By: Alena Wiese
Chris Quintana is a renowned CEO and financial expert specializing in teaching clients how to achieve financial freedom in a much shorter time frame than traditional financial advice does.
“At CQ Consulting Services, our mission is to empower individuals with safe, innovative, and intentional strategies that can transform their financial lives. We want to help people make more money, keep more of it, and start living more now.’None of us are promised tomorrow,’” said Quintana, who advocates using Roth IRAs for tax-advantaged growth.
A Roth IRA offers a unique advantage for retirement savers: it allows you to pay taxes on your contributions today and then enjoy tax-free withdrawals in the future, which can be especially beneficial in a landscape where future tax rates are likely going up. You may know this about Roth IRAs, but due to earning too much or having contributed to your employer’s 401k; you may think it is impossible for you to enjoy these benefits, but that is not the case- you can with a Roth Conversion, Quintana likes to call it a backdoor Roth for those who make too much to qualify.
In this article, we will explore the mechanics of Conventional Roth IRA conversions, dissect the benefits with practical examples, and highlight the potential impacts on your financial planning.
What is a Roth IRA Conversion?
A Roth IRA conversion involves transferring funds from a traditional IRA or 401(k) to a Roth IRA. Here’s how it typically works:
- Determine the amount to convert from your traditional IRA or 401(k) to a Roth IRA.
- Pay income taxes on the pre-tax dollars converted for the year of the conversion.
- Enjoy tax-free growth and withdrawals on those converted funds, subject to Roth IRA distribution rules.
Key Benefits of Roth IRA Conversions
Tax-Free Growth and Withdrawals
Traditional IRA accounts and 401(k) accounts are tax-deferred accounts. When filing taxes, it is a tax deduction- which can be beneficial to your current year tax strategy, but when assessing your overall tax strategy – how your money is taxed now AND in the future- deferring taxes can be a costly mistake! There are two reasons: (1) You delay paying taxes on the contribution and growth until it is larger. If you pay taxes on the amount now- when it is the “seed,” you will be paying a percentage of a smaller amount of money, whereas if you wait to pay taxes on the amount when you withdraw- when it is the “harvest” you will pay a percentage of more money. (2) The TCJA sunsets increasing the tax rate as of January 2026, so in essence, you are deferring taxes into the future when the tax rates are going to be higher.
Example: Mary contributes $22,500 to her Solo 401(k). She was able to use that as a deduction in her 2023 taxes. In this example, we will say she was in the 24% bracket, saving her $5,400. However, the amount contributed and the growth will be taxed in the future. If she were to make the stock market average of 8% per year, after 20 years, $22,500 would turn into $104,871.54. If she were to withdraw that, again using 24%, she would pay $25,169.16. So, to save $5,400 today, she is paying $25,169.16 in the future- not a good financial move! To further this point, the tax rate will be higher in the future. After TCJA sunsets, those in the 24% tax bracket will be charged 28% in taxes. So when Mary withdraws, she will be paying $29,364.03. It makes more financial sense to pay the taxes now!
No Required Minimum Distributions (RMDs)
Since the release of the Secure 2.0 Act, Traditional IRA accounts require you to start taking minimum distributions (RMDs) at age 73, regardless of whether or not you need the funds or what your tax situation is for any given year, which can lead to higher taxes and a quicker depletion of your retirement funds. Roth IRAs, however, do not have RMDs during the owner’s lifetime, allowing the funds to continue growing tax-free.
Example: Jane has converted to a Roth IRA and does not need to take withdrawals at age 73, allowing her account to grow until she decides to withdraw or pass it on to her heirs-tax free.
Compared to John, at 73, who retired comfortably with income from his pension, social security benefits, and taxable investments totaling $191,550 annually, placing him in the 24% tax bracket. However, due to Required Minimum Distributions (RMDs) mandated by the IRS, he is required to withdraw a set percentage each year. For instance, if he has $1,000,000 in a Traditional IRA with an RMD rate of 3.67%, he must withdraw $36,700. This withdrawal boosts his annual income to $228,250, moving him into the 32% tax bracket. This is detrimental to John because not only is he paying taxes on these funds, but he has also been forced to remove them from the account that benefits from compound interest.
This scenario highlights a common misconception that retirees will always be in a lower tax bracket. In reality, RMDs can push you into higher tax brackets, increasing tax liabilities. Consequently, converting traditional retirement accounts to Roth accounts while in a lower tax bracket can be a strategic financial decision to mitigate future tax burdens.
Effective Tax Rate Management
The conversion allows taxpayers to lock in their current tax rates, which can be advantageous if rates are expected to rise.
Example:
We have already discussed Mary’s contribution to a traditional account this year and how it wasn’t a financially sound strategy. But what about those who cannot contribute to a ROTH or who have accumulated a substantial amount in a traditional account?
Well, the same logic applies. If you have $1,000,000 in a traditional IRA today, you could convert it into a ROTH by paying taxes on the million dollars. For example, you pay 30% or $300,000 on that million. That sounds painful, I know. Now imagine that a million dollars turns into $2.158 mil, and you have to pay 30% taxes. You would owe $647,400. Which would you rather pay?
Mitigating Social Security Taxation
Converting to a Roth IRA could reduce the taxes owed on Social Security benefits since Roth withdrawals are not considered income to the IRS. The IRS looks at your total annual income when determining how much of your Social Security benefit to tax. Fortunately, for those who have Roth IRAs, whatever you take out of that account doesn’t count towards your total taxable income; therefore, you keep your taxable income low, which is good in this case because the IRS will only tax a certain percentage of your benefit. The lower your total taxable income- the lower the percentage being taxed.
Example: Lisa and Mark receive $50,000 annually in retirement income. Without Roth conversions, up to 85% of these benefits could be taxable(if married filing jointly, when your combined income is more than $44,000, you are taxed on up to 85% of your benefits). By converting to a Roth IRA, they reduced the taxable income for the year to only the amount of their Social Security benefits, which were below the taxable threshold, saving them thousands in taxes every year.
Reducing Medicare Premiums
This is one area most people don’t understand, and it is one of the big land mines designed to make them more money. Remember, the less you know, the more *they make. The higher your taxable income level, the more you pay in Medicare; it goes off of a sliding scale. So, reducing your taxable income through Roth conversions can lower these premiums dramatically. The sooner you realize that having to take RMDs will affect your Income levels and will affect Medicare Part B and D premiums -you can flip that script.
Example: Converting $100,000 from a traditional IRA to a Roth might increase your taxable income this year. However, future Medicare premiums could be lower since Roth withdrawals do not count as income, which could save you tens of thousands of dollars over the course of your retirement years.
Benefits to Heirs
An inherited IRA, also known as a Beneficiary IRA, is an individual retirement account created when you inherit a tax-advantaged retirement account like an IRA or a 401(k). Whether you’re the spouse of the original account holder or not, the rules for handling the inherited IRA vary based on factors like whether required minimum distributions (RMDs) were taken, your beneficiary status, and the age of the original account owner at their passing. Understanding these rules is crucial because they determine how quickly and how much you’ll pay in taxes on the inherited IRA, which can be a significant financial burden.
For instance, imagine Sarah leaves her $1,000,000 Traditional IRA to her daughter June, who is a designated beneficiary under the 10-year rule. This rule requires June to distribute the assets from the inherited IRA over 10 years, culminating in a full liquidation by December 31st of the 10th year after Sarah’s death. Without proper financial planning, June might face an unexpected tax bill of $755,623.75 at a 35% tax rate after ten years of growth.
However, had Sarah (mom) converted her Traditional IRA to a Roth IRA, the tax burden could have been significantly reduced. Even at a 35% tax rate, the tax liability would have been just $350,000, less than half of what June faced under the inherited IRA rules. Plus, with a Roth IRA, June could access the money tax-free whenever she wanted, offering greater flexibility and financial security.
Strategic Tool: Roth IRA conversions
Roth IRA conversions offer a strategic tool for managing retirement savings and future tax liabilities. By converting, you can potentially save on taxes, reduce mandatory distributions, and provide better benefits to your heirs. As with any financial planning tool, it’s advisable to consult with a financial strategist to tailor the strategy to your personal circumstances and goals. This proactive approach can secure your financial future and ensure you maximize the benefits of your retirement assets. This all sounds amazing, right?
It is, but the tax liability is more than many can stomach, so millions of traditional qualified accounts (IRAs, 401ks, and the like) go unconverted. That only kicks the tax can down the road when the tax consequences are likely to be much worse and unavoidable.
Uniquely, CQ Consulting Services offers a two-part ‘reduce and recover’ conversion. This strategy presents traditional tax-qualified plan owners with a way to dissolve the partnership with Uncle Sam today. Chris Quintana likes to call it a discounted Roth Conversion, where clients convert money that was never theirs – into forever theirs.
There is no minimum or maximum case size. CQ Consulting Services has helped clients convert traditional accounts as small as $100,000 – and as large as $5,000,000, with no upside limit. Chris Quintana’s strategies for achieving financial freedom are truly revolutionary. To connect with Chris, visit https://calendly.com/cqconsulting/roth-conversion-consultation
Financial Disclaimer: This content is for informational purposes only and is not intended as financial advice, nor does it replace professional financial advice, investment advice, or any other type of advice. You should seek the advice of a qualified financial advisor or other professional before making any financial decisions.
Published by: Khy Talara
