Ed Slott: ‘Your IRA Is an IOU to the IRS’

Christine Benz: We want to talk about IRA conversions for people who are potentially eyeballing an IRA conversion in the waning days of 2023. Let’s just discuss the basic case for doing those conversions—why you would want to consider them.

Ed Slott: Well, what you’re talking about when you say an “IRA conversion,” an IRA to a Roth, moving your IRA money, converting it to a Roth IRA, where it will remain income-tax-free for the rest of your life, and even under these new Secure Act rules, 10 years beyond to your beneficiaries, all growing tax-free. So, that’s what you get for your money. Why would anybody do it? I did it years ago in 2010 when they opened the floodgates. Remember, before 2010, there was a rule that says if your income exceeded $100,000, you couldn’t convert. Well, Congress eliminated that rule, and they got a flood of money from people like me and everybody else because they gave you this great deal, which I know you and I talked about. If you were at my programs, I begged people to take that deal. That was the deal of the century. You paid no tax. I converted everything. You paid no tax in 2010, half in ‘11, half in ‘12. In essence, the government, because they needed money so bad, which they still do today, they gave everybody an interest-free loan to build a tax-free savings account. So, that was a good deal. But you had to pay the tax. Same thing goes now.

So, it’s a bet. That’s all the Roth conversion is. It’s a bet on where you think your future or the tax rates are, but more specifically, your future tax rates. If you believe your rates will be the same or higher, the Roth bet pays off. I think that’s a pretty good bet, especially when you see what’s going on in Congress and the budget deficits. I believe in math. I don’t know if they do. They keep kicking a can down the road, but the whole country is running on a credit card. At some point, the bill has got to get paid. I don’t know when that day is, but I don’t want to be the one caught in the soup when the music stops.

It just reminded me the minute I said that. I remember writing something like that, wasn’t the exact phrase, in one of my books, before publication, and there was a big note on there from the editor, I did a “double” something, I forget what it’s called, a “mixed metaphor.” They said, cross it out. It must have been the dream of that editor, “Oh, look what I got, a mixed metaphor.” So, that’s a mixed metaphor.

Anyway, so, you’re betting on future tax rates, your future rates going up. I think that’s a good bet. If you don’t do it, remember, the problem doesn’t go away. It’s not like you’re saving taxes. This tax bill on your IRA will be paid. It’s not if, but when. So, the whole key, the foundation of all good tax planning, it’s so simple: Always pay taxes when the rates are the lowest. I believe that, for many people, everybody may be different, but for many people, that’s right now. We’re in the historically lowest tax rates most people will ever see in their lifetime. And that’s only going to continue for ‘23, ‘24, and ‘25, then they’re slated to go up, unless they increase because of budget deficits, like I said, eventually, I believe they’re going to have to raise taxes, especially on the people with the largest incomes and the largest IRAs. So, not converting doesn’t mean the problem goes away because the IRA continues to grow. And then, you’ll be on what I call the “government plan.” I always tell people in consumer programs, “You want your plan, not the government plan.” And they would always say, “But Ed, what is the government plan? Maybe I’m interested.” No, you’re not interested in that plan. That’s forced RMDs starting at age 73. Now, you’re not in control. By converting, you can control your tax rates. You can do a series of smaller Roth conversions each year, over time, bringing down this taxable IRA.

Remember, a lot of your IRA is a debt owed back to the government. Your IRA is an IOU to the IRS. You know what I tell people in a lot of these seminars to make the point, I said, “You all understand, especially married couples, you have a joint account. You each own half. Your IRA is a joint account with Uncle Sam.” Here’s the difference. With a regular joint account, as I just said, you generally own half. You have a joint account with Uncle Sam where you don’t know what his half will be. That’s yet to be determined based on how much money the government needs at the time you take that money out. Now you do know what the rates are. You’re in control. And it’s harder to convert once you reach your RMD age 73 because once you’re into RMDs, your RMDs, required minimum distributions, cannot be converted. They have to be taken, and those are the first moneys out. So, they have to be taken, but they can’t be converted. So, you’re paying tax on that money. Yes, once you satisfy the RMD, then the balance can be converted, but it’s going to cost more because you’ll have to take it out. The Roth conversion, I believe, is really just something I call “tax insurance.” You’re insuring against the uncertainty of what future higher tax rates could do in retirement to you. So, that’s the long and short of it. It’s a bet on future tax rates.