
Option one, a $2 million IRA at 6%. 6% is moving from our traditional IRA to somewhere else by the end of the year with emphasis on spending the money first. That's $120,000 a year. Call that $10,000 a month. This lands just under the top of the 22% bracket for married filers. Again, spend what you can convert what remains. If you have half of that amount, cut my numbers in half.
Option number two, a $3 million IRA at 7%. Right? That's $210,000 per year, $17,500 per month. Now, this target percentage lands just under the first Irma cliff of $218,000 for joint filers. That's a good comfortable buffer. A nice round target round percentage, right? Nice round income number. Spend what you can convert anything you don't manage to spend.
Option number three, $4 million IRA at 6%. That's $240,000 per year, about $20,000 per month. That sits inside of Irma tier 1. And that's okay for a $4 million IRA. avoiding avoiding Irma tier one entirely probably not very realistic or maybe even worth your efforts. This really illustrates the idea of in for a penny in for a pound principle. If you're going to be in tier one anyway, well, maybe you should convert enough to use that whole tier rather than stopping at a random number below that.
Now, a very important disclaimer to all this. All these examples should be proven out in a written retirement plan. Please don't just blindly spend money out of your portfolio based on a YouTube video. I take these examples from real situations that I work with with clients, but obviously your situation is unique to you. So, you want to prove this out in a written retirement plan that you either create yourself or with a retirement professional. Don't just blindly follow advice on YouTube.
Now, before we move on, I know some of you are sort of doing this math in your head and you're thinking, "Well, Ben, what about social security? How's that going to fit in?" Well, the short answer is if you're deferring Social Security, if you're not collecting yet, these examples work exactly as shown. Your IRA is your primary income source, and the math is really clean. If you are collecting social security, simply subtract that income from your target first. So, if your target is 120,000 and you're already collecting 20,000 in social security, you've got 100,000 of room left for IRA withdrawals and Roth conversions before you hit that that ceiling of that target percentage.
By the way, if you want to stay sharp on retirement planning without spending hours digging through content every week, I put together a newsletter every Thursday called This Week in Retirement, where I find the best retirement articles and videos and podcasts and any research on the internet, and I put it straight in your email inbox. So, it's free, it's fast, and it's built for people who want to take retirement planning seriously. So, sign up at this weekendretirement.com or click the link in the description.
Now, before we get to that year-end tax move that I promised, I want to address a question that I get more than almost any other question in my YouTube comments, and that's Ben, where are we paying the taxes from on this Roth conversion? And people get really hung up on this idea being, if I do a $40,000 Roth conversion, I want that entire $40,000 to land in my Roth IRA. So, I should only convert if I have money in a savings account or a brokerage account to cover that tax bill. Otherwise, I'm wasting part of that Roth conversion. And I understand the math. I understand what you're trying to do, but I want to offer you a different frame. And this is going to make even more sense when we talk about some year end tax moves. I would encourage you not to be a Roth conversion perfectionist, especially when we're following this spending first plan. Spend first and convert to a Roth IRA what's left. And here's why.
From a net worth perspective, it really genuinely does not matter where you pay the taxes from. If you owe $10,000 in taxes on a conversion and you pay for that out of your savings, well, your net worth goes down by $10,000. If you withhold it from the IRA itself, your net worth still goes down by $10,000. Yes, we're paying taxes from different pockets, but from a net worth perspective, we get the same place. So, in a spending first retirement plan where our goal is a smaller traditional IRA, not necessarily the the perfect Roth, Roth conversion perfectionism actually becomes an excuse in many cases not to convert because you don't have outside assets to pay the tax bill and that leaves your IRA larger than it needs to be, which is exactly what we're trying to avoid in this situation. So, convert, pay the taxes however it makes sense, and move forward. Again, emphasis on actually spending the money over Roth conversions and it all fits into your target percentage.
All right, here's that year- end tax move that I promised. And this is how we actually run it for clients. And there's a bonus in here that a lot of people I think miss altogether. So, in October, November time frame, we sit down and we calculate everything involving taxes for that year. We carefully look at what was actually spent that year, where income landed. social security, pensions, capital gains, what have you, whatever came in, and we calculate that total tax liability for the year. And then we figure out the conversion amount based on whatever room is left in that target bracket or that target percentage. Then in December, we move the money. We make all of our conversions, and we pay our taxes all at the same time. And we do that in December because we want to know exactly where our income is going to land before we pull the trigger on moving any money. because I've seen people do big Roth conversions in March because they're, you know, excited about the idea of Roth conversions and then we have some sort of unexpected income event later on in the year and then that's going to mess up any planning that we did, right? That's going to push them over any target bracket, whatever penalties and Irma and taxes come along with that. So, if we wait until December, we've got the most certainty about our income than that we can possibly have.
Now, here's the bonus, and this is specifically for people over the age of 59 and a half. Most people following this plan really aren't doing much withholding right throughout the year. So, you might expect that they're going to pay some sort of quarterly taxes or they're going to have withholding from social security or from their investments or what have you. Here's what most people don't know. Withholding from an IRA distribution is treated by the IRS as equally distributed throughout the year, even if it happens in December. No underpayment, no penalties, no interest. The IRS treats it as if you've been paying steadily all year long.
Now, even if you time everything correctly with your withholding, it is possible to still get stung with underpayment of taxes. So, I'll add a quick refresher for avoiding that as well. You can avoid penalties by meeting one of our safe harbor rules. So, we've got the 90% rule, and that tells us that if we pay at least 90% of the tax shown on our current year's tax return, and this is the number that we're calculating at the end of our year and tax meeting, we'll avoid any underpayment penalties. Then, we've got the 100% rule, which is pretty easy. that is pay 100% of the total tax shown on the previous year's tax return. So we just this year we're paying 100% of last year's bill that comes with one bit of fine print and that's the high income exception. If your adjusted gross income was over 150,000 or 75,000 if you're married filing separately, you've got to pay 110% of last year's tax bill.
So in our December meeting, One Move does three things at once. We calculate the Roth conversion, we calculate the full year's tax liability, everything from all sources, all taxes owed. And then we send the entire payment as a withholding from that same IRA distribution. And here's the part that always makes clients smile all year long. That money that you would have been paying in quarterly estimated taxes, well, it's been sitting in your money market all year earning interest. And depending on interest rates and the size of your tax bill, that's a few hundred to even a few thousand in extra earnings just by being intentional about your timing.
So set that target percentage in January. Spend first. Really spend it on things that matter. convert whatever's left at the end of the year when you've got the most amount of certainty in December. And certainly don't be a Roth conversion perfectionist. If you'd like help building this plan for your specific situation, that's exactly what we do in our retirey blueprint. Click the link in the description and we'll walk through your numbers together. So until next time, my name is Ben. I hope this video helped to make your retirement even better.