Roth Conversions: How to Prepare for the TCJA Sunset In 2026

4.26.24: Audio automatically transcribed by Sonix

4.26.24: this mp3 audio file was automatically transcribed by Sonix with the best speech-to-text algorithms. This transcript may contain errors.

Speaker1:
Welcome back to the federal retirement Show. I am your host, Val Majewski with American Benefits Exchange. As always, I really appreciate those of you who have reached out and said you enjoyed the show. You enjoy the content. Thank you for that and keep that feedback coming. I want to hear the good, the bad and the ugly. I want to hear the stuff that you like, what you don't like, what you want to hear. More of, topics that we've not yet covered, anything that your little heart desires. Because this is for you, the federal employees who are tuning in to listen to this podcast radio show and get this content, consume this content. Um, if there are questions you have, you got to reach out to us. You have to go to our website, Federal Retirement Show.com fill out the form. We'll answer any of your questions, get you the information you're looking for. Oh, and by the way, we'll get you a complimentary copy of the book I wrote on federal benefits called There's No Excuse Your Guide to Maximizing Your Federal Employee Benefits. So with this today, this is a topic that has come up recently. I got asked about the future of taxes and whether you know it or not, there are current tax codes that are set to go away, right? Tax levels, tax percentages that are set to sunset in 2026. And this is a combination of a topic we talked about before called Roth conversions. So let's dive in to today's content and talk about Roth conversions prior to the Tax Cuts and Jobs Act sunsetting at the end of 2025.

Speaker1:
So what do I mean by this? Well, if you were not aware, we are in historically low tax rate time when it comes to our income tax. If you're not familiar with the Tax Cuts and Jobs Act, this was put into place several years ago and it lowered our tax brackets to a certain point. And there again, are historically low. But those are set to sunset. They're set to go away come 2026. Now what exactly is this going to mean? Well, that means our tax rates, depending upon which tax bracket you're in, could go up starting in 2026. So what are we talking about previously when it came to Roth conversions. Well if you're not familiar with that I'm going to back up and talk about that for a second. A Roth conversion allows you, a federal employee or anybody really, to take a portion of or even all of their retirement savings if it's traditional money. So these are, let's say, monies that you have not been taxed on yet, like the pre-tax bucket in your TSP. And when you're eligible to do so, or move that money to your own IRA, let's say out of TSP. Or if it was a previous 401 K and you're no longer with that job, you can do it. Currently, you can do it now. But let's say you're in a position where you're eligible to utilize whatever monies you have in either a previous 401 K.

Speaker1:
403 B, or even your current TSP. And you want to take money that will be taxed in the future because it's in the traditional bucket and you want to turn it into tax free money. This is known as a Roth conversion. And that's where you take taxable money, money that will be taxed upon withdrawal and you convert it to tax free money. It's like a magic trick. The problem with this magic trick, though, there is no free lunch, right? We do have to pay the taxes on whatever amount that you convert. And ultimately then going forward, that money that you converted will be tax free should grow with interest. Hopefully it does. And all of that money then in the future, the money you converted, plus future interest that is earned will be tax free. Now this also means not just money that you withdraw, but money that you pass on to your beneficiaries will be tax free. And we've covered this in detail in other episodes when we talked about Roth conversions. So if you want to go into further detail, you want to see what this is all about. Check out our previous episode or episodes. When we talked about tax free retirement, we talked about Roth conversions because you might find that helpful in coming back and talking about this when it when these tax cut and jobs Act sunsets and these new tax codes may negatively affect you if you want to convert in the future.

Speaker1:
So let's take a look at where we're currently at versus where we're going to be in just a short period of time, relatively speaking. So with the Tax Cuts and Jobs Act, that's going to sunset at the end of 2025. Here's our chart to show what the rates are currently and what they're going to be in the future, starting in 2026, assuming there's no other changes. And they they allow this to just kind of sunset, right, to go away and revert back to previous tax rates. So this this chart shows the different tax brackets the the modified adjusted. Gross income that you're going to fall into and what your effective tax rate is based upon where you fall. Now, why is this important when it comes to Roth conversions? Because if you're thinking of retiring soon or even retiring down the road, and we're in historically low tax brackets, it might be in your interest. I'm not going to say always in your interest, but it might be in your interest to look at converting some of that taxable money into tax free money. Right. Doing a Roth conversion. Now, we can see this in the short term that if you're looking at doing this in the future, when would you rather do it? If you're going to convert money anyway, you're going to take money and put it from taxable into tax free and do this conversion.

Speaker1:
Which one would make more sense. Would you want column A or column B. Would you want the the Tcja Tax Cuts and Jobs Act column. Or would you want the post Tax Cuts and Jobs Act column when it comes to your tax rate? Logic would tell me I'd probably want the lower one. Right. So if you're looking to convert or turn taxable money into tax free money in the short term, it may be in your better interest to look at doing it before this act. Sunsets starting in 2026. So you can be paying at a lower tax rate bracket today than you would into the future. If you're thinking, well, we are in historically low tax rates now tax brackets now I think taxes are going to go up in the future. Then maybe just converting in general with whatever your eligible convert might be in your best interest also because you think you're going to be paying a higher tax rate in the future, that's completely up to you. But let's just look at how logic is pointing this out. If I'm looking to convert in the near future, or I want to turn my taxable into tax free again, which column would I rather have? The lower or the higher column that would tell me, hey, I'd want to pay Uncle Sam less when it comes to my conversion. So why are we bringing this up? Well, it's a combination again of two things that these historically low tax rates and what we're currently in now is going to go away unless there's a change made, but just currently there's that's not in place.

Speaker1:
It's going to go away starting in 2026. And the older tax rates, those slightly higher tax rates are going to come back. If I'm looking to convert, not only do, uh, we we ask this question at every conference or convention or talking point that we do. Hey, which which way will pull the audience? Which way do you think taxes are going to go lower or higher. Stay the same. Most people will tell me they're going to go up. They're going to go higher. Very few say they're going to stay the same. And nobody has told me they think taxes are going to be lower in the future. So Roth conversion may be something you look into anyway because we think just in general. Right. It's a consensus, it's not unanimous, and we don't have a crystal ball to know. But just the general thought is taxes will be higher in the future. I want to convert or make as much of my money tax free as possible in the future. And I can do that now by converting and prepay the tax on all that at a lower rate. That's great, but we know 100% based on what's going on today, and I say 100%, I'll back up on that. We don't know 100%, but just based on the current situations and there is not any continuation currently in play.

Speaker1:
They're not talking about, you know, this being a continuation or continuing these low tax rates. So as of 2026 we're going to revert back based on today. That's the that's what we're looking at. And it may be in your interest to convert any of that taxable money into tax free dollars. I might sound like a broken record, right. You might be looking at this like Val, I get it. I understand what you're saying. Um, tax rates or tax brackets or percentages are going to go up. Yeah, it makes sense, but I, I harp on it and I'm passionate about it because part of what we do with federal employees when they're nearing read during retirement, this is something we do with federal employees all across the country, all different agencies, all different situations, is try to make sure you're set up in the best place. And one of the things that we can try to help with is limit your liabilities, right. Limit your risks in retirement. And one of those is a tax risk. If we can eliminate as much as we can, we can't entirely eliminate the risk of taxes. But if we can take part of that off the table, great. That's not something you're going to be worried about. If tax rates down the way like up ridiculously, we don't know what's going to happen in the same way. We don't think they're going to go down. We think they're going up.

Speaker1:
I'd rather you take some of that risk off the table as much as you possibly can, by taking taxable money and turning it into tax free dollars. Now, if you realize you got to do something. Okay, you realize, yeah, I want the first column, not the second column. Right? I'd rather the lower tax rate than the higher tax rate. If you think that this is an option for you, you think this is something that you'd want to do. What are the next steps I. Continually say, reach out to us, right? How do you do that? You go to our website, Federal Retirement Show.com you fill out the form, one of our representatives across the country. Again, if it's not me personally, we'll be reaching out to you to go over your situation, answer your questions, and point you in the right direction. We want to make sure you're set up properly, as I said so federal retirement Show.com is your next step if this is of interest to you. If you want to talk further about this, if you want a review of your situation, you want just some some guidance and you're not sure where to turn, reach out to us. The question we get asked all the time, I'm going to answer it before you're even asking it. Or maybe you're not. Maybe you're not thinking it. Maybe you are. What is this going to cost me? Is this consultation? You know, is it hundreds of dollars per hour? What is it? The consultation is complimentary.

Speaker1:
The information that we provide. We're experts in this area complimentary. So you can get your questions answered. You can get some guidance you don't have to worry about, you know, any kind of cost or any kind of hidden fees or things of that nature. So reach out to us again, see if your situation, see if it's beneficial for you to do some sort of conversion or to eliminate or limit. I should say I don't want to say completely eliminate, but eliminate as much as you can your future tax liability. I said earlier that it's a risk, right? What is the risk? The risk is us thinking taxes are going to remain the same or go down, and then next thing you know, they go up and we need to use our money in the future and we get to use less of it because more is taken from us in the form of taxes. If you want to get that risk off the table, repay the taxes, or as much as you care to or want to or are able to, that way Uncle Sam is out of your pocket and you own your money free and clear. You let it sit and grow. All of that is tax free. Plus, if you pass on and leave that to a beneficiary or multiple beneficiaries, that also passes to them at a tax free basis. So again, federal retirement Show.com fill out the form.

Speaker1:
Be happy to assist you answer all of your questions. Make sure you're pointed in the right direction. So I know today was relatively short compared to some of the other things that we've talked about, but this is a topic that came up when talking to federal employees just about future taxes and everything. And with the fact that this, uh, Tax Cuts and Jobs Act is set to sunset at the end of 2025. So starting in 2026, we're going to revert back to the previous tax rates, tax percentages, tax brackets. We want to make sure you know all the information so you can make the right decisions for you, your family, your future retirement. Well, I really, really appreciate you taking the time out of your schedule. Thank you for joining us and tuning in to the Federal Retirement Show. Be sure to tune in next time. Also, go back and view our previous episodes. We have a lot of things in there, not only just different topics, but we've got different guests, uh, different representatives of American Benefits Exchange who have given you their opinions on what is important, what they see out in the field when helping federal employees. You know, their guidance is extremely valuable for you. So I highly encourage you to check out our our previous sessions review all the content that we have here for you, because that is why we do what we do. So thank you again and look forward to seeing you on a future episode.

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