Bull Financial

𝐖𝐡𝐞𝐧 𝐈𝐬 𝐓𝐡𝐞 𝐁𝐚𝐜𝐤𝐝𝐨𝐨𝐫 𝐑𝐨𝐭𝐡 𝐄𝐯𝐞𝐧 𝐖𝐨𝐫𝐭𝐡 𝐃𝐨𝐢𝐧𝐠?

Before reviewing the rules and strategies for efficiently and effectively using the backdoor Roth strategy, let us first address the concern raised by many advisors, clients, and tax preparers, which is some variation of, "This sounds like a lot of work for $7,000 or $8,000"

Going around to the back door makes sense when you can’t get in through the front. Making backdoor Roth contributions is an extension of the broader decision that going with a Roth makes sense for a particular taxpayer. For taxpayers who are concerned they will be in a higher tax bracket in the future, either because their income increases or because tax laws change, backdoor Roth contributions can be a great tool for filling up their tax-free bucket. We should first explore contributory Roth options through employer sponsored retirement plans (which don’t have the income limits that Roth IRAs do) and verify the taxpayer can’t make direct Roth IRA contributions before beginning backdoor Roth contributions.

To understand the value of the backdoor Roth strategy of 'just' $7,000 annually, backdoor Roth contributions of $7,000 in each of the next 20 years growing at 10% annually could produce a tax-free bucket of some $400,000(double, if married.) Which, in round numbers, would save you some $50,000 in taxes.

The Backdoor Roth Strategy Sounds Great, But What Exactly Is It?

It's important to first acknowledge that the backdoor Roth IRA contribution is not officially a 'thing', at least not to the IRS, but rather a tax loophole that the IRS and Congress know about but have chosen not to close (thankfully, the IRS has acknowledged that taxpayers are using this strategy and has not made any focused effort to prevent or crack down on it).

More specifically, the backdoor Roth IRA strategy consists of a 2-step process involving 1) a contribution made to a traditional IRA, followed by 2) conversion into a Roth IRA. This process is designed to get annual contributions into a Roth IRA for taxpayers whose income levels surpass the Roth IRA contribution phaseout range, precluding them from making these contributions. For 2024, the income phaseout for a taxpayer (Married Filing Jointly) making contributions to a Roth IRA ranges from $230k to $240k of Modified AGI (reported on Form 1040 Line 11, with some adjustments)

What is Co-Mingling?

Unfortunately, things get complicated quickly if taxpayers have existing IRA dollars (in any account) and/or if they plan to rollover funds from a qualified account at any point during the year. This is because of the IRA Aggregation Rule which states the value of all IRA accounts will be aggregated together for the purpose of any tax calculations.

Example: Bob, did a $6,500 backdoor Roth. But has $100,000 of pre-tax money in another IRA.

Because of the $100,000 pre-tax and $6,500 after-tax balances, the combined total account value reported on Line 6 of Form 8606 would be $100,000 + $6,500 = $106,500, which means that every future distribution would be approximately $100,000 ¸ $106,500 = 93.9% taxable and $6,500 ¸ $106,500 = 6.1% tax-free.

So instead of Bob's $6,500 being converted wholly tax free as he originally thought would be the case, what actually ended out happening was that only $6,500 ´ 6.1% = $397 was tax free, and the remaining $6,500 – $397 = $6,103 was taxable!

Anything Else I Should Know About Backdoor Roth Conversions?

Anytime we are talking about IRAs, Roths, contributions, and/or conversions, we need to revisit both the 5-year rule that applies to Roth conversions (which serves to determine whether the principal of amounts converted to Roth can be considered penalty-free), and the 5-year rule that applies to Roth contributions (which serves to determine whether a withdrawal of growth from a Roth IRA would be considered a tax-free 'qualified' distribution, and for which separate rules exist for Roth accounts under employer retirement plans).

Any distributions taken from a qualified account are characterized in the following order: first from Contributions, then from Conversions, and lastly from Growth.

The 1st 5-year Rule (for Roth conversion principle) says that account owners under age 59.5 must wait 5 years before they can withdraw the principal of a prior Roth conversion without penalty (ignoring any other qualifying event). Once the client reaches age 59.5, this 5-year rule is no longer an issue.

The 2nd 5-year rule (for Roth growth of any type) says that any Growth on a Roth (from contributions or converted amounts) cannot be withdrawn without penalty until they have had any Roth account open for at least 5 years (and they must be over age 59 ½, or deceased or disabled, or using the money under the first-time homebuyer exception).

If this all sounds complicated and labor-intensive, take a step back to remind yourself that strategies like these can be beneficial and well worth the time and effort they require to implement; taking the time to understand them can result in numerous tax-free dollars.

Bull Financial has vast experience with Roth IRA planning. Everyone’s unique situation creates its own path of action to create their most tax-efficient scenario. Use the link below to schedule a quick 15 minute phone call or Zoom to see if Roth planning makes since and could benefit your financial future.

Barry Barnette

Bull Financial

https://bull.financial/

ARE REQUIRED MINIMUM DISTRIBUTIONS SATISFIED FROM A ROTH CONVERSION?

Hello!

As the likelihood of higher tax rates increases, many proactive investors are looking to the Roth Conversion to protect
their retirement assets. As they do so, one question sometimes arises: Does the amount that you convert to a Roth
IRA count towards the Required Minimum Distribution? The short answer is no.

Let me illustrate with an example: Let’s say you want to convert $30,000 from your IRA to your Roth in a given year.
Let’s also say that in that same year, you have a Required Minimum Distribution of $20,000. Before you can do any
Roth Conversions, you are required to first take your $20,000 RMD. Once received, you can then proceed with your
Roth Conversion. Remember, however, that both the conversion and the RMD are taxable events, so be prepared to
pay taxes on an additional $50,000 of income. If this is too pricey, you can still do a Roth Conversion, but perhaps at
a lower amount.

What typically becomes of the $20,000 RMD, especially if you don’t need it for lifestyle purposes? In many cases,
these RMDs get deposited into some sort of taxable account like brokerage account or just a savings account, etc..
So, that $20,000 moves from an environment where it only gets taxed once, upon distribution, to an environment
where you will pay taxes yearly on any realized gains or dividends you experience. Doing this only creates a more
taxable imbalance in your financial situation and may lead to increasing your tax liability. So, instead of depositing this
into one of your taxable accounts, contemplate using it to pay taxes on your conversion, fund a Roth IRA (if possible),
or fund a life insurance program that has long-term care benefits.

We hope this information has helped clarify these questions and helped you with some new ideas as well to help your
financial situation!

Sincerely,

Barry Barnette
Bull Financial
404 Memorial Drive Ext.
Suite C
Greer, SC 29650
(864) 469-5991

Advisory Services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor.
Securities offered through Registered Representatives of Cambridge Investment Research Advisors, Inc., a broker-
dealer, Member FINRA/SIPC to residents of South Carolina, North Carolina, Florida, Tennessee, Texas, and Illinois.
Cambridge and Bull Financial are not affiliated.
Cambridge does not offer tax or legal advice.
Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors
should be prepared to consider loss, including loss of principal.

https://bull.financial

The Complexities of Roth Conversions

Roth conversions essentially involve paying income taxes on pre-tax retirement funds in return for tax-free growth and withdrawals in the future. Deciding whether to convert pre-tax assets to Roth is seemingly straightforward: If converting and paying taxes today would result in a lower tax rate compared to future withdrawals, then a Roth conversion is logical. Conversely, if the converted funds would be taxed at a lower rate upon withdrawal in the future, it's more sensible not to convert.
However, determining the appropriate tax rate for this analysis is not as simple as solely looking at an individual's current taxable income and their corresponding tax bracket at the federal or state level. The tax bracket alone often fails to capture the actual impact of a Roth conversion due to additional effects triggered by income adjustments, which are not considered when assessing the tax bracket.
For instance, when an individual receives Social Security benefits, adding income through a Roth conversion could raise the taxable portion of those benefits. As a result, the increase in taxable income caused by the conversion goes beyond the converted funds alone, amplifying the tax impact beyond what the tax bracket indicates. Similarly, the reduction in tax resulting from replacing pre-tax withdrawals with tax-free Roth withdrawals can also be magnified by a decrease in the taxable portion of Social Security benefits.
Consequently, relying solely on tax brackets to decide whether or how much to convert to Roth may lead to ill-informed choices. Instead, it is crucial to determine the "true" marginal rate of the conversion—the increase or decrease in tax solely attributable to the conversion itself—to fully comprehend its impact. Understanding the true marginal rate enables strategic timing of conversions to minimize negative add-on effects (e.g., avoiding Roth conversions that would increase the taxation of Social Security benefits) and maximize positive effects (e.g., utilizing converted funds to reduce pre-tax withdrawals, thereby reducing the taxation of Social Security). This approach maximizes the overall value derived from the decision to convert assets to Roth.

Roth conversions are a popular tax-planning strategy used by individuals to minimize the impact of taxes on their retirement portfolios. The strategy involves converting funds from a tax-deferred retirement account, such as a traditional IRA or pre-tax 401(k) plan, into a Roth IRA. Although the conversion amount is taxable in the year of the conversion, the newly converted Roth funds can grow tax-free, and future withdrawals of both principal and earnings are fully excluded from income tax.
The usefulness of Roth conversions lies in their ability to take advantage of shifting tax rates over time. Taxpayers can choose when to pay taxes on their retirement account funds, and if timed correctly, they can ensure that those funds are taxed at the lowest rates possible.
For instance, individuals in low-income years, such as retirees who have not yet filed for Social Security benefits, can convert funds to a Roth account and pay taxes at lower rates compared to withdrawing the funds later when their income is expected to be higher. This strategy locks in a permanently low tax rate on the converted funds, making Roth conversions popular among recent retirees, especially during the "gap years" before Social Security benefits begin.
Recent economic and financial conditions, such as bear markets and early retirements due to the COVID-19 pandemic, have made Roth conversions even more favorable. Bear markets create opportunities for converting pre-tax funds to Roth because lower portfolio values allow individuals to convert a greater proportion of their funds. Additionally, early retirees with lower incomes can take advantage of Roth conversions at lower tax rates.
However, Roth conversions may not be suitable for everyone. The decision to convert funds to Roth depends on comparing the potential cost of increased taxes today with the expected benefits of reduced taxes in the future. Conversions only make economic sense if the funds converted to Roth would be taxed at a lower rate today than if left in a tax-deferred account.
Furthermore, determining how much of an individual's pre-tax funds should be converted to Roth is not always clear. Large conversions can push tax rates higher, reducing the advantage of paying taxes sooner and potentially negating the tax benefits. The decision of how much to convert requires comparing the potential cost of increased taxes today with the expected benefits of reduced taxes in the future.
The comparison between current and future taxes in a Roth conversion is typically made based on tax rates. If the tax rate on the conversion is lower than the expected future tax rate, it makes economic sense to convert funds to Roth. Conversely, if the tax rate at the time of conversion is higher, it is generally better to delay paying taxes until withdrawing the funds. If tax rates are the same at both points, converting or not converting funds would have the same wealth outcome, unless there is an expectation of future tax rate increases.
When considering how much to convert, it is important to understand that Roth conversions have diminishing benefits as the amount converted increases. Higher conversions can push taxpayers into higher tax brackets, reducing the benefits of converting funds to Roth. If the conversion is large enough, it may result in higher tax rates than would be paid in the future. Therefore, it is advisable to limit the conversion amount to avoid diminishing or reversing the tax benefits.
Tax brackets alone do not account for the full effects of Roth conversions. Tax brackets determine the amount of tax owed on the next dollar of taxable income, but they do not capture the complex interactions and add-on effects of a conversion. For example, the taxation of Social Security income and other factors can significantly impact the actual tax rate on a Roth conversion.
Factors such as increased ordinary income leading to higher capital gains taxes, changes in the threshold for deductible medical expenses, reductions in the Section 199A deduction, and phaseouts of state tax benefits should also be considered. The add-on effects can affect various aspects of taxation, such as the taxation of Social Security income, Medicare premiums, and other deductions and credits.
To accurately determine the value of a Roth conversion, it is crucial to calculate the actual change in tax liability resulting from the conversion. This involves calculating the marginal tax rate for the change in income. The marginal tax rate is the amount of positive or negative change in tax for each dollar of income added or subtracted.
Tax planning and financial planning software can assist in analyzing the impact of a Roth conversion. These tools can calculate the additional tax owed on various conversion amounts and project the impact on future years. They can account for the add-on effects and provide a more comprehensive analysis than simple tax brackets.
In conclusion, analyzing the effects of a Roth conversion requires a thorough understanding of the individual's tax situation, future income projections, and the add-on effects of the conversion. It is important to consider factors beyond tax brackets, such as the taxation of Social Security income and other tax-related interactions. By accurately calculating the true marginal tax rates and leveraging the add-on effects, individuals can maximize the tax savings from a Roth conversion and make informed decisions about their retirement accounts.

If you are interested in a Complimentary Roth Conversion Plan for your personal situation, feel free to schedule an online or in-person consultation using the link to my calendar below.

Have a great day,

Barry

Click here- https://calendly.com/barry-241/30min?month=2022-02 to schedule a meeting with Barry.

Barry A. Barnette Investment Advisor Representative Bull Financial 404 Memorial Drive Extension Suite C Greer, SC 29651 Phone: (864)469-5991 Fax: (864)751-6344 Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Bull Financial, LLC and Cambridge are not affiliated. The Information in this email is confidential and is intended solely for the addressee. If you are not the intended addressee and have received this email in error, please reply to the sender to inform them of this fact. We cannot accept trade orders through email. Important letters, email, or fax messages should be confirmed by calling (864)469-5991. This email may not be monitored every day, or after normal business hours.
Cambridge does not offer tax advice.