When and Why To Use Roth Conversions

So today we're talking about Roth conversions.

And for the solopreneur, the entrepreneur out there, conversions have really powerful opportunities because our income changes year to year.

And because our income changes year to year, it gives us opportunities to use conversions to our long-term advantage in years, in particular, where the income drops.

And so today we're going to talk about why to use them, when to use them, how to use them, that sort of thing.

So first of all, but where and really where I want to start is what exactly is a Roth conversion? So what we're doing in a Roth conversion, say we have money in an IRA or an old 401k or something like that.

How that works is, I should say, is that money is going to be taxed when you take it out come retirement, right? So let's say that money continues to grow until you're 65 and then you take out $100,000.

That $100,000 is taxed at your income tax rate.

What's more important, probably even more than that, is at 75, for most people now, when they hit 75, they have to take a certain percentage out.

So when that happens, particularly those who, you know, we're entrepreneurs, we expect some success at some point.

If you have... high Social Security, you have other retirement accounts, and you have RMDs all hitting at once, you can have a very large income tax bill, even though you're 75.

And so one thing that we do over the course of our life is use what's called Roth conversions.

Because what we can do is say, hey, you know that traditional IRA that I had? Well, or have? Well, There's $50,000 in there.

I'd like to take $25,000, declare it as income today, and then move it into a Roth.

So what I'm doing is paying taxes on that $25,000 that I am now moving into a Roth, and now I will never have to pay taxes on it again.

So let's say you're in your 40s, you do that, and it has 20, 25 years to grow, and now it's $300,000, let's just say.

that $300,000 is tax-free.

You no longer have to pay taxes on any of that.

And so that's the real power using these in retirement.

And more importantly, at 75, you don't have to take required minimum distributions using that money.

It can continue to grow.

So if you have plans to pass along money as well, then it's a really useful tool for that in estate planning.

So all of those reasons are reasons that we consider Roth conversions.

um at all times now the reason that we're often not doing that in our 40s and 50s is because our income is higher than it ever will be but and you can kind of imagine the math right because if your income is higher now than it will be 10 years from now well we'd rather not pay income tax on it now and pay income tax on it when it's a lower rate 10 years from now and so we wouldn't want to do the conversion in that rate right But what can happen is, particularly for the self-employed, is income can be way up one year and way down the next year.

And it could be expected, it could be completely controlled, and it could be completely natural to the business, but it's down.

And so when it's way down like that, that's when we're like, oh, did the income tax rate drop? Well, this might be a good year for conversions because now we can Convert that money at that lower tax rate and never have to pay taxes on that again.