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IRA Financial Group Blog

Last Minute Roth Conversion Strategies – Episode 323

Adam Talks
13 Minute Read

In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses the pros and cons of the Roth conversion and why you may want to consider one before the end of the year.

2021 is coming to an end, and this could be your last chance to take advantage of a Roth conversion. In this podcast, we will go through the tax advantages of potentially doing a Roth conversion in 2021. I’m going to talk some of the items to consider before doing a Roth conversion, some strategies and then how we can prepare for 2022 Hey everyone. Adam Bergman here, tax attorney and founder of IRA Financial. And on today’s, Adam Talks last minute Roth conversion strategies for 2021.

So it’s hard to believe 2021 is coming to an end. It’s been a year. Most of us want to forget dealing with COVID and all kinds of other crazy stuff in the world. But from an investment standpoint, it’s been a very productive year. Here are some statistics to chew on, which could play into whether Roth conversion strategies makes sense for most of us.

So as of December 27, 2021, that’s when I’m recording this podcast, the S & P 500 is up 27% year to date. The Dow is up 18% year to date. The Russell 2000 is up 14% year to date. Bitcoin is up 78% year to date. Ethereum is up 459% year to date.

Gold is down 4.9%. So I wanted to look at some real estate numbers. So I took two contrasting states. Florida, which is very hot real estate market and California, which is more of a weaker real estate market. So here are some numbers.

Closed sales in November ’21 to November ’20:  27,500 from 26,000. Paid in cash: 8500 from 6000, a 41% increase. The median sale price has gone from $305 to $364, a 20% increase. The average sale price went from 432k to 507k, a 17% increase. The dollar volume went from $11.4 billion to $14 billion, a 22% increase.

So Florida has obviously been a super hot market. Obviously, why I’m saying all this is that when you do a Roth conversion, you do it based off the value of your asset on the date of conversion. So if you’re looking to do a Roth conversion today and your value of that underlying asset is up 15%, 20%, 40%, doing a Roth conversion makes less sense than it did if the asset was depressed. So if you look at California, this is from November. Monthly sales rose 4.7% on a monthly basis from October, down 10% from a year ago.

Okay, so you look at Florida, which is up. California is down on terms of sale price, sale pace. Excuse me, 10%. Okay, if you look at the median price $782,000 in November, it was down 2% from October, and it was up 11% from last November. So pricing is rising everywhere, whether it’s Florida, which is a hot real estate market, or California, which is a cooler real estate market; the pace is decreasing, but the prices are going up.

Okay, so honestly, other than Gold or a few other assets, obviously, there’s underlying stocks in the S&P 500 or the Russell 2000 or the Dow that has gone down. But if you look at overall, the markets, the markets are up. Okay? And that means that it may prove not very tax-efficient this year, at least, or right now to do a Roth conversion. So keeping that in mind, let me just briefly chat about what is a Roth conversion.

A Roth conversion means that you take a pretax IRA or pretax 401(k) and you convert it to Roth. Again, you pay ordinary income tax on the fair market value of the converted amount that includes cash plus/or the fair market value of the in-kind asset like real estate or stocks or Bitcoin. Tax is due next April, and it’s not capital gains, it’s ordinary income tax. So here are some factors to consider. And I’ve talked about this on numerous podcasts and videos.

But here they are again, number one, your age, the younger you are, clearly, the more tax opportunities you have to build-in tax-free growth. So doing a conversion at 40 versus 68 generally makes more sense, because as you get older, you have less time to take advantage of the power of tax-free growth. That’s one factor. Second factor, can you afford to pay the tax right? If you want to convert $2 million or $400,000 and that’s going to cost you $120,000 in tax, do you have it?

Taking the converted amount and using that to pay the tax doesn’t make economic sense, and you can run through those numbers. But you’re just literally pulling money out of the Roth to pay the tax on the conversion, makes no sense. Keep it pretax. Three, third item to consider doing a conversion, what will your tax rate be when you retire? If you’re going to be in a low tax bracket, you plan to retire, play golf or sail around the world after age of 72 and you’re just going to live off Social Security and some investments.

Then doing a Roth conversion maybe doesn’t make as much sense because you could just pull the asset or pull the cash out after 72 when you need it. So let’s say you have $100K combined, you and your spouse with Social Security, some passive investments and you’re 25, 30 grand short.  You just pull out the cash when you need it. Pay the tax on it.

There’s no penalty. You pay the cash to pay the tax on the cash. And luckily, your tax bracket will stay in the same bracket. And that’s what I tell people to do. Think about where your tax bracket will be, especially if you’re rounding 60s, getting to the 70s, and then think about how much income you need and then look at your retirement account and think about what you need to supplement your income to get to a comfortable place in your life, and then see where your tax bracket will be.

If going to that comfortable place will make you increase your tax bracket, then something to consider. Maybe the Roth conversion seems a little bit more attractive. But if you’re still going to stay at a relatively low tax bracket 20% or under, then maybe paying converted tax at a higher ordinary income tax rate maybe doesn’t make as much sense if your tax bracket at conversion, excuse me, at retirement will be low. So that’s another item to consider. One more item is, what are you converting?

If it’s cash, it’s cash. Okay, that’s just a tax on the amount of cash. If it’s an in-kind asset like stocks or real estate, where’s that asset value today? Is it depressed? Has it dropped 20 or 30% in value over the last year? Has it increased 20 or 30% in last year?

Where do you expect it to go in the next three to ten years? Something to consider. And the last item I think to consider is how much confidence do you have in this investment? If it’s an in-kind asset you’re converting or the cash you’re converting, how confident are you in your investment talents? If you’re not super confident, meaning, you know, you can hit between five or 10%, but you’re probably not going to hit 20% to 50%, then conversion looks a little less appealing.

But if you’re super confident, like, hey, the crypto I’m buying in 2022, let’s say Polygon, which I’m a big lover of Polygon, which has actually hit its all time high in the last week or so over $2.80.  And I think it’s going to go to $10 then yeah, Roths conversion on that asset maybe is worth the risk. But if it’s Ethereum and Ethereum is up almost 400% this year and I missed the boat, maybe I’m not as confident over the next two years or three years, depending on my age, because of the upside cap potential, at least the ceiling may be capped a little bit.

Now, again, there’s no right or wrong.

That’s something to be absolutely clear. There’s no right or wrong. I know people that have done conversions that have done fabulously well, because the investment needs to cash for hit. And I know some where disaster struck, where they converted an asset and it remained depressed or the asset went bankrupt or it’s subject to a lawsuit. And it’s been a nightmare.

So there’s no right or wrong. One other item to consider now, which we probably didn’t consider three or four months ago, is the government, right? We saw with the Ways and Means Tax bill, which I talked ad nauseum about which was released mid-September. There’s provisions in there that sought to cap retirement accounts at $10 million. Also, there were provisions on requiring you if you surpassed $10 million, even if it was ina  Roth and you’re under 59 and a half to do forced taxable distributions.

Now that part of the $10 million cap has been removed from the Build Back Better Act, which is technically right now in a coma, potentially dead but potentially could be resurrected. So, that’s one more wrinkle to consider that. Hey, can an administration in five years, ten years, 20 years, just change the rules on us again and say, hey, you know what? We need money, so tough, even though you think you have a Roth, if you’re under 59 and a half and it’s over x million, maybe it’s not ten, maybe it’s two, maybe it’s five.

You got to pay tax on it.

I’m not saying that’s going to happen, but that’s another wrinkle that we just haven’t had to experience really, ever since the last few months. Now, I’ve given this example before Social Security prior to 1982 was not taxable. Now it is. Okay. So things do change.

The government changes. All it takes is one policy initiative by someone in power, whether it’s Senator Wyden or Senator Sanders or Senator Manchin or Senator Sinema or a Republican Senator, anything championed by someone in power can become policy. So it’s just something else to consider. I don’t think that is as important as can you afford the conversion. Your age, your income rate now, your income rate when you retire and your confidence in your investment skills.

I think the government risk is low, but it’s still an element to consider, which prior to September this year, really wasn’t something to consider. So last minute stuff. One other thing to mention is your income level now, right? 2020, everyone struggled more than they did in 2021.

Other than just getting free money to the government we were dealing with COVID, there was no vaccines, there were shutdowns. It was an utter mess. 2021 has been a bit better. The free money has dried up, but generally equity markets, people have received higher salaries, raises. We all know about inflation.

People are doing better. Doesn’t mean they have more money in the bank, but they’re generally making more money because of increase in salaries and bonuses and the like. So with inflation, with a pretty tight labor market, incomes have gone up, so tax rates should go up. What does that mean for conversions? Well, if you have losses that you can use going forward, any losses from ’20, for example, that you can push forward, then maybe doing a conversion this year, even though your asset may have appreciated, could be a good strategy because it’s all about how much tax you’re going to owe on that conversion.

So even if you make $175,000, you’re married file jointly, you had a business loss last year that you can carry forward to this year that will reduce your taxable income and your tax rate to a super low number, even including a converted amount. Something to consider. Also another strategy. You don’t have to convert everything you want right away. Right?

If there’s an asset worth $200 and you’re in your 50s, you have literally 20 years to convert it. If you really expect to live in that asset, for example, over the age of 70 or it’s an income producing property and you’re going to want to live off that income tax free after the age of 72 and you got time to convert it. You generally don’t have to convert the whole asset at the same time. If it’s a home and you hold it directly in an IRA, you do have to do the conversion all at once.

But if you hold that asset in an LLC, you can do partial conversions of the LLC interest.

Also, if you have investment in an investment fund or a private business, you can also do partial conversions. Same with crypto. So there are strategies and there’s another strategy is, hey, do the conversion whenever the value is at its lowest. So if it’s December 30 or January 20 or it’s April 21, you always want to try to time the low end of the value. Now we know we can’t time the markets, right?

You don’t know when your Walmart stock is going to hit the lowest or your Procter and Gamble stock or your Tesla stock. Very hard to do that. Same with Bitcoin. Same with real estate, but you can take educated guess if you feel like, hey, the values drop 5%, 10%, 15%. I could potentially live with that and maybe even do a discounted valuation on top of that, maybe get another 20 or 30% based off the fact that it’s in illiquid investment, it’s raw land in an LLC or it’s a 2% interest in a private business that’s probably not worth as much as I paid for it because of the liquidity issue.

That’s another item to consider. So lots of strategies. Unfortunately, I wish I can tell everyone there’s a right or wrong. I probably talked to handful of people each week and they asked me my opinion, should I convert? And I’m like, first of all, I don’t want to give you any advice because I don’t know your full financial picture, right?

I’m not scouring your tax returns. That’s why you need to get and find a good accountant, someone that can run numbers for you and say, okay, Joe, if you convert $80,000, your tax bracket will go up to this. Now you have itemized deductions or you have standard deductions or losses. This is what you will pay. That’s why it’s important.

Yes, I can explain to you what the tax law says. Yes, I’m a tax lawyer, but no, I don’t have full access to your entire financial position, including tax returns and also other deduction opportunities, whether it’s accelerated appreciation or the like. So it’s important to think this through. I know it’s towards the end of the year. We’ve got a couple of days left in 2021.

There’s still chances to do conversions. All you need to do is elect to do it. You do need to get evaluation. But if you bought Crypto at $62,000 and now it’s at $50,000, hey, maybe you do the conversion now, or maybe you even sell it. Take the loss and then buy it back next year.

And that’s the last thing I wanted to talk about, even though it wasn’t part of the subject of this podcast. Capital Gain losses. Okay. And this is something I’ll probably chat about in the YouTube Live, so you can always go to our YouTube channel and check it out. It’s probably going to drop today, Wednesday.

But if you’re listening to this later on, then you can just go to IRA Financial, subscribe if you haven’t already and just check out the video. But this is a great last minute opportunity to do some loss harvesting. So the way it works. Is there something called capital loss, right? When you sell a capital asset like stocks or real estate, it’s deemed a capital loss because it’s a capital asset, so it will only offset against other capital gains plus $3,000 maximum of ordinary income.

Right. So if you make $100,000 as a teacher or a lawyer or a doctor and you have tons of losses on the capital side from cryptos or stocks or real estate, you can only use maximum of $3,000 of that loss to offset your ordinary income. But, you can harvest losses in the capital world. So if you have short term capital gains or long term capital gains, you have to first zero those out. So if you have $5,000 of long term capital losses and $2,000 of long term capital gains, you have $3,000 of long term capital losses, then you can use those losses to offset any short term capital gains.

But first you got to offset long losses with long gains, short losses with long gains. The net amount of that, you can then cross over to the other capital world just briefly. Long term capital gains means you hold the asset longer than twelve months. Short term capital gains means you hold the asset less than twelve months. You have to offset long term capital gains with long term capital losses.

First, you have to offset short term capital gains with short term capital losses first, and then you can take any net amount and net those out together. Your net on top of that, only can use $3,000 on ordinary income, which is basically compensation. The rest of it is carried over for other years. So something to keep in mind if you got a bunch of loser stocks, which we all do.

My kids wanted me to buy Peloton literally in the heart of the pandemic, so thankfully, they only put like, a couple of grand in there. I’ve lost tons. I’ve actually lost on Coinbase too. I chased that IPO for whatever reason, even though I use Gemini and I love Gemini, I just wanted to get some exposure to Coinbase, and that’s been a loser for me. So I’ve sold those positions this year.

I own them personally, and I’m going to harvest those losses and use at least $3,000 of those losses against ordinary income. Everyone who has losses should harvest and use at least $3,000 to offset ordinary income. It’s a free deduction, so you might as well take it. Now the Wash sale rules state you got to wait 30 days to buy back that position. So if you sell JPMorgan or Walmart or Salesforce or Boeing or Caterpillar at losses, if you want to take advantage of that loss on your tax return, you got to wait 30 days to repurchase that stock.

The wash sale rules do not apply to cryptos. You don’t have to worry about now. There was a provision in the Build Back Better Act that sought to apply the Wash sale rules to cryptos. But as I mentioned, that bill is in a coma right now, so seems like that may not work for 2022 as well, but in any event, sell your losses now.

Use your losses to offset capital gains and use at least $3,000 of those net capital losses to offset ordinary income. You still have a couple of days to do it. Talk to your broker, your advisor, your investment advisor. If you trade on your own, just take advantage of the loss. If you’re going to take anything away from this podcast, assuming you don’t want to do a conversion, harvest your losses, your capital losses against each other, and then ultimately against your ordinary income.

It’s a free deduction that will reduce your taxable income. Governments giving you free $3,000 ordinary income deduction might as well take it. There you have it. Other than that. Again, Roth conversion. There’s no right or wrong.

I hate giving you kind of the lawyer answer, which is so annoying. I hate when lawyers do that. I hate it when I do that. That’s kind of the way I was taught to write is you set a position, you give both sides and you basically don’t give the client any concrete conclusion that could come bite you in the you know what? I hate doing that, but it’s just the truth because with conversions, it’s not a black or white.

It’s all gray and it depends on the future outcome of the investment and a few different factors that I outlined in today’s podcast. So Happy New Year Happy Healthy New Year. I hope we all have great prosperity and health and happiness in the New Year. I appreciate you guys, all of you who listen to this podcast on a weekly basis. Thank you so much.

I love doing it and I’m going to continue doing it. I’m going to go strong in 2022. If you have ideas on podcast topics, hit me up, hit me up on social media, Facebook, Instagram, Twitter, YouTube. You can also email [email protected] and just say Adam Talks or Ask Adam and just hit me up with a question or an idea or thought, they will get to me. I promise.

Otherwise. Enjoy Happy Healthy New Year and I’ll talk to you again in 2022. Take care.

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