Thread by @roncaruthers

1. How to Strategically Convert Your Traditional IRA or 401K to a Roth IRA Part TWO:

In part one, I explained the difference in how Roth and Traditional IRA's work both in the way they are taxed and what those taxes look like.

If you missed it, you can read it here:

https://twitter.com/roncaruthers/status/1423426690148179976

2. So now, let's assume you want to convert, what is the best way to do that?

I'll give you 3 strategies to keep in mind.:

Here you go:

First, there is the Tax Capacity Method:

3. Here's what that means...

You pay attention to what tax bracket you're in, and pull as much as you can withOUT going into the next larger tax bracket.

So, the brackets are as follows (for now):

10%
12%
22%
24%
32%
35%
37% (Likely going to 39% plus)

4. If you notice, the big jumps are 12-22%, a 10% increase, and 24 to 32%, an 8% increase.

The rest of the increases are relatively modest.

So, here is an example of how the Tax Capacity Method works:

Let's go back to my example of a 30 year old making 50k a year.

5. They would get a Standard Deduction of $12,400 for last year (2020) and their Federal Tax rate would be 12%, and after the deduction, they would pay $4,315.

The question is: how much more can they pull out without going into the next bracket of 22%?

6. The answer is $2,500.

So, they can convert $2,500 that year, and still stay in the 12% bracket, so they only pay $300 in taxes on that conversion amount.

NOW, IF there are some capital losses OR a side hustle that has losses, we can use those to convert more.

7. So, let's say they have $3,000 in Capital loss carry forwards, we can convert another $3,000 and pay NO taxes on that, because they offset each other.

8. Or, if they're getting a side hustle going and have $5,000 in losses getting the business running (often which are just normal bills that are now deductible), we can use that amount and pull another $5,000 and still be in a 12% tax bracket.

9. So this is one method.

Paying attention to your tax capacity throughout your entire life is a HUGE life and tax hack.

In fact, we meet with our clients at the end of the year as best we can to determine what they're eligible for, especially if they own businesses.

10. Now, let's talk about the 2nd method.

The 'Available Cash' method.

Since you're going to have to pay the taxes out of money in hand (rather than from what you convert), this simply means that you need to pay attention to how much money you have before converting.

11. In other words, lets say you just want to get the Roth conversion OVER with...even if you pay a little more in taxes.

You would wait until the end of the year, see how much money you have to pay those taxes with, and then figure out how much you can convert based on that.

11.5 Or....better still, you'd figure out that number at the beginning of the year, so you can use the 3rd method I'm about to show you as well.

12. So, let's say our 30 year old has $5,000 at the end of the year extra to use towards the taxes on the Roth conversion:

We simply would figure out how much that would buy us.

In this case, it looks like we could convert $24,000 in one year and raise federal taxes by $5,000.

13. If you have state taxes, then you'll have to figure in those as well.

I just left those out for the moment to keep this simple.

If you want a good calculator to help with this, @smartasset has a great one.

smartasset.com/taxes/income-t…

Just put in your city and state,

14. Finally, we get to the 'Loss Discount' method.

What's that?

It simply means that you watch and wait for the markets to drop, then convert immediately when they do, so you get the 'discount' when you pay the taxes.

15. If the markets drop 20%, and you were going to convert $10,000,

you now convert $8,000....and save the taxes on the $2,000.

If you're going to do this one, I would have your Roth account ready to go at the same place your Traditional IRA is, so you can journal stuff.

16. Journaling simply means it's getting moved over 'in-kind' immediately.

That way you don't miss out if the markets recover the next day.

Now, what method do I recommend out of these 3?

Answer: ALL of them.

17. In other words, figure out first how much money you have to pay the taxes and what your tax capacity is, so you know how much you can reasonably convert.

AND get the new account ready to go.

Then, I'd watch for a dip in the markets to take advantage of.

18. If none come before the end of the year, then go ahead and convert anyways.

IF that's too much work, then convert 1/4th of what you were going to do each quarter and just avoid the end of the quarters when the numbers tend to jump around a little more

19. The most important piece of all of this is to have a plan rather than just winging it and paying a bunch of taxes you don't need to, or being stuck when you get the tax bill.

And hopefully, these 2 threads opened your eyes to how to do this and save the most money.

20. Oh, and if you're trying to research the methods I just described, good luck.

Those are my names for them, so I'm not sure you'll find them anywhere else.

However, you have what you need for now to do this strategically and efficiently.

21. Paying the least in taxes is THE best way to stick it to the man.

And you can quote me on that!

/end.