The Power Of Zero Show Convert to Roth… But Not TOO Much: The $400,000 Rule Explained
David McKnight addresses an issue he sees more and more in his conversations with retirees and pre-retirees: the so-called Roth over-conversion trap.
The problem stems from converting too much money with the result of shortening the lifespan of your retirement savings.
David believes that the reason why many Americans are racing to convert everything they have in their IRAs and 401(k)s has to do with the fear about where the country is headed financially.
Penn Wharton has warned repeatedly that, if we don't right our fiscal ship by 2043, no combination of raising taxes or reducing spending will arrest the financial collapse of the country.
According to former Comptroller General of the U.S. Government David M. Walker tax rates could have to double to pay for the country's massive $200 trillion unfunded obligations for Social Security, Medicare, and Medicaid.
The debt-to-GPD ratio, which is one of the simplest measures of a nation's financial health, keeps climbing higher: By 2035 it will be at 150%, while by 2043 at nearly 200%.
David warns that what most people don't realize is that in their zeal to avoid higher taxes, they may actually be marching straight into an over-conversion trap – which is just as dangerous as not converting enough money into tax-free.
If you end up not having taxable income left to be offset by your standard deduction, you'll end up having a tax shield with nothing to protect.
In other words, your deduction will sit idle, completely unused, and will go to waste every single year.
That's why David suggests leaving a small, strategic amount of money in your tax-deferred bucket.
The idea is to want enough in your IRA or 401(k) so that when required minimum distributions begin at age 73 or 75, those distributions are offset by your standard deduction.
David touches upon what he refers to as the "Holy Grail of retirement planning:" You got a deduction on the way in, you grew your money tax-deferred and then you took the money out 100% tax-free by offsetting it with a standard deduction.
The million dollar question is how much should you leave in your IRA or 401(k) to make everything work? That's roughly $400,000 for married couples, around $200,000 for single retirees.
If you aren't strategic with your retirement planning approach, you may have up to 85% of your Social Security taxable at your highest marginal tax bracket.
David sees ensuring your money lasts as long as you do as the #1 retirement planning goal.
Remember: you shouldn't reflexively convert 100% of your tax-deferred retirement savings to tax-free.
You want to be aware of how the standard deduction in retirement works and execute your Roth conversion strategy accordingly.
Mentioned in this episode:
David's new book, available now for pre-order: The Secret Order of Millionaires
David's national bestselling book: The Guru Gap: How America's Financial Gurus Are Leading You Astray, and How to Get Back on Track
Tax-Free Income for Life: A Step-by-Step Plan for a Secure Retirement by David McKnight
PowerOfZero.com (free video series)
@mcknightandco on Twitter
@davidcmcknight on Instagram
David McKnight on YouTube
Get David's Tax-free Tool Kit at taxfreetoolkit.com