On this episode, host Darren Wurz explains the fundamentals of Roth conversions and why they are a game-changer for law firm owners. He discusses how converting traditional IRAs and 401(k)s into Roth IRAs can allow your money to grow and be withdrawn tax-free. Darren also highlights crucial timing strategies to make the most of Roth conversions and avoid potential pitfalls, such as unexpectedly high tax bills or increased Medicare premiums.

Why Roth Conversions Are Crucial for Law Firm Owners

You’ve worked hard building your law firm and saving for retirement. But instead of enjoying the fruits of your labor, you might be hit with a surprise tax bill and forced withdrawals you didn’t anticipate. Roth conversions aren’t just a tax strategy; they offer a way to take back control of your financial future.

What is a Roth Conversion?

A Roth conversion allows you to transfer money from a traditional IRA or 401k—both pre-tax accounts—into a Roth IRA. This move triggers income taxes on the amount you convert, but the payoff can be monumental. In a Roth IRA, your money grows tax-free, withdrawals are tax-free, and unlike traditional IRAs, Roth IRAs don’t require minimum distributions (RMDs) starting from age 73 or 75, depending on your birth year.

The Unique Benefits of Roth Conversions

• Tax-Free Growth:Your investments grow without being hindered by taxes, maximizing your returns.
• No RMDs:This gives you more control over when and how much you withdraw, allowing you to strategize your income and reduce tax implications.
• Lower Future Taxes:Pay taxes now when rates are likely lower, especially with the current Tax Cuts and Jobs Act, and save substantial amounts in the long run.

Key Considerations for Law Firm Owners

As a law firm owner, you might have diligently saved into pre-tax accounts such as 401ks or SEP IRAs. While these are great tools for reducing taxes now, they come with a future price tag. RMDs can force you to withdraw more than you need, pushing you into a higher tax bracket unexpectedly. Moreover, higher tax rates are on the horizon, making Roth conversions a proactive strategy.

The Widow’s Penalty: A Rarely Discussed Risk

When one spouse passes away, the surviving spouse inherits the traditional IRA funds and potentially faces a higher tax bracket as single filers. This sharp increase in taxes is known as the widow’s penalty. Roth conversions can mitigate this risk by allowing the surviving spouse to inherit tax-free funds.

When to Consider a Roth Conversion

Timing is critical for Roth conversions. Here are key periods to consider:

• Low Income Years:Ideal when you reinvest in your firm or take a break.
• Post-Retirement, Pre-RMDs:The years after retirement but before RMDs kick in at age 73 are golden years for conversions.
• Offset by Deductions:When you’ve made large business investments or have significant deductions, reducing your taxable income is a prime opportunity for Roth conversions.

How Much to Convert?

A strategic approach is essential. One method is ‘filling up the brackets,’ converting just enough to avoid jumping to the next tax bracket. Alternatively, spread conversions over several years, minimizing the annual tax hit while still benefiting from tax-free growth.

Avoid Common Pitfalls

Always analyze your taxes each year. A client once faced unforeseen high taxes because his advisor recommended a blind, $100,000 annual conversion. A more strategic plan would involve monitoring yearly income fluctuations.

Strategic Roth Conversions for Succession Planning

If preparing to sell or transition your firm, consider lower-income years leading up to the sale for conversions. This mitigates tax impact when your income is noticeably low.

Estate Planning Benefits

Roth IRAs are excellent for passing wealth to the next generation. Under the SECURE Act, heirs must withdraw retirement accounts within ten years, but withdrawals from Roth IRAs remain tax-free, potentially saving your family thousands.

Actionable Next Steps

1. Run the Numbers:Estimate your current tax bracket and compare it to projected tax brackets in retirement.
2. Plan for Taxes:Ensure you have sufficient cash to pay the taxes, without dipping into retirement accounts.
3. Get Expert Advice:Work with a financial planner to create a customized Roth conversion strategy.
4. Think Long Term:Focus on optimizing your tax situation over your lifetime.

Setting up a Roth IRA immediately can help you avoid pitfalls like the five-year wait for tax-free distributions.

Conclusion

Roth conversions are a powerful tool in your financial planning arsenal. As we approach the end of the year, it’s a prime time for them. Proactive planning can save you thousands and secure your financial future.

Resources:

• Schedule a Call with Darren
• Wurz Financial Services
• The Lawyer Millionaire: The Complete Guide for Attorneys on Maximizing Wealth, Minimizing Taxes, and Retiring with Confidence by Darren Wurz
• LinkedIn: Darren P. Wurz
• The Lawyer Millionaire Podcast and Book Club
  To connect with podcast guests and other law firm owners, discuss these topics further, and access our quarterly book club, join our LinkedIn Podcast and Book Club

Transcript:

Darren Wurz [00:00:00]:
Are you unknowingly setting yourself up for a massive tax bill in retirement? Welcome to the Lawyer Millionaire where we deliver financial planning insights and business strategy for ambitious law firm owners so you can enjoy more time, more abundance and less stress. Even if you’re still growing your practice, Imagine this. You’ve worked hard building your law firm and saving for retirement. But instead of enjoying the fruits of your labor, you’re hit with a surprise tax bill and forced withdrawals you didn’t see coming. Roth Conversions could be the answer.

Intro [00:00:40]:
We are on a mission to help lawyers and law firm owners maximize wealth and achieve financial independence. Welcome to the Lawyer Millionaire with Darren Wurz from Wurz Financial Services.

Darren Wurz [00:00:54]:
Here’s a proactive thought you could have millions save for retirement but lose a huge chunk to taxes simply because you didn’t plan ahead. Roth conversions aren’t just a tax strategy. It’s a way to take back control of your financial future. Well, what is a Roth conversion? A Roth conversion allows you to transfer money from a traditional IRA or 401k, which are pre tax accounts, into a Roth IRA. This move triggers taxes on the amount that you convert. It’s going to be subject to income taxes, but the payoff can be significant. Your money grows tax free. Withdrawals are tax free and unlike traditional IRAs, Roth IRAs don’t require minimum require don’t have required minimum distributions or RMDs which start at age 73 or 75.

Darren Wurz [00:01:52]:
If you were born after 1960, this means you can let your money grow tax free for as long as you want. And when you do withdraw it, it won’t increase your taxable income. Well, why should you care as a law firm owner? Let’s talk about why Roth conversions matter for most law firm owners. Many law firm owners have been diligent about saving into their pre tax accounts like 401ks and SEP IRAs. A lot of people I talk to, they’ve built up their pre tax accounts pretty sizably and these are great tools for reducing taxes now, but they come with a future price tag when it’s time to withdraw those funds. They are fully taxable and required minimum distributions can force you to take out more than you need, pushing you potentially into a higher tax bracket. Failing to plan for this can lead to serious consequences. You know, imagine being in your 70s, retired and facing higher taxes all because of RMDs you didn’t account for.

Darren Wurz [00:03:02]:
Now add in the fact that tax rates are likely going to increase over time. A Roth conversion allows you to address this proactively paying taxes now at what, what are likely lower rates, Especially, you know, with the current Tax Cuts and Jobs act, which was passed in 2017 and is now likely to be extended for a little bit of time, we have an opportunity to take advantage of some Roth conversions. Now, there are some other key consequences. You know, so when you get into your 70s and you have to start taking RMDs, that additional income not only, you know, increases your taxes, obviously, because you have more income, especially if you don’t necessarily need that income. Your RMDs increase over time because your RMDs are based on your life expectancy. So the IRS has these tables and they start out, I think it’s. I think it’s 1 29th. It’s based on average life expectancy.

Darren Wurz [00:04:04]:
And then each year the amount you have to take increases, okay? So you may find yourself later in life where you having to take out large amounts and this is forcing you into a higher bracket. Not only that, it’s going to raise your Social Security taxes, your taxes on your Social Security benefits. It’s also going to raise potentially your Medicare premiums, thanks to irmaa. Right? So there’s a lot at stake here. Now, there’s another big thing that not a lot of people think about, and we call it the widow’s penalty. Okay? If you’re married and one of you passes away, you know your spouse passes away, right? You then inherit their traditional IRA funds. Let’s say you’ve got all this money in traditional IRAs, you’re taking money out. You have your Social Security benefits.

Darren Wurz [00:04:57]:
Now, here’s what happens. When one of you passes away, you’re going to lose one of your Social Security benefits, whichever is the lesser, right? If you made more money and you had a higher benefit, great. Your spouse’s benefit’s going to go away. Either way it goes, you’re going to lose one spouse’s ira, Social Security benefits. At the same time, you’re going to potentially go into a higher tax bracket because you’re going to go from married brackets down to single brackets. So you face the situation where income drops potentially and tax rates rise. Now, if you’re taking RMDs, you’re in higher brackets. And especially if you inherited IRA money from your spouse and you have larger RMDs to take, wow, you could wind up in a much higher tax bracket than you anticipated.

Darren Wurz [00:05:49]:
This is called the widow’s penalty. So one helpful way to plan around that is Roth conversions. Trying to get more money over into the Roth IRAs, strategically, when it makes sense. And Roth conversions is all about the timing of income. With the ability to do a Roth conversion, you have the ability to control when your money is taxed. And that’s key, Right. What we’re trying to do is pay the taxes at the lowest effective rate, at the lowest possible rate, right? It’s not about low, you know, paying the least amount of taxes every single year. It’s about making sure we pay the taxes at the lowest rate.

Darren Wurz [00:06:38]:
And some years it might make sense to actually pay more in taxes by doing a Roth conversion and prepaying some taxes at potentially a lower rate. So here’s how it works. When you execute a Roth conversion, you’re essentially moving money from a traditional IRA or 401k into a Roth IRA. The amount you convert is added to your taxable income for the year, which means you’ll pay taxes on it now. But once that money is in your Roth ira, it grows tax free, and you won’t owe taxes on qualified withdrawals in the future. When to consider a Roth conversion. The timing of a Roth conversion is critical. So here’s a few examples of when it might make sense.

Darren Wurz [00:07:25]:
Low income years. If your income dips, for example, you’re reinvesting in your firm or taking a break, it’s a great time to convert. The economy has a tough year, incomes down. Fantastic. Great time for a roth conversion. Number two, post retirement. Before your RMDs or required minimum distributions kick in. The years after you retire, but before RMDs kick in at age 73 are a golden opportunity because likely income is lower, right? And you’re in a lower bracket.

Darren Wurz [00:08:00]:
That’s a golden time to do some Roth conversions. Number three, offset by deductions. If you have made large business investments or have significant deductions in a particular year, you can use those to reduce the tax impact of a conversion, right? Because it’s going to lower your tax, lower your income, maybe even had a loss in the business because you had so many deductions. Great time to do a Roth conversion. How much should you convert? Well, one strategy is to convert just enough to avoid jumping up into the next tax bracket. We call that filling up the brackets. So if you’re in the 22% bracket and you’ve got, you know, $10,000 before you cross into the 24% bracket, go ahead and fill up that bucket, fill up that that bracket, you’re going to pay tax on your conversion at that 22% rate. Another is to spread conversions over Several years called laddering.

Darren Wurz [00:08:57]:
It allows you to minimize the tax hit each year while still moving a significant amount of money into a tax free Roth account. But I would caution that you want to do this strategically. You want to analyze your taxes every year, project where you’re going to be, and do this smartly and strategically. Because let me tell you something, one of our clients was advised by his former advisor at a very large reputable investment firm to convert $100,000 a year from his traditional IRA to his Roth IRA. Well, that’s, that’s not a great idea just to go and do it blindly. A smarter plan would be to watch your income because he had a really high income year. He did this Roth conversion at the beginning of the year, $100,000, and you can’t undo it anymore. They don’t let you undo it anymore.

Darren Wurz [00:09:54]:
So what ended up happening is it just, you know, he just had a much higher rate than he needed to be. He ends up paying a lot more in taxes than he needed to pay. And then the next year his income is lower. It’s like, well, we should have skipped that year and broth conversions and done it the next year. So it’s really important to pay attention to your taxes and project those out. Now let’s dive into some ideas for law firm owners. If you are a business owner, leveraging those business deductions can be one way to try to drop your income in a particular year. Right.

Darren Wurz [00:10:33]:
And make that an opportunity year for you to do a Roth conversion. And one thing you want to watch out for is that if you’re a high income earner, Roth conversions can trigger some unintended consequences like the net investment income tax or higher Medicare premiums. Thanks to Irma Irmaa the income something something. I can’t remember what all the letters stand for right now. Basically, at a certain point, if your income is too high, there’s a surcharge on your Medicare premiums. So you want to plan carefully with a tax planner or financial planner who can really help you look at these things carefully. Another consideration, if you’re a law firm owner thinking about succession planning, if you are preparing to sell your firm or transition to a partner, the years leading up to that sale could be lower income years compared to the year when you the years when you start getting paid from the sale itself. So those might be years where you do the Roth conversion.

Darren Wurz [00:11:41]:
So think about that strategically. Years where your income is lower comparatively take advantage of those lower tax years. If you have those and do your Roth conversions Then. And there are big benefits. In terms of estate planning, Roth IRAs are an excellent tool for passing wealth to the next generation. Under the SECURE. Under the SECURE act, heirs must withdraw inherited retirement accounts within 10 years. But with a Roth IRA, those withdrawals are tax free.

Darren Wurz [00:12:14]:
This can save your family, save your kids thousands in taxes and make your legacy even more impactful. Okay, actionable next steps. Now that we’ve explored the ins and outs of Roth conversions, what can you do? Well, here we are at the end of the year. It’s a golden opportunity time for Roth conversions. Number one, run the numbers. Start by estimating your current tax bracket for the current tax year and comparing it to your projected or past tax brackets. Right. And what you think your tax bracket will be in retirement.

Darren Wurz [00:12:47]:
Number two, plan for taxes. Make sure you have enough cash on hand to pay the taxes on the conversion. Okay. Without dipping into your retirement accounts. What you don’t want to do is have the taxes withheld from the conversion. Sometimes you can do that, but if you’re under 59 and a half, you’re going to pay a penalty on that conversion. On having those taxes withheld, it’s going to count as a premature distribution. So you don’t want to do that.

Darren Wurz [00:13:14]:
Number three, get expert advice. This is where working with a financial planner can be very helpful. Roth conversions can be complex, especially with the unique income streams and deductions that you as a law firm owner deal with. A customized plan will ensure that you don’t leave money on the table. And finally, think long term. This is about optimizing your tax situation over the long haul. And doing this carefully and strategically can save you thousands of dollars over your lifetime. Now, we are not advocating for.

Darren Wurz [00:13:48]:
You want to convert everything over to the Roth. That wouldn’t be smart, right? Because again, it’s not about ever. You don’t ever want to be tax free because that means you paid too much tax in an earlier time. It’s about making sure over your lifetime that your taxes are minimized. I’ll give you another actionable tip. You want to make sure that you set up a Roth IRA right away if you don’t have one, because there’s a five year window. There’s a five year window on taking distributions from a Roth ira. There are actually two five year windows.

Darren Wurz [00:14:24]:
There’s a five year window on the Roth IRA itself in terms of when it starts. So you can’t take distributions tax free until five years after you opened the IRA. And there’s a five year window on conversions pre 59 and a half. Okay, so you want to pay attention to that very carefully. All right, so in summary, Roth conversions are a very powerful tool. And the end of the year is the time to do it because the deadline is December 31st. A very powerful tool in your financial planning toolbox, one of the biggest things that we look for and talk about with our clients every single year. So, and it’s just one example of how proactive planning can make a huge difference in your financial future.

Darren Wurz [00:15:15]:
Here at the Lawyer Millionaire, we’re here to help you with things like this. Ideas, strategies to optimize your wealth, create and generate and protect your wealth, protect your business, and enjoy the rewards of the hard work that you’ve done over time. If you want to explore whether Roth conversions are right for you, let’s connect the link to my calendar is in the show notes. Schedule a call with me today and let’s create a tax efficient plan that works for you. Also, check out thelawyermillionaire.com and you can learn more about all the great stuff that we do. You can even schedule a call with me there as well. This has been the Lawyer Millionaire podcast. I’m your host, Darren Wirtz.

Darren Wurz [00:16:02]:
Thank you so much for joining me on this journey to expand your business, maximize your profits and secure your financial future. I can’t wait to connect with you again next time. Until then, take care and keep pushing forward.

Outro [00:16:21]:
Thank you for listening to the Lawyer Millionaire. Click the Follow button below to be notified when new episodes become available. This content has been made available for informational and educational purposes only. This content Content is not intended to represent investing or tax advice. Always seek the advice of a qualified investment or tax advisor with any questions you may have regarding your own financial circumstances.