[00:00:00] Welcome to The Financial Call. We are financial advisors on a mission to guide you through the financial planning everyone should have, whether you're doing it yourself or working with a financial advisor. These episodes will help you break down complicated financial topics into practical, actionable steps. Our mission is to guide motivated people to become financially successful. Welcome everybody. This is the tax season of The Financial Call. I'm here with Laura and this is season. What, four? Season four. Season four. Episode two. Last episode was all about tax basics and we laid out exactly how taxes are calculated. I shouldn't say exactly. We laid out approximately how taxes are calculated. There you go. Yep. And we laid out conceptually what's going on under the hood, and I think if you can understand that, you'll be great. If you'd like to go back and listen to that. Great. This one I think is a standalone episode. If you wanted to listen to this one alone, it's fine as well. This is just. And 

[00:01:00] traditional investment decisions for retirement accounts, so Roth versus traditional. One of the most listened to episodes that I had early on was to Roth or not to Roth, and this is basically that episode again just with Laura and with more going on, I think it's gonna be great. Anything you'd add before we go in? No, I don't think so. Just this is one of, well, I said no and then yes, I'm gonna add something. No, but I'd like to, this is one of the most common questions that we get working with people, talking to 'em. Should I be doing Roth? I've heard that's the best. You know, that's the common myth out there is that Roth is always better and it's not always the case. Roth is awesome, but we're gonna talk through the math behind it and help you find what's the real question to be asking. When making that decision. So just to go back a little bit, to think about the traditional versus Roth question, you have to remember that that is the tax type of the account. That's not the account type. So you have your 401k, you have an IRA, 

[00:02:00] that's the type of the account, and then you have the tax type. It can be traditional or it can be Roth. So you can have a traditional 401k and a Roth 401k. I told Zacc before this. Oftentimes people get confused. I ask, oh, is that inside of your Roth four ? And they go, no, no, no. This is just my 401k. So they don't understand that you can have a traditional and Roth inside of the 401k. You might not see it. You know, when you log into your four , you might not see how much you have in traditional versus Roth, but it is there. Or they'll ask like, does a Roth make more money or does a traditional, like which, which one has better investments? Right. And that's the other aspect to it. You can own different investments inside of those types of accounts, or you could own the same ones. Yeah. Right. Or the same ones. I mean, you could buy a particular stock if you're interested in Apple stock, you could buy it in a Roth or you could buy in a traditional Yes. Or Microsoft or Google, whatever it is. Exactly. It's the same. It could be the exact same risk, exact same investments. It's just the tax structure. And how the money is taxed on the way 

[00:03:00] in and on the way out. Think of it as a room. There are a couple doors you can enter on each side of the room, and it's whether you're going in or out the tax-free door or in or out the taxable door. And that's all that's going on here with Roth versus traditional. Yeah. So let's talk about that. So traditional, it's also referred to as your pre-tax. That's the same thing. So any money that's going. You've not paid taxes on it yet, so it just goes into that account and it's gonna continue to grow. When you take the money out of the account, usually in retirement, everything is taxed. Both the money that you put in and the growth inside of the account. Your Roth is a little bit different. You pay taxes on the money before it goes into the Roth account, and it grows tax free. So in retirement, when you take the money out, both the money that you put in and the growth is tax free. I almost would love to call this episode like the common myths around Roths, like Roth myths or the things that no one understands about Roths. I remember when I first learned about Roth and Traditionals 

[00:04:00] being the nerd that I am, I made an Excel file and I was like, okay, which is gonna make more money for me in the end. And if you started with insights, I put in numbers and put in growth rates, and I'm like, I'd like to eliminate all the variables I can. Except just Roth versus traditional. See which one is better and that's the one I'll do. So I threw $10,000 into the file and I said, all right, I'm going to assume there's a 25% tax bracket here, or 25% tax rate, federal and state together. And so if I invested in a Roth, I have to pay that taxes right away. So now I only have $7,500 left to invest because of the 25%, a quarter of it went to taxes. If I invest in traditional, I can invest the full $10,000. Now I'm gonna use a simple growth rate. I wanted to use the same growth rate on each of them because again, I'm trying to just figure out which is better, traditional or Roth. So I applied the same growth rate. To make life simple for us, if you earned about 7.2% per year 

[00:05:00] for 10 years, you will double your money. So, we're just gonna use that for today. Same growth rate on both. So your $10,000 goes up to $20,000 inside your traditional IRA. Your $7,500. Remember we had to pay some taxes on it cuz it's Roth. We pay taxes up front and grow to $15,000 because it doubled. So, so far traditional ahead, right? We got $20,000 in the traditional $15,000 in the Roth and now we want to spend it. And so I call this what is the spendable money? Cause that's what we care about here. We don't really care what it. In the brokerage account or the investment account, we wanna know, can I go buy that $15,000? I wish cars were, I was gonna say car, but they're not $15,000 anymore, but can I go spend that $15,000 on something? Right? Okay. Traditional, you have to pay the 25% tax. Again, we're using the same tax rate, and one fourth of that is $5,000. So you end up with $15,000. And I kind of spoiled it by giving people the answer there. So 

[00:06:00] $20,000 in your traditional. Fourth of it goes to tax. You have $15,000 spendable. The Roth is all tax free. No tax. So you also have $15,000 spendable. And this is where I started to get a little bit frustrated. And I thought they're exactly the same. They are exactly the same. What's the point? Why does this matter? And it really doesn't matter if the tax rate is the same and the growth rate is the same. You pick any tax rate, any growth rate, it will always work out to send you back to the same spendable amount. So the reality is if all those variables are the same, it actually doesn't matter. And that's a little bit confusing for people. But how many people have the same tax rate in retirement as they do when they're working? It's pretty rare, and governments will change tax rates over time. and you may have other goals to really do what you know, what's called them ultra max out your contribution. So we're gonna talk about that. So here's the deal. If tax rates are going to drop, you want to experience 

[00:07:00] the rate that's the lowest possible rate over your investment period, right? So if tax rates are going to drop, we won't pay the taxes. Now, you should do traditional and take advantage of the lower tax rate later if you think tax rates will rise in the future. Then you should do Roth because you should take advantage of the lower tax rate now and avoid the higher tax rate later. That could be because of what you believe the government will do with tax rates, or it could just be because your situation is going to change, you know, you may retire. Give you an example. I had a doctor, he was making, I think it was around $450,000 a. and he was doing Roth contributions and he really, really wanted to avoid a higher tax rate in the future. And he was thinking, I'm gonna invest it now and it'll grow all tax free. And the problem is this couple was extremely frugal and they still are. They currently live on about $80,000 a year. So they went from having this tax rate that was applicable to a 

[00:08:00] $450,000 income, which was higher. And then in retirement, because they spend so little, we can control that. And you mentioned in a previous episode that you know when you get social security, it's not all taxable. In our last episode, that's a big deal. So they're getting some of their social security back tax free and they have a really low tax rate. And I told 'em, guys, you've gotta do traditional here because if you do Roth, you're putting, and they were maxing it out, you're putting almost $30,000 into this account and you're paying rates in the twenties and thirties on it with state included. Whereas if you put it into the traditional, you could avoid that rate and get it out for 10 to 12 to 15 next year. Yeah. You said they were making 450,000. Yep. There was something in that, I can't remember. It was four. It was above four 50 though. But yeah, so if it was four 50, they're 32, almost in the 35% tax bracket. Wow. And if you could take it out in retirement, 10 or 12% mean you're saving 25%. Yeah. And at their rate, that amount would have come. Probably most of it 

[00:09:00] in the 12% tax bracket. Maybe a tiny bit of it in the 22. 22. So they still That's a big savings. Yeah. So it was one of those they didn't know because all they were thinking is, well, it's gonna grow and I wanna pay taxes on the smaller amount. They didn't think about how the math works and how they actually should have done traditional and taken it out at a lower rate later. So there's your example of someone who should actually be thinking traditional with their contributions. But that's, there's a lot of marketing out there right now. To really push Roth accounts for whatever reason. And I think it gets people, especially near retirees thinking cause they didn't have those options when they first started saving and then they'll call. And so it, there is a little bit of a marketing play there. Okay. You think tax rates will rise in the future or you think your income will go up in the future than Roth Makes a whole lot of sense. And as we see young people especially making, not that much money. Have high deductions have a lot of help because they have kids and they get tax credits for that, and their 

[00:10:00] tax rates are in the 10 and 12% brackets. I would look at Roth contributions every time for those people. Not necessarily because I think the government's gonna hike rates, but they probably will go up from 12%. We talked about this in the last episode. They are going to go up in 2026, a little bit. And overall, they're some of the lowest that they've ever been. So it's not a bad idea. You know, if you're in the 10 and 12% tax bracket, it's a pretty good rate. You might not get better than that. So if you're there and you know your income is going to go up, or you have a long time to retirement, so we have no idea what tax rates are gonna do. Yeah, do some Roth contributions. Well, if you're on the other hand, you know, making 450,000, or maybe you're in the 32% tax bracket at 35%, you're paying a pretty high rate. There's probably a good chance that it will go down in the future. Probably do some traditional, even if rates go up, like even if the government moves the rates up, that couple is going to drop multiple marginal tax bracket tiers. So even though the government might move rates up, their particular 

[00:11:00] rate will go down. And so that's hard. That's a hard thing because if you just ask people where do you think tax rates are going? Most people will say, oh, they're going up for sure. That might not be their exact situation. Yes, exactly. If you're in the 22 and 24% tax bracket, which a lot of people are, that's between the 80,000 to 330,000. A lot of people fall in that range of income for a couple, right? For a couple, yes. For. You know, single individual's, 40,000 to 160, you're paying 22 or 24%. And in there it kind of depends. You know, if you're close to retirement and you can see, yeah, I'm gonna be paying 10 and 12% in retirement and just do traditional, maybe if you're younger, we have a long time until retirement. Maybe you do all Roth, or maybe you do a little bit of both. Yeah, that's a good point because someone who is making that much money may be a good saver and their tax rates may actually be higher in retirement because they've saved enough and rates have gone up and, and they want to live an elaborate retirement. You know, they wanna spend a lot in retirement, and so they're going to 

[00:12:00] be drawing a lot from their accounts and they'll have a high income, or they have a high pension that they can't control. I thought elaborate was probably a better word than lavish, right? Yeah. . Elaborate. Yeah, I like that. Okay, so then the third category. So we've talked about if your rates will go up or they will go down. Now these other two ways of making this Roth versus traditional decision are a little bit different. They kind of break that rule a little bit. So the third one is called you want to ultra max out your contribution limits. Now a 401k, an IRA, they only allow you to put so much into the account. And what is it now? $22,500 I think it is for someone under 50. We're in January. It takes me a couple months to figure these out for a year. I know I had it figured out and we talked about it in the last episode. I just had a baby, so I've been on maternity leave. I'm still actually on maternity leave, but came in today to get, she's enough to be here. This is the first time I've seen Laura in a couple months, almost , and so my brain, I'm not on top of it and lacking sleep, but yes, somewhere around there. We'll get it pulled up. Yes. 

[00:13:00] Okay, so. It's 22,500, and then the catch up is another 7,500. If you're over 50, you can do 7,500 more, so $30,000 total. Okay, so let's say we have a 53 year old who's thinking about retirement and they're catching up and they just really want to throw as much money into these retirement accounts as possible. If you put $30,000 of traditional money in, it's not really $30,000 to you the government. Kind of owns a piece of that. Right. As you take it out, you'll have to pay some of that away in taxes. It's like you're giving storage to somebody else. You know, your garage, you only have a certain amount of space in there, and you're letting your cousin or your son, whatever, put his junk in there. Then you don't have as much room for everything. Apparently the cousin, everyone hates because it's the IRS, but yeah. But anyway, the uncle, they guess Uncle Sam. So then that money is not all yours, and so some of it's going to go to the government. So in other words, you really don't have $30,000. But it's interesting, the contribution limits are not 

[00:14:00] different for Roth versus traditional. So you could put 30, th that person who's 53 has the catch up of eligibility. They could put $30,000 of Roth, which is, depending on their tax rate, is probably like 38 to $42,000 of traditional, right? Because of the fact that you do not have to pay any taxes on that money as it comes out. So keep that in mind if you're really trying to max out your contribution limit. Filling it with Roth money in your retirement accounts is actually like putting more money into the account than traditional. And you'll feel it too, because if you put that 30,000 in Roth, then your taxes on your, on your actual w2, you're going to have to pay more in taxes to account for it cause it's after taxes. So you're, you'll actually feel the rest of that contribu. In terms of a tax payment. Yeah. And that contribution limit applies to both combined. So if you do 15,000 to traditional, you can then put 15,000 in the Roth. You can do any sort of, Combination of it, but the total can be that 30,000 with the catch up, so that would 

[00:15:00] be someone over 50. So it's early 2023 and Secure Act 2.0 came out. That is a piece of legislation that followed the original Secure Act. I think the original one was in 2019 and they just changed something here. All match contributions to a 401K. Were traditional and had to be traditional. So a lot of people would do a little bit of Roth and then end up with traditional, meaning their employer match. Yes, they did. What they get from their company always goes into the traditional bucket. They just made it so that employers can match with Roth contributions. But you keep in mind you will have to pay taxes on those contributions. So it's, it'll be like. Almost like phantom income that you'll have to show on your tax return, even though it went into your 401k, because it needs to make its way to an after tax status. But that's brand new. That's like new as of only a couple weeks and not all employers have already built that out. In fact. Like our 401k and payroll providers are currently working through. Okay. 

[00:16:00] Logistically, how would we actually even set that up? Cause the government isn't so kind as to talk to all of the providers and say, Hey, we're thinking about this. You might wanna start building out your systems. They just send it out and here it is, and everybody reads it and thinks, oh my gosh, we've gotta get that figured out. So keep in mind, your employer may not have that system set up yet. They may not choose. I do not believe it's a forced eligibility. Your plan may not. Offer it as a Roth contribution. They're not required to, but at least it's a possibility now for plans to adopt it and make it so the match could go in as Roth. Okay. Category number four. So I'm gonna repeat the first three. How do you make this decision if the math really doesn't matter between traditional and Roth? It doesn't matter when the tax rates and the growth rates are the same, but it does matter if your tax rate is going to change, if it's going to go up in the future, do Roth. If it's going to go down, do traditional. If you don't know, that's normal, but we're all guessing in life anyway. Right. And then number three, we

[00:17:00] talked about ultra maxing out your contribution limit. And then number four has to do with something that is, is like you talked about, nerding out on taxes last time. Managing marginal tax brackets is about like the nerdiest thing you could ever talk about, but it does save a lot of money. And let me explain what I mean. If you want to keep your options open so that you can really control your tax bracket in retirement, it's actually really healthy and good to have assets in both traditional and Roth. Now, for a lot of people, it used to be that they would just make Roth contributions traditional match, and they naturally ended up with some tax diversification there. . If you have a Roth contribution and a Roth match, you may have to more purposefully choose so that you end up with both. Now, why would you end up with both? We talked about marginal tax brackets. Imagine you fill up your, this is a couple, you fill up the first 20 to, let's call it actually up to $80,000. You fill up $80,000. With your Social 

[00:18:00] security and traditional IRA withdrawals, you're only paying 10% and 12% tax on that. But the next jump, uh, we mentioned it, is the biggest jump. It's 10%. It goes from 12 to 22. That's a massive increase in the amount of tax you pay on the next dollar. So you could at that point, stop taking from your traditional, go over to the Roth and take money from the Roth for maybe extra purchases or even monthly distributions in retirement. So that's managing the marginal tax bracket. And you could control that, or maybe you're actually right up against a Medicare premium line and instead of crossing it and having to pay an extra 2, 3, 4, $500 in Medicare Part B premiums, you could take money from your Roth IRA and avoid having that penalty as well. So having the different asset types. Really allows, I actually have an executive at a firm who is an engineer by education and profession, but he's actually now in management at this firm. So he, he was an engineer, worked his way 

[00:19:00] up, and then was the CEO of the firm. So he talked about it in terms of degrees of freedom when I explained some of this to him. He said, oh, you're talking about degrees of freedom. And I said, I have no idea what you're talking about. That's like a statistics term. Is that right? And in the way that he described it to me was degrees of freedom. And then I had, of course, had to look it up later. Puts you in a position with multiple options moving forward. In other words, it puts you in a position where you have freedom to go in many multiple paths in the future. , if you set your accounts up so that you have traditional and Roth, and we haven't talked about after tax money, but you have money that's neither, that's just invested in brokerage and other investments, maybe even some real estate, you just have many different assets of different tax structure. Then you've set yourself up in a position with degrees of freedom to be able to control your path moving forward and have more leverage to pull to manage your tax bracket in retirement. And that's why we see most people have. A little bit better tax situation in retirement. Okay. So to summarize this, you alluded to this already, 

[00:20:00] Laura, like 10 and 12%. Tax brackets seem like almost always people are looking at Roth 32% and up tax brackets, traditional. And then if you're in about the 2224, that's where it depends how much time. What do you think? Do you have to invest in it? How do you think your income will change in the future? What do you think tax rates will do in the future? You know, if you're right by retirement, you know you're gonna have less income. You're probably thinking traditional. Anything else on that? To summarize it? Make it easy for people. No, I think that's the most helpful. So you don't have to understand all of it, but just understand, okay, this is where I fit. This is probably a good place for me to be, or this is a good contribution type for me. So the same consideration exists for contributions versus conversions. A contribution is you just putting money into these accounts, either from your paycheck or from your bank to a Roth IRA, the same thought process should be used. When thinking about converting money from your traditional IRA over to a Roth, if you move money from a 

[00:21:00] traditional to a Roth, you have to pay taxes on it, but at that point, it grows tax free forever in the future. I had somebody once to do a 1.7 million conversion from a traditional over to a Roth. Oh, wow. Yeah, it was huge, but I'm sure he's happy about it now because he had a previous employer, so that was back in 2000 and 10, So it's been 12 years. Markets have done fantastic over that time. Now I think he's happy about it, but he probably doesn't know the alternative too well. He was in the highest tax bracket. He had a pension that was gonna pay him $600,000 a year for the rest of his life. Oh wow. That's a nice pension. He's right. That's the best one I've ever seen. Yeah, so it was kind of one of those decisions where he said, listen, my tax rate is never going to be low, and he also had another eight, $900,000 sitting in a trust account. He literally wrote a check for that whole account to the government to get his 1.7 over to a Roth. Back then you had the ability to back out of a conversion and 

[00:22:00] then do it again, or kind of go back and forth. So if the market went up, he could be happy about it. If it goes down, he could back out of it and then reconvert at a lower rate, and have lower taxes. Anyway, too many people took advantage of that, and finally the government said, no. No more of that stuff. But anyway, that is a consideration. Roth conversions in retirement can be fantastic. Most people, we don't recommend that they go that far. That guy, I don't think it was that beneficial, cause it was when tax rates were 39.6 and he was paying, he could have got it out at 37. That's a minor difference, but, Bottom line. If you are in the 10 and 12% tax brackets, that's a pretty good opportunity to take advantage of and it's probably worth looking at. Roth conversions. Here's the catch. If you are also on social security, Some people don't realize that if they take $20,000 of a Roth conversion, add it to their income, it could force another 20, $30,000 of their social security to show up, and then all of a sudden it was way more expensive than what they thought.

[00:23:00] Yeah, and this can be really confusing. Basically your social security. Is taxed based on your other income that you have. So if you have no other income that you're receiving, it's just social security, you're not gonna pay any taxes on Social security. However, once you start to earn more income, more of your social security income is added to that taxable income. Up to 85%, that's the max that it will be. You'll always get 15% tax free, but that's something to be aware of. So if we're adding more money to the income through a Roth conversion, then more of your social security income may be added to your total income. Let me give you an example of this because I ran this for a couple and they were one of those people that you talked about. We've recorded three episodes today , so I can't remember which episode, if it was 10 minutes ago or an hour ago. You talked about a lot of people paying very, very low taxes in retirement, and some people not paying hardly any taxes in retirement. This was one of those couples, they had $40,000 of social security

[00:24:00] benefits and $20,000 of other income from a pension. And some IRA withdrawals. So you've got a couple here with $60,000 of total income. Now, here's the interesting thing, the way the calculation works, and I can't remember, you'll have to remind me, Laura, if we actually went into the social security taxation calculation already in the social security section or if we're going to do that, but the bottom line, we're happy to explain this to people if they want to know, but here's how it worked for. They had $60,000 of income. They only had to show $4,000 of their social security. Their social security was 40. They only have to show four of them. That's 10%. 90% of their social security income just evaporated, no taxes on it whatsoever. Then they have to show that $20,000 other income, so their total income they have to show is 24,000 standard deduction right now. Wipes that out entirely. Zero taxes for this couple. So it's kind of crazy now.

[00:25:00] If they did a $30,000 Roth conversion, their other income goes up to 50. Remember, they had 20% of other income and 40 of Social security. Now they have 50% of other income and 40 of Social Security. They don't get to sneak away that 90% of Social Security anymore. Now they have to include 70% of it. They only get 30% of it back tax free. I know I'm throwing a lot of numbers out here, but here's the bottom line. They added $30,000 of Roth conversions. And that forced them to tack on another $24,000 of social security. So they thought they were adding $30,000 of income. Now, we didn't actually do this. We modeled it out, but they planned on adding $30,000. They're like, well, why'd you do it then you idiot. But no, I'm just saying like they planned on adding $30,000 of Roth conversion. We modeled it out and it actually added $54,000 total. And that was way too expensive from a tax cost to make it happen compared to what they

[00:26:00] thought. They thought they were in the 10 to 12% bracket, which, yeah, and they still probably were. That was probably their marginal rate, but their effective rate. . Yeah. Their real rate was high because it threw so much of their social security into the equation was too high. Yeah. That's something interesting to be aware of, but maybe somebody hasn't flipped on Social Security yet. They're not at R M D H, which is now 73. That was a change with the Secure Act 2.0 as well. And so maybe they want to do Roth conversions before they get on Social Security, before they have to start taking money out of their traditional account. They wanna move it over to Roth. Because if you think about it, you know, if your traditional account is larger, you're gonna. Forced to take out a higher amount of, that you do not have to take RMDs from your Roth account. So that can be another reason that people do these Roth conversions for sure. We see that a lot between the ages of 60 and 70. It's now turning to 73. Another change recently, but we see people kind of in a rush to try to get as much over to a Roth as they can, but be cautious that don't go so fast that you end up subjecting yourself to a higher rate than you would.

[00:27:00] Just letting it be a minimum distribution, so be careful there. Okay, again, we're in the tax planning season, we're wrapping up. This is Roth versus traditional, and we are moving on to how your non-retirement investments are taxed. You touched on this today, you know, being able to control your after tax account, so we'll talk through all of that, but maybe you don't have a 401K or an IRA. You wanna know how your other counts are. Or you know, your real estate capital gains. We'll talk through all of that next. Thanks for listening, everybody. We're excited to work through these seasons. We're almost halfway through the eight seasons. Excited about that. Excited to have Laura coming back. We've missed her on maternity leave. It's fun to be back to see everybody. I've missed it for sure. I bet. All right, cool. Thank you. This podcast is intended for informational purposes only and is not a substitute for personal advice from Capita. This is not a recommendation offer 

[00:28:00] solicitation to buy or sell, any security past performance is not indicative of future results, there can be no assurance that investment objectives will be achieved. Different types of investments involve varying degrees of risk, including the loss of money invested, therefore, It should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or proposed by Capita will be profitable. Further capita does not provide legal or Tax advice. Please consult with your legal or tax professional for advice prior to implementing any strategies discussed during this podcast, 

[00:29:00] certain of the information discussed during this podcast. Is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity, capita beliefs that such statements, information and opinions are based upon reasonable estimates and assumptions. However, Forward-looking statements. Information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

[00:30:00] Registration with the S E C does not imply a certain level of skill or training.