Dave: I’m here with my business partner, Tim, today. He recently helped a client convert $160,000 to Roth and pay no additional tax. So, we wanted to share this story with you because I know that we get quite a few questions around Roth conversions and when it might make sense and things like that. Hopefully this story can help you as you’re evaluating your own financial life in retirement. So, Tim, how did this conversation come up with the client and just tell us how it all started.  

Tim: Yeah, Dave, my favorite part about all of this is it actually didn’t start with the goal of how can we convert more money from IRA to Roth IRA? But it started with their values–what was most important to them? And most important to them was maximizing charitable giving over their lifetime.

With them being business owners and looking at potentially selling the business in the future, we were doing some future tax planning, looking at ways we could either accelerate some of the taxes that they might have to pay in the future or, give to charity so that they could deduct taxes now, rather than spreading out their charitable giving over their lifetime.

Dave: Did you talk about charitable giving with them in previous years?

Tim: Yeah, that’s always been an ongoing conversation. Their goal was to give about 10 percent of their gross income every year for the rest of their life. So, we said, hey, let’s map this out over the next 30, 35 years. This sounds maybe a little extreme of something to do. But we saw when we did that, there were some unique opportunities they had in this specific year of doing a lot of their charitable giving over the next four to five years, and maybe not doing any charitable giving after that.

Dave: Okay. A lot of people, when we bring up the idea of front-loading the gift, they’ll bring up how they don’t want to front-load the money to the charity in one year. Any discussion around that?

Tim: A big concern with a lot of generous people is, I don’t want to overwhelm the organization with my gifts now. I’d like to spread it out over a long period of time. And so, we brought up the donor-advised fund. This is a tool that we share with a lot of people that says, I can make the gift to my donor advised funds now. I can get the tax deduction for it now, in a year where my income is really high. Then I have ultimate flexibility on giving to those charitable organizations over the rest of my lifetime. I can even automate it. And, maybe this is too much, but I can invest it. I can invest the donor advice on the charitable dollars. I can invest over the next 30 years. Potentially, I could have an even greater impact on those organizations over time.

So tax benefit now, invest for tax-free growth through the future, and have the flexibility to give out to organizations over time and even change who you’re giving to 10, 15 years from now.

Dave: Gotcha. I think it makes sense, conceptually. How did you map it out with your client, just so you knew it was the right decision? It’s such a big money decision, just like every one is important. How did you map it out?

Tim: Well, one of the things that made this work, and this comes back to your Roth IRA question from the beginning where we got started, is in this particular year, they decided they were going to do, I want to say, a hundred thousand dollars of charitable giving. And because this was a high-income year for them, we said, what if we did an additional $250,000 of charitable giving this year. So, that lowers their income quite a bit.

At the same time, let’s convert $160,000 from their IRA to their Roth IRA. Again, these numbers worked for them. You obviously have to work with your tax professional to figure out what scenario is best for you. But it made it where those two moves, the taxes sort of offset one another. It made it seem like they weren’t paying any additional tax to do that Roth IRA conversion.

Dave: Interesting. Are there any negatives or pitfalls when thinking about if you want to front load or do the same sort of strategy? Any negatives there?

Tim: Yeah. There’s a couple of things that you want to think about if you’re considering a strategy like this one. There are AGI [adjusted gross income] limits that the IRS has in place for the amount of the percentage of AGI you can give. And, in the form of appreciated assets, in this specific scenario, ideally, we would have loved to give appreciated stocks or ETFs [exchange traded funds] away in their case. We had just done a lot of tax-loss harvesting six months prior, so none of it was long-term gains. So, this year we gave cash. There are different limits for appreciated assets and cash that you have to be very mindful of. Above that, you can actually roll over those charitable contributions to future years, but it’s something to keep in mind.

Another potential negative is you are front-loading your giving so the money’s not yours anymore. It’s going into that donor-advised fund and it’s committed to charity. That’s why you get the tax deduction. So, make sure you’re running this charitable plan along with your retirement income plan, making sure it’s sustainable over time. In this case we saw this actually is a benefit to the retirement income plan over time because they had already pre-committed to give for the rest of their lives.

The third one is look back at your values around giving and having an impact. Not everyone wants to do that. Is it one of your top values as a family? Once you’ve defined your values, then you can consider strategies like this, but maybe this isn’t for you.  Don’t give to charity just because you’re getting a tax deduction, but maybe try though.

Dave: Excellent. So any other benefits that we should know about behind the strategy?

Tim: I think there are two things that we probably haven’t hit yet:

Number one, they were able to move over $300,000 into a tax-free bucket, whether it’s a tax-free bucket for giving or a tax-free bucket for their family, the Roth IRA, those two can both stay invested over the next 20, 30 years and grow tax-free. That’s one really neat way to look at it. Especially if you feel like you’re paying no more tax than you did the year before.

The second benefit of moving money from IRA to Roth IRA, and most people probably know this, but at age 72, when the required minimum distributions kick in, some people might be like this couple, where at age 72, as we mapped out their retirement income plan, they’re getting a significant forced pay raise that they have to pay taxes on at that point. The more we can move into the tax-free bucket, that’s not susceptible to RMDs, the less that pay raise is going to be at age 72.

Dave: Hopefully that makes sense and gave you a couple of things to think about as if you’re asking questions about Roth conversions and tax planning and income planning. One of the big takeaways here is that you can’t control everything. Obviously, we can’t control a lot in our lives. Two things that we have a pretty good hand on when it comes to your income plan and retirement plan is the ability to control costs of what you’re investing in, and then also control taxes. It seems like a lot of the political environment gets decided for us. But there are some things we can still do. This is one example with Roth conversions of being able to decide when you’re going to pay tax and how is that going to benefit you in the future when tax rates might change and things like that.

There’s a lot of factors that come into this. If you have questions, and specifically if you’re thinking about charitable planning, but you don’t know all of the strategies out there and you want to talk about it, we do leave space, I think maybe one or two spaces open a week to talk to Tim or I specifically just around charitable planning. It’s not even a meeting to talk about our services at Streamline and how we help people. It’s really just for people who want to know more. We want to help people if they’re charitably minded. We want to make sure that they’re getting the most benefit as well for what they want to do.