00:00:00
Podcast Intro: You’re listening to ChooseFI. The blueprint for financial independence lives here. If you’re looking to unlock the secrets to financial independence and early retirement, you’re in the right place. Stay tuned and join a community of like-minded people who are getting off the Instagram and taking control of their lives in the pursuit of financial independence. ChooseFI, your home for financial independence online.
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Brad: Hello and welcome to ChooseFI. Today on the show, we have Sean Mullaney and Cody Garrett, two of my all-time favorite guests, and we’re going to be talking all things Roth conversions. So a lot of this is thrown around their backdoor Roths, mega backdoor Roths, Roth conversion ladders, but what are they all? And as these guys told me, there’s a lot of interest in taxable Roth conversions, but are they really necessary? And we’re going to really try to talk through every aspect of this. You’re going to leave here with a lot better understanding of all things Roth conversion.
00:00:42
Brad: Cody and Sean, I neglected to say you guys are the authors of the incredible book, Tax Planning To and Through Early Retirement. The book has been an immense success from what I’ve seen. Huge congrats guys.
00:00:55
Sean: Thank you, Brad.
00:00:56
Cody: Yeah, I appreciate that.
00:00:57
Sean: We’ve been excited. It’s funny; nobody writes a book to make money, you know, but we’ve been excited probably by the time this podcast comes out about 8,000 copies, which, you know, I think about like, if we were to stack those books, like how high would they go? It’s just really exciting. It’s less about the number of books quantitatively, but just thinking what’s the long-term impact of just educating people about the fundamentals of tax planning.
00:01:17
Brad: Yeah, no, it’s massive. Selling books is really, really difficult. Selling 8,000 books puts you in rarefied air. That’s how hard it is to sell any kind of books. Huge congrats. This is not obviously like the murder mystery that’s the summer hit, right? But to sell this many books right off the bat, I believe since the first second I read it, when you guys gave me an early copy that this book is going to have legs for years and years and years.
00:01:44
Brad: So again, thank you guys. To anybody listening, if you haven’t checked this book out, you can buy it on Amazon. A lot of libraries now I’m seeing Facebook posts and the ChooseFI, wow, the book is now in my library. So they grabbed it, and this is a book worth reading.
00:02:03
Brad: So with that, guys, let’s hop into this. I think you guys always come prepared and you gave me an amazing outline as usual. So I’m just going to throw it over to you, Sean, to start, and we’re going to pick up from there.
00:02:11
Sean: Yeah. So I think we want to focus on this episode on taxable Roth conversions because there’s a lot of debate, discussion, confusion, frankly. Oh, I know I need to do a taxable Roth conversion before year-end or whatever it might be. I want to distinguish taxable Roth conversions versus a backdoor Roth. A backdoor Roth is a transaction where you use the Roth conversion mechanism to get money into a Roth account. The trade-off there is very favorable during our working years when we’re high income.
00:02:37
Sean: We, for whatever reason, don’t qualify to make a direct Roth contribution, so we do a backdoor. It could be the conventional backdoor Roth IRA or the so-called mega backdoor Roth. That money, generally speaking, would have gone into a taxable account, so why not throw it into a Roth account instead through this backdoor mechanism?
00:02:55
Sean: Instead of focusing on those backdoors, where we think the trade-off profile is generally very advantageous, we want to focus on these taxable Roth conversions. These taxable ones, the idea is we’re going to pay tax, or at least we’re going to create taxable income, right? There’s no debate about that. The idea is we’re going to create taxable income through an elective transaction. We don’t have to do taxable Roth conversions, but we’re allowed.
00:03:26
Sean: There’s no income limits; there’s no work. The only thing you need to have is a traditional retirement account in order to do a taxable Roth conversion. The mechanism’s pretty easy; you go into your traditional retirement account and you say, convert a certain amount to my Roth. The platform’s going to alert you that this is taxable income to you, and you accept that, and we just move this money from the traditional IRA or 401k to a Roth account. It’s fully taxable in the year of the transaction, and we do that for planning purposes.
00:04:53
Sean: So that’s what we’re really talking about today: these taxable Roth conversions.
00:04:57
Brad: Yeah, that all makes sense. I just wanted to clarify a few things, and Cody, you can jump in obviously at any point to clarify further. A lot of people ask because they hear all these terms thrown about with these conversions or anything with the backdoor Roth, mega backdoor Roth, and I think there’s a massive distinction, as you’re making, Sean, between the backdoor, the mega backdoor, and these taxable Roth conversions.
00:05:23
Brad: I say that specifically because I get this question. I’ve gotten this question for nine years on ChooseFI, which is, “Hey, do you think I’m still going to be able to do this in the future?” We’ve talked about Roth conversion ladders as a really essential part of a potential strategy down the road. People are always concerned because they hear, “Oh, that might not still exist.”
00:05:39
Brad: And I want to get your guys’ opinion on this because the way that I look at it is the backdoor Roth and the mega backdoor Roth, those seem to be in some way skirting the intention of the rule. There’s a contribution to a Roth IRA that has income limits, and these are ways to essentially get around that. Now, I’m not saying they’re illegal or wrong in any way; the rules are the rules, whether we like them or not, but I think it goes against the clear intention of the income limits.
00:06:11
Brad: Whereas a Roth conversion, as Sean just said, is something that you are saying, “Hey IRS, please tax me on this amount that I’m converting from my pre-tax vehicle, which would be a 401k or IRA, into a Roth IRA.” Every dollar of that, the fair market value, that amount that you converted just goes on your tax return as taxable income.
00:06:39
Brad: So I see no reason why that will ever change because what kind of government anywhere would say no to a taxable event? So that’s my take. I’d love your guys’ thoughts on it.
00:06:47
Cody: I think it’s important to say that there are two primary reasons that people convert to Roths, especially speaking about the taxable Roth conversions. One reason to convert to Roth is the excitement about the future tax-free growth. Once this money’s in a Roth, it’ll grow tax-free, and I can take it out tax-free under the qualification of future distribution. So there’s that greed and excitement.
00:07:17
Cody: I found that a few years ago, people were more excited about Roth conversions and Roth because of the excitement of tax-free growth. Now, the other side of the coin is fear, which is, you know, some people are excited about the tax-free growth while others are doing Roth conversions because they’re fearful about being crushed by taxes in the future. They’re saying, “Hey, I’m going to pay my taxes now because I know, objectively, this is my last opportunity.”
00:07:43
Cody: I’ve heard a lot of objective analysis and people trying to convince me with a sense of urgency that if I don’t convert to Roth today, I’m going to be crushed with taxes in the future. Specific commentators have said things like, “Hey, I don’t know if I’m actually making the right financial decision, but at least I’m making an intentional decision to control when I pay taxes rather than having the government control when I pay taxes and how much in the future.”
00:08:39
Sean: Yeah, Brad, let me give you a little bit of history here and some comparison to a neighbor of the United States. The backdoor Roth came into existence in 2010. It was based on a 2006 law change. Before that, you could only do a Roth conversion if your income for the year was less than $100,000. A lot of folks couldn’t do Roth conversions, but they said starting in 2010, we’re going to lift this restriction.
00:09:11
Sean: So everybody, it doesn’t matter what your income is—zero or a billion or anything in between—you just get to do a Roth conversion. I think they’ll be very hesitant to eliminate or restrict Roth conversions. There was a proposal back in 2021 that said, “In 10 years from today, we’re going to stop the ability to do a Roth conversion, but only if your income is over $400,000 or $450,000 if you were married.”
00:09:44
Sean: It was meant to be a rule that would apply to nobody because people at that high level of income generally wouldn’t want to do Roth conversions. The other thing about the backdoor Roth is, think about Canada; they have a tax-free savings account, their analog to the Roth IRA. There’s no income limit for the ability to contribute to a tax-free savings account. Essentially, the backdoor Roth IRA is a gimmick that gets around a bad rule. There shouldn’t be an income limit on the ability to contribute to a Roth IRA, but there is.
00:10:31
Sean: So this is a gimmick that gets around another bad rule.
00:10:35
Sean: And then on the mega backdoor Roth, which frankly, is one of these things that helps tech workers, it tends to be that tech workers have access to it because you have to have access through your workplace plan. Well, it turns out that mostly it’s tech workers that have access, not exclusively, of course, but whether you like it or not, there’s an IRS and Treasury notice from 2014 that essentially blesses it. We can debate all day whether that’s a good thing or a bad thing, but it is what it is.
00:11:07
Brad: Yeah, no, that’s fair. I love the clarification there. And yeah, we shall see. But I think, as far as I’m saying—and Sean, it seems like you agree—the taxable Roth conversions, I can’t imagine are going anywhere anytime soon. So that’s where we’re going to spend the majority of this episode talking about. And I think this is a tactic that can be really useful, potentially for people in our community.
00:11:25
Sean: So I think we now have to think about our two phases, or we’ll start with two phases: accumulation and draw down or retirement. So you say, alright, these taxable Roth conversions, they’re all over the personal finance commentary, and the advisors talk about them—how should I approach them? A very easy way to start that approach is working years, retirement years, accumulation, decumulation, however you want to phrase it or call it. One thing that’s really interesting is if you have a job, that’s usually a really good indicator you should not be doing taxable Roth conversions. That’s the time to do a backdoor Roth potentially, or a mega backdoor Roth. But if you got a job, why would you do a taxable Roth conversion?
00:12:07
Sean: Because essentially, what Cody and I generally like to do is pay tax when we pay less tax. Well, when do you pay the most tax? Typically, it’s when you’re working. So if you’re already paying a lot of tax and income tax, why are we going to add a taxable Roth conversion, which stacks on top of our other income and is likely to face a very high tax bracket? Now, are there some exceptions to that? Yes. In the book, we refer to them as income disruption years. So it could be maybe you read Jillian Johnsrud’s book, and you’re convinced and so you’re going to do a mini retirement, and you don’t work for most or all the year. Okay, that could be a time during the accumulation phase.
00:12:50
Sean: Hey, I have hardly any income; fine, I’ll do a bit of a taxable Roth conversion. Maybe I’m going to grad school or law school or something like that. That could be a time to do a taxable Roth conversion sort of during our accumulation years. But generally speaking, if you’re getting a W-2 in the mail at the beginning of the year, that’s a pretty good indicator. Oh, yes, maybe I can think about it during retirement. But boy, during the accumulation years, the taxable Roth conversions, because I’ve seen online some confusion about this. But that’s like the first big indicator. Do I have a job? If the answer is yes, then most likely a taxable Roth conversion is very far off the table.
00:13:25
Cody: Yeah, that’s a great back of the envelope just as a starting heuristic for this because the vast majority of people are going to be at least in the 22% marginal bracket. And that’s somewhere where, based on a lot of your guys’ analysis that I’ve seen or the discussions we’ve had in case studies, it really is going to be highly unlikely that that’s going to make a ton of sense. So yeah, that’s a great way to approach this, Sean.
00:13:49
Cody: And I’ll add a brief personal example. So I was a professional musician for 10 years, you know, from age 20 to 30. Then I changed careers, kind of overnight to become a financial planner. And my first job paid a W-2 full-time job, but it paid $40,000. And my wife had just become a stay-at-home spouse at that point, not earning money outside the home. So as a married couple, we had about $40,000 of W-2 income as our only income source.
00:14:13
Cody: During that time, through some full-time work as a musician, I had put some money in a traditional 403(b) when I worked at a church. So this is an example of a kind of income disruption, right? We go from, you know, both working full-time to one spouse working full-time, and actually taking a big pay cut to become a financial planner initially. So that was one of those disruption years where I said, “Hey, like, we’ve just drastically reduced our taxable income; maybe this is the year to take some of those old traditional contributions and earnings and convert them to Roth.” And at that point, I was converting them to Roth within like the 10% and 12% brackets.
00:14:46
Cody: Okay, and that makes sense. And yeah, of course, as always, everyone listening to this, we’re not giving financial advice to you specifically, we’re talking about broad generalities of what might make sense. And this is how the three of us would mentally approach this. So yeah, does that mean if you’re making a W-2 income, and you have $5,000 of income, are you the prototypical example of what Sean’s saying to avoid? No, of course not. But for the 99 plus percent of people, it’s a pretty good back of the envelope way to start this.
00:15:13
Sean: From there, we’ve got to go to taxable Roth conversions during retirement. And you can’t just approach this in a vacuum; you have to say, well, what am I doing by doing a taxable Roth conversion in retirement? And who am I helping? The first insight to tackle here is that taxation in retirement tends to be light. And I know that’s a counter-message to what you hear in other places. But I’ve done this on my YouTube channel, we did this in the book, and what we keep finding is we have folks who have traditional retirement accounts and Social Security, and maybe even some taxable brokerage accounts, and even very successful, very affluent folks in retirement.
00:16:07
Sean: Time after time, when we run the numbers, we find that retirees tend to be lightly taxed. So that raises an issue. If I’m worried about taxes in retirement, I might do more in the way of Roth conversions. But why am I worried about taxes in retirement? What typically happens, Mike Piper made this point in a 2024 speech, we can send you the link for the show notes; it’s a really good talk. It’s from the Bogleheads conference. And he essentially said, “Look, the two main tax benefits of a Roth conversion are going to be the reduction of the taxes on taxable brokerage accounts. Essentially, what you do is you do a Roth conversion, you trip some income taxes, and you pay for it with those taxable brokerage accounts. So they now can’t trigger taxable income to you; they’re not generating dividends.”
00:16:57
Sean: So that’s the first benefit. And then the second benefit is a Roth conversion reduces the negative tax effects of RMDs. So that’s very insightful. And then Mike, in that same speech later says, Roth conversions do not improve, generally speaking, financial security in retirement. He acknowledged to the audience, “How can that be? Can we hear all these great things?” And part of what our book does is it says, wait a minute, the tax drag on those taxable accounts in a low yield world with qualified dividend rates tends to be very small. So it’s like, okay, the Roth conversion helps against tax drag, but that tax drag in this environment tends to be very small.
00:17:30
Sean: Then, well, what about RMDs? Right? Aren’t they terrible? Well, maybe not so much. In fact, at this year’s Bogleheads conference, Jim Dolly said something provocative that I sort of generally agree with—not entirely. He said, “The biggest misperception of personal finance is that RMDs are bad.” It’s like, whoa, Jim. Okay, slow your roll. No, but actually, generally speaking, I think the white coat investor—Dr. Jim Dolly—pretty much got it right. I’m not a big fan of getting raises later in life; that’s the one drawback to my mind of RMDs is I’d rather spend more earlier rather than later—a different conversation. But essentially, when you look at the RMD tax environment, it too is not all that bad.
00:18:13
Sean: So those are big parts of the reasons why, generally speaking, Roth conversions aren’t needed. They can be beneficial; we can talk about some examples later on where absolutely, you see a benefit to doing the Roth conversion. But even in those examples, you’re not going to really see a need to do the Roth conversion.
00:18:31
Cody: Yeah, and I suspect this is something we’re going to get into. This is something I asked Sean about before we hit record, which is in retirement, what income is going to fill up the standard deduction and maybe your lower income tax brackets? And I think for a lot of people, we’ve talked for years going back to, I think, episode 17, our way back in 2017, about the Roth IRA conversion ladder just as a really elegant way of potentially getting all of your money out of pre-tax vehicles like a 401(k) or traditional IRA into a Roth while laddering this over many years and potentially paying essentially zero tax on all of that money.
00:19:10
Cody: So that was just an interesting construct. But that’s not the only way to fill up those brackets. And I’m curious, as we go through this, to talk more about that.
00:19:19
Cody: Yeah, I think that there’s this big assumption that’s happening, especially within our community, the ChooseFI community, and just the overall financial independence community, that somehow we’re going to have more income in retirement than we did while working. And I would love for us to step back and ask the question, right. So, you know, if you stopped working, you know, in retirement, maybe especially early retirement, where do you think your sources of taxable income are going to come from? Most likely, you’re not going to have access to Social Security; you might even delay all the way till 70 for Social Security, which is another, you know, potential tactic, assuming you have sufficiency.
00:19:56
Cody: But I did a small poll—not definitely not representative of the American world out there—but I would say that doing a small poll on even the ChooseFI Facebook group, asking, “Hey, how many of you expect to receive a private or public pension, besides Social Security in retirement?” And it was about two-thirds said no. And I think that this isn’t something we just think; you know, this has been happening—what they call the transition from what was called a defined benefit plan to defined contribution plans. This started in the 70s and has expanded out.
00:20:27
Cody: A lot of you listening might even have a pension from an old employer, but now that it’s been shifted from a pension plan to a 401(k), or 403(b), something like that. So one big misconception, just to question yourself on is, will I really have more sources of retirement income than I did while working?
00:20:38
Cody: The second is the quote that we see often in the comments in the posts is, “I know, I need to convert to Roth.” There’s this belief that it’s a necessity rather than something that can be beneficial. So I will say a lot of people have told me, “Hey, you’re anti-Roth,” and things like that. I know, first, it’s Roth at the right time; it’s kind of a fun phrase. But the second is that I’m not against Roth conversions. I’m just against thinking that they’re a necessity to be financially successful in retirement.
00:21:05
Cody: So they’re not a need; they’re a benefit, potentially.
00:21:10
Cody: Clients as a financial planner, I’m not accepting new clients, so this is not a way to market my practice here. But I will say working with financial planning clients, I would say that most of the retirees I work with are doing Roth conversions. What I mean by that is they’re using them strategically, tactically, usually not very aggressively. These are pretty conservative Roth conversions, especially in early retirement. Sometimes they’re actually increasing their taxable income to increase their premium tax credits, for example, for the ACA health insurance. So, even speaking briefly with Sean here that we are not anti Roth conversion, they need to be very intentionally thought through without making a lot of assumptions about the future of tax rates, and more focused on your sources of taxable income now and in the future.
00:22:04
Cody: I think it’s also helpful to think about who are the primary beneficiaries of Roth conversions? I’ve boiled it down to two. One of them, if we’re born in 1960 or later, is our 75 and older selves. What the Roth conversion essentially does when we do it before our RMD years is it reduces our future RMDs. But let’s think about that 75 or older person. If that person could be in a position where they have a high tax rate on an RMD, they’re already financially successful.
00:22:28
Cody: So, in our 40s, 50s, and 60s, we’ve done tax planning and incurred a lot of tax on a large Roth conversion to benefit someone in their 70s or 80s, who probably can’t even spend the money because they don’t have the energy to do so, and is already financially successful. The primary beneficiary of a Roth conversion is often a very financially successful elderly person who has no particular financial need for the money and may not even have the energy to spend it.
00:23:01
Cody: The second beneficiary of a Roth conversion is our loved ones, our heirs. They’ll inherit a Roth instead of a traditional, and they get a benefit. But let’s think about that for a second. That’s a person who just experienced a financial windfall. We’ve done tax planning for people who have financial windfalls. It’s important to step back and ask what’s the primary job of our retirement accounts? It’s not to do tax planning for other people; it’s to get us and our spouses to and through retirement with financial success.
00:23:39
Cody: I’d rather focus on the individual and getting them to and through retirement with financial success.
00:23:42
Sean: No, I love that analysis, Cody. There’s so much here. I wanted to clarify real quick: you mentioned that Roth conversions reduce future RMDs. A lot of people might not know that, but they’re not required minimum distributions from Roth IRAs and Roth 401(k)s, correct?
00:24:21
Sean: That’s exactly right, Brad. Here’s a good way to look at it. Consider a 60-year-old who’s single and has a $5 million traditional IRA. We can project their RMDs starting at age 75. To compute the required minimum distribution, you take the year-end balance coming into the year and divide it by the factor on the IRS table. The first factor for age 75 is 24.6, so the RMD is about 4.07%. It goes to close to 5% by age 80 and 6.25% by age 85.
00:25:12
Sean: For that 60-year-old with the $5 million IRA, they’ll likely end up in the 32% bracket due to their RMDs. This person would generally benefit from doing Roth conversions through the 24% bracket. I think most financial planners will agree with that. However, even if they ignore our advice and don’t do Roth conversions, they’ll still have over $200,000 of after-tax cash flow measured in 2026 dollars when they start taking RMDs at 75.
00:26:01
Sean: They would be fine without the conversions. Yes, if they did them in their 60s, they would have reduced the IRA balance, which would reduce RMDs, and would most likely lower the RMDs subject to the 32% tax. But even for that person, I wouldn’t call Roth conversion a necessity.
00:26:20
Sean: If an RMD is about 4% of a traditional retirement account, that’s often more money than the retiree needs to live on. This suggests that they are not only financially successful but might also be over-saved and overworked. If someone is concerned about needing to do Roth conversions, it might indicate that they over-saved and invested for retirement.
00:27:00
Cody: Sean, may I add something there?
00:27:02
Cody: So, this 60-year-old with the $5 million IRA might find it beneficial to do Roth conversions through the 24% bracket. However, they might also want to step back and consider that the fee to the IRS this year to avoid paying a higher tax rate in the future could be better allocated towards experiences today—like visiting friends and family or charity work.
00:27:42
Cody: Nobody goes to the tropics for the first time in their 80s, right? You don’t have to manage to go to the tropics, but my point is that it might be better to do modest Roth conversions in our 60s and use that tax money for living experiences now rather than sacrificing those experiences for potentially better tax outcomes in the future.
00:28:00
Sean: Exactly, Cody. This reminds me of putting on your oxygen mask before helping others.
00:28:05
Sean: We are talking about these various strategies, and we don’t know everyone’s exact situation.
00:29:01
Brad: It’s worth reflecting on how we’ve already filled up the standard deduction and are making decisions to make this conversion while actually paying tax in the current year. We want to ensure that this strategy makes sense.
00:29:16
Brad: As you mentioned earlier, there’s a common belief that Roth IRAs are always better than traditional IRAs. I think all three of us would agree that it’s not always true.
00:29:30
Brad: Another point made is that people often assume they’ll have a higher income in retirement, leading to higher tax levels. I struggle to find examples that clearly demonstrate this assumption. The beautiful part is we actually control a lot of what our taxable income will be in retirement.
00:30:01
Brad: This reinforces the idea of controlling what you can control along the path to financial independence. I appreciate that perspective and think we should consider the opportunity costs involved, not only in financial terms but also in terms of life experiences.
00:32:33
Sean: If you’re listening and you’ve been thinking about Roth conversions, I kind of think about the time and energy spent thinking about them. You’re not just on the path to the Roth conversion, but even afterward, there’s a regret avoidance and a lot of therapeutic things that come into play. Also, I find that sometimes when there’s a lot of focus on something like a tactic of a Roth conversion or tax gain harvesting, sometimes it goes beyond optimization as really a form of procrastination.
00:32:59
Sean: One thing I’m finding a lot is that people, especially those newly into retirement, have just flipped that switch from saving and investing to spending and giving. There’s already so much fear and anxiety, which I call the fear of future uncertainty when transitioning into retirement. I find that a lot of people, especially within our community, deal with stress and anxiety by going deeper into spreadsheets, adding more sheets to our analysis. Optimization can actually be a form of procrastination, avoiding pain and pushing it into the future.
00:33:40
Sean: Just stepping back qualitatively sometimes, Roth conversions—yes, do the math, but don’t let yourself spend so much time and energy stressed about something that’s primarily out of your control. We have to think about predictions about the future, and there have been plenty of them. It’s revelatory to see just how successful or not they have been.
00:34:12
Sean: For years now, we’ve heard that taxes are going up on retirees. There’s only one problem with those predictions: they keep being exactly wrong. At some point, we have to say, those predicting taxes are going up on retirees keep getting it wrong. The future keeps happening, and Congress, whether Democrats or Republicans, keeps cutting taxes on retirees. I’m not here to say that’s good or bad, but when we actually play the game, it keeps having tax cut after tax cut for retirees.
00:35:06
Sean: It’s interesting that despite the very high national debt and deficits, they keep cutting, not increasing taxes on retirees. They’ve cut taxes so much in the last decade, we had to distill it into a table we call the litany of tax cuts for retirees, as we couldn’t go into chapter and verse on it or it would have made the book too boring. I’m not saying retirees are never gonna have a tax hike, but it’s interesting that they keep cutting taxes on retirees while commentators say they’re gonna increase taxes on retirees. That doesn’t add up.
00:35:50
Sean: I wanted to ask, why does everyone push Roth conversions? To be clear, I’ve talked about the Roth IRA conversion ladder as a strategy for years, but I wouldn’t say I’ve been pushing this. It’s a fun potential strategy, but many in the finance world push these things, and the whole cause for this episode is to emphasize this is not something you have to do. Yet people feel that sense of urgency, and it seems personalities are pushing that.
00:36:31
Brad: I think you have to step back and ask, what is the master of reason? Oftentimes, the master of reason is motivation. Your motivation drives your reasoning more than you’d like to think. So we have to consider: what’s the motivation? For some advisors, it might be relevance. You don’t get a lot of relevance by saying, “Hey, this tactic might be beneficial, but it’s no big deal.”
00:37:00
Brad: Instead, you gain relevance by saying, “This is necessary, very important,” and you must ask what are people’s incentives and what drives their reasoning and motivations. There’s also outdated thinking in this space. Just last year, you could argue you should be doing more in the way of large Roth conversions because taxes are going up, and that was nominally true. However, those tax cuts from 2017 were scheduled to go away.
00:37:45
Brad: Well, they didn’t go away; in fact, the standard deduction increased. This reflects a lot of outdated thinking. I think folks haven’t updated their thinking; the standard deduction is now permanently higher, the brackets went down, and they’ve made some other changes; RMDs now start at age 75 instead of 70 and a half.
00:38:32
Brad: There’s also excitement about financial advisors needing to show they’ve been actively doing something. If they’re not actively trading, they might discuss value-adds like Roth conversions. It’s ironic that saying Roth conversions might not make sense doesn’t sound exciting. It’s this idea of hurry up and do nothing. There’s excitement around optimization, like Roth conversions and tax gain harvesting.
00:39:01
Brad: Even in ChooseFI, we have to be careful. These tactics are exciting, but you constantly remind people that just because something exists doesn’t mean it applies to your situation. We collect a bag of tricks, each year with its theme. Right now, that’s Roth conversions. Ironically, there’s a debate; thumbnails on YouTube tell you to convert all or not convert anything, leading to binary thinking in personal finance.
00:40:04
Sean: That doesn’t get as many clicks. In our book, we have a concept called the tailored taxable Roth conversion, which is a modest Roth conversion that could potentially be federal income tax-free. We’re not against Roth conversions, but we tend to ask as many questions and be more skeptical of large-scale conversions.
00:40:42
Cody: If we look at 2026 and the married filing jointly tax bracket, we can have up to $133,000 of income without it being subject to the 22% bracket or more. All that income is likely subject to the 0%, 10%, or 12% brackets, which suggests we should spread out income over a lifetime. Large Roth conversions concentrate income into a single year, which might not be advisable.
00:41:23
Cody: I’m not saying every case is 100%, but in most cases, we want to spread out income as much as possible. Questioning larger Roth conversions could be beneficial, whereas modest ones might be a beneficial but not a necessary tactic.
00:41:45
Brad: I love that, and I’m glad you emphasized 2026. We didn’t prepare for this, but I think it’s an important summation. While we’ve discussed that Roth conversions aren’t absolutely necessary, they are an option. We’re not suggesting not to do them, but situationally they can be great. Anytime you hear a drumbeat of “you have to,” it’s important to step back and assess the incentive behind it.
00:42:34
Brad: Do any of my experiences lead me to believe that this thing is an absolute necessity? Just like you mentioned earlier with I bonds—there was a time when they were a great suggestion.
00:42:53
Brad: Yeah. And it was great, you know, but does that mean that I closed my brain and I just kept putting money into I bonds thinking it’s the greatest thing since sliced bread? No, of course not. Life changes. This is how the world works. Things constantly change and we need to update our thinking.
00:43:12
Brad: Okay guys. But I think what would be really helpful and illustrative is just to kind of talk through, all right, we know people have fears, right? We’ve talked about this episode. People fear higher taxation in retirement for some reason. I don’t know why, but Sean just said, okay, in 2026, let’s say this was retirement year for you and you’re married filing joint. You could have $133,000 of income. That’s the actual income. And then you take out the standard deduction and the remainder is taxed in either the 0% tax bracket, the 10% tax bracket, or the 12% tax bracket, guys.
00:44:02
Brad: I haven’t done the math, but I assume on that 133, the effective tax rate is probably somewhere, if I had to guess, five to eight percent somewhere, plus or minus seems fairly standard. A five to eight percent effective tax rate on $133,000 of income is astonishing. Right? I mean, how many of us need $133,000 of income to live off of in our five lives? I can’t imagine there are that many of us.
00:44:21
Brad: So just the back of the envelope proves like, I don’t think you need to fear the high taxation like most people are fearing. And so anyway, that is a very long way of saying, let’s talk through what can make up income for people in early retirement. You guys see clients, et cetera. Like what makes up this income? Because I think a lot of people just don’t even have a sense. Like capital gains distributions, dividends are obvious ones like interest income; things that by virtue of having a significant net worth, you’re going to have a baseline quote unquote income. But those are just three right off the top of my head.
00:45:11
Brad: But I’d love for you guys, the actual experts, to talk through how someone should think about what is my income actually going to look like?
00:45:15
Sean: Yeah. And Brent, now we’re getting into drawdown tactics and strategies, even just separate from the Roth conversion. And I think it’s beneficial to start with, for many in the FI community, you get to early retirement, what’s the first spend assets? It’s the brokerage accounts, right? It’s the taxable accounts and you don’t have to take RMDs. So your income is going to be maybe a little bank account, right? So a little interest income, but we’re in a 4% yield world. So maybe that’s $2000 interest income. Okay. That doesn’t eat through the standard deduction or barely does.
00:45:50
Sean: And then you have this brokerage account and it spits out dividends. But what do we live in? We live in a low yield world, domestic equities, my goodness. As we record this in December of 2025, a well-diversified domestic equity index fund is yielding something like 1.2%. So a million dollars will kick out about $12,000 of taxable income. Oh, by the way, 90 plus percent of that is going to be so-called qualified dividend income. So even if you have a million dollars of a taxable brokerage account going into retirement, plus a small bank account, your initial taxable income is about $14,000. Single married, you’re not going to pay any taxes on that.
00:46:26
Sean: Now you’ll probably then sell some of those brokerage accounts, trip capital gains income, which is very favored. And now, yeah, maybe you trip $50,000, $60,000, $100,000 of capital gains income, but even that might be taxed at 0% or maybe a little bit of that. Some of that might be taxed at 15%. So you just saw a very affluent, either single or married person would pay maybe zero federal income tax, or maybe they’d pay a little bit on the capital gains, but that’s 15% of a little piece.
00:47:02
Sean: And then what happens is, so you asked about sources of income. Well, then let’s fast forward it to later in life when we’ve spent down those brokerage accounts. So we spend on the brokerage accounts, they’re pretty much gone. And now we’re taking Social Security and we have the so-called requirement of distribution out of the traditional IRA. Well, okay, let’s do our tax return. Interest income, we still have a bank account, fine. So we get a little interest income, let’s call that $2,000. We get our Social Security, that’s generally going to be 85% taxable. For some people, it’ll be less than 85%, but let’s just call it 85% for our more affluent listeners. And then we have our RMD from our retirement account.
00:47:40
Sean: And okay, that could be a big number. I did an example recently; it’s on my YouTube channel, but I also separately have the spreadsheet where I posit an 81-year-old widow in the dreaded, they call it the widow’s tax trap. Everybody worries about this. Oh no, we’re married, so we don’t pay a lot of taxes because married filing joint, but then one of us dies and now we’re in the terrible, the dreaded widow’s tax trap.
00:48:11
Sean: Okay, so I posit this widow; she’s 81 years old. So her RMD is just a smidge over 5%. And I posit her with a $3.68 million Traditional IRA. Most financial planners are going to tell you that is the worst, the worst, the worst possible outcome. Well, I run through her numbers and I even say she still has a bit of a taxable brokerage account because she and her husband took RMDs that were in excess of their needs.
00:48:28
Sean: So what I find is, okay, so she’s doing the RMD as an 81-year-old and she’s got this horrible, terrible, awful $3.68 million Traditional IRA. By the way, a position most Americans would gladly—good problem to be having. Yes.
00:48:48
Sean: But what I find is that she takes $189,700 RMD, which is an RMD level most Americans will never sneeze near, but let’s go with it. All right. So she has this almost $200,000 RMD. Her total income for the year is almost $250,000 with Social Security, with some dividends, a little interest income. That’s her tax return, right? It’s not all that complicated.
00:49:12
Sean: And on that, she pays $45,000, $46,000 federal income tax. And there’s a little bit of what they call net investment income tax. Two years later, she’ll have this Medicare surcharge at $6,500 to her when she’s worth more than $4 million. No big deal. And what I find is, so her effective rate, even if we include the IRMA, as a wildly financially successful widow, is about 21.3%.
00:49:50
Sean: And that includes that IRMA surcharge. And that’s two years down the road, but let’s just include it because it is an effect of today’s taxes. But what I find is the first thing is her after-tax cash flow in 2026, so not including the IRMA, but otherwise, it’s $201,000.
00:50:08
Sean: So, in the widow’s tax trap, paying 32% on some of the RMD, she does have after-tax $201,000. She’s doing fine. Her RMD, that $189,700, almost 15% of it is subject to the 12% tax. So in the widow’s tax trap, she still has an RMD that goes off a bit at 12%. A bunch of that RMD is going to be taxed by the 22% bracket and about half the RMD, almost 51%, is taxed in the 24% bracket.
00:50:40
Sean: Of that $189,700 RMD, a little bit more than $10,000 is taxed in the 32% bracket. About 5% to 6% of the RMD. By my quick and dirty numbers here, and Brad, I can share this spreadsheet with you. We could post it. I’m fine with folks looking at it.
00:51:00
Sean: But my point is that in this dreaded widow’s tax trap, this horrible, horrible widow’s tax trap that people fear taxes and retirement because they’re going to be so high. Well, okay. Let’s posit a widow. Let’s posit that she has almost $4 million in a Traditional IRA. Her RMD, most of it is taxed at 24% or less.
00:51:18
Sean: 6% of it, let’s round up, is taxed in the 32% bracket. And oh, by the way, her after-tax cash flow is $200,000. She’s doing fine. So yes, the IRS gets the win on IRMA; it’s not technically the IRS, let’s call it the federal government. The IRS essentially gets a win. She probably could have done some more Roth conversions, had less IRMA, but let’s call it a win on IRMA. And let’s call it a win for the IRS on that RMD hitting the 32% bracket. Those are what I refer to as garbage time touchdowns.
00:52:38
Sean: And Brad, I will say this; I don’t like the term expert. I really don’t like that term. I never use it, but I’m going to make an exception. If there’s one thing Sean Mullaney is an expert at, it’s garbage time touchdowns. Why? Because I’ve spent more than a third of a century rooting for the New York Jets. And as a Jets fan, if you know something, you know about garbage time touchdowns. The offense scores a touchdown where it puts points on the board, but it has no impact on the ultimate winner or loser of the game.
00:52:57
Sean: This widow, probably she and her husband should have done some Roth conversions and maybe they would have been taxed at 22 or 24%. Well, okay, they didn’t do those Roth conversions. And what happens? The IRS scores some garbage time touchdowns. She pays a higher tax when she can easily afford to pay the higher tax.
00:53:26
Sean: And let’s think about the tax planning arc of this widow who has this $3.68 million Traditional IRA for a second. This widow, she and her husband deduct into a 401k, call it 24% saved. So they’re winning against the IRS at work, but we know that that’s fine. Then they get to retirement and maybe they spend down some taxable accounts first, and they’re paying hardly anything in federal income tax, and they might even be doing some small Roth conversions.
00:53:47
Sean: I say they don’t here; let’s just say they don’t. But so they win against the IRS in the working years. They then win against the IRS to spend down the taxable brokerage accounts. They might be paying zero federal income tax for a few years, spending those things down. Then they’re married and they start having RMDs. The RMDs are mostly going to be taxed in the 12 and 22% bracket. While they’re still both alive, they’re married.
00:54:20
Sean: So the arc of their tax planning life is win against the IRS while working, win against the IRS in the early part of retirement, win against the IRS when they start taking the RMDs as a married couple. Only in the late fourth quarter, when I call her Jane, she’s 81 years old, she’s a widow. Only in the late fourth quarter does Jane start giving up some garbage time touchdowns to the IRS.
00:54:52
Brad: The IRS starts winning. By the way, even in that phase, 14 or 15% of the RMD might go against the 12% bracket in my numbers.
00:54:57
Brad: Even then they might still have some Ws against the IRS, but yeah, paying 32% on some of the RMDs is a loss, but it’s a garbage time touchdown that the IRS wins. But that doesn’t change the fundamental tax planning arc of her life. It’s win against the IRS after win against the IRS after win against the IRS. Then late in the fourth quarter, a few garbage time touchdowns to the IRS, but she’s still doing great.
00:55:26
Sean: I love the garbage time touchdowns. A little fun fact for the audience is we grew up about 10 minutes apart on Long Island and our high schools were actually 1.6 miles apart. We didn’t know each other.
00:55:38
Brad: That’s right.
00:55:40
Brad: That’s really 1.6 miles, and we’re both long-suffering Jets fans, you much more than me, and New York Mets fans. So yeah, we’re used to some pain, needless to say.
00:55:50
Brad: But yeah, I love this as a worst-case scenario. So again, there’s so much fear, and yet when you come up with examples, it’s hard to do worse than this.
00:56:00
Brad: And we say that kind of dripping with sarcasm because, as we said, this woman is doing wonderfully in your example. She has millions and millions and millions of dollars. There’s no world.
00:55:10
Brad: She paid a 20% effective tax rate, which for everybody out there, effective tax rate is just tax liability divided by the gross income that we’re talking about here. So in this instance, if she had $250,000 of gross income, 20% of that would be 50,000. So if she had a 50,000 tax liability, the effective tax rate would be 20% on this $250,000 of gross income.
00:55:33
Brad: It’s really important in our graduated income tax system that you understand that there are tax brackets, but that is the first X number of dollars depending on your filing status are at 0%. Then the next Y number of dollars are at 10%, the next Z number of dollars are at 12%. That’s how it works. But the smartest way to look at it is your overall tax burden is your effective tax liability. So that’s why we refer to that, but it’s important that you understand the definition.
00:56:02
Brad: So yeah, Cody, I know you wanted to jump in, but I wanted to just touch on that in that this is the worst case scenario and it’s still fantastic, right? Like we’re talking, as Sean said, about garbage time touchdowns and for most of us, our effective tax rates in retirement—early retirement or other traditional retirement—are going to be well less than 10% because we control most of this. And that’s the beautiful thing.
00:56:20
Brad: As Sean said, you get to play with your taxable brokerage at first and a lot of that is long-term capital gains. Cody, you’ve talked eloquently on the podcast before about how there’s a significant—a huge percentage—we get showered with benefits on long-term capital gains up to, I don’t know what the exact number is in 2026, but it’s something like probably 98 or $100,000 are taxed at 0%. This is crazy. That’s the gain, not the amount of money you pulled out, right? It’s the actual gain. For most people, you can play around with this and your effective tax liability is going to be almost zero or under 5%, under 8% in retirement. Like there is nothing to worry about at all.
00:57:03
Brad: Well, my one fun pushback for Sean is you’re going to have listeners of this podcast yelling at their podcast player saying, but Sean, I want to be able to control taxes, not just during my lifetime, but I want to control those taxes from the grave. So I want to mention this idea that if she passed away after this scenario, her heirs, by the way, her heirs could also include charitable organizations that pay $0 in tax on that money inherited. If they inherited $3.7 million, a lot of the concern within our community is, but aren’t those kids—maybe her adult kids—might be even in their highest earning years; they just inherited $3.7 million and they’re going to have to pay a ton of taxes on that.
00:57:53
Brad: And from hearing on both sides, we talk about the regrets of the dying a lot, right? Of saying, oh, I wish I would have had more experiences and had more memories with the people I love while I was alive. Guess what the regret of the heir is? First off, they inherit $3.7 million from mom or grandmother. They’re like, wow, that’s amazing. Like that is life changing money. By the way, even $3.7 million hit with taxes after tax, that’s still an incredible inheritance. But also mentioned that the heir is most likely—yes, maybe they’re paying a little bit of taxes on that money—but the most common story I hear when somebody inherits a large amount of money is, I wish my mom would have been able to spend this money while she was alive.
00:58:15
Brad: And I wish we could have spent that money to enhance our experiences together, staying right on the beach rather than a few blocks from the beach. My grandma never got to go to Norway, by the way, true story. My grandmother, her whole life, she talked about how much she wanted to go to Norway, never went. So when we inherit a million dollars from grandmother, right? Our initial thought isn’t, oh, I have to pay taxes on this money. It’s, oh man, I wish my grandma would have been able to spend this money to go to Norway and her physical and mental health was in a good place.
00:58:50
Brad: So I know I kind of pushed back on Sean that if somebody told you, but what about the kids paying taxes? What’s your response, Sean?
00:58:51
Sean: So a few things. First of all, we have to ask a fundamental question. What is the job of any retirement account—traditional, taxable, Roth, or any retirement account? I argue the job of a retirement account is to get me and my spouse to and through retirement, period, full stop. It is not to manage the tax liability of someone else. So that’s the first thing I will say to that. In this case, this widow’s doing fine; her and her husband, presumably, while he was still alive, were doing fine with $3.68 million at 81 years old. So the retirement account did its job.
00:59:28
Sean: Second thing is, okay, so you’re worried about the taxes of a person who just had a windfall. All right? So that’s not the most compelling financial planning concern, particularly when we’re doing our own financial planning. Third, are you sure your heir or heirs are going to pay a lot of taxes on this? So this can happen in different ways. One, maybe you only have one heir, but they inherit the $3.7 million IRA, and now they’re going to do an early retirement. So they’re going to primarily spend this down over the 10 years and they’re going to use their own early retirement to reduce the taxes on it. So that’s a possibility.
01:00:03
Sean: And then lastly, I’ll just give you an option: you know, if you got a $3.7 million IRA, and you’re worried about your heirs paying taxes on it, well, you spell my last name, M-U-L-L-A-N-E-Y, right? You can just name me as the primary beneficiary, and I’ll take care of those taxes. Your heirs don’t have to worry one bit about.
01:00:25
Brad: Oh, goodness. I love that, Sean. And I want to just clarify also, because again, a lot of people, it’s just lack of knowledge. A lot of people fear taxation, as we’ve talked about this entire hour for the vast majority of heirs of estates and also recipients of gifts. I think it’s important to clarify that recipients of gifts and heirs in very rare cases pay tax on the receipt of those gifts or the estate, right? Because there’s the massive exclusion for estates that is a lifetime exclusion. So we’re talking about something distinct here, which is—and guys, I want you to clarify, because obviously, again, you know this much better than I do—but there is a massive exclusion. So again, people worry like, oh, I’m going to get this windfall from my parents’ estate. I’m going to immediately have to turn around and sell everything and pay taxes on it—the quote-on-quote death tax and all this nonsense. The vast majority of people, 90% of people pay $0 on the receipt of this.
01:01:26
Sean: Well, so let’s talk about two different taxes, right? One is the estate tax. And in this case, most likely, most estates in the United States, even very affluent folks, even people worth $10 million, there will be no estate tax at the time of death. And that is incurred—the estate pays that—and that’s paid within the first year after death, generally speaking. So that’s one concern. Then the other concern is a very legitimate concern. And I was joking a little bit. I’m not against folks who want to prioritize the kids tax. And maybe the kid is in the 37% bracket and you’re in the 22% bracket and you just want to short the IRS 15 cents on the dollar, and you’re doing fine financially. I’m all for it; go for it. There’s nothing wrong with that. But I also don’t find that all that compelling. If the kid’s already at 37%, they’re doing just fine. They can more than afford the tax.
01:02:18
Sean: The other thing, too, is, yes, the traditional IRA creates taxable income to the heirs. It might be that there’s one heir, but maybe they’re early retired, or maybe you got five kids. Well, now you’ve just sliced and diced that IRA into five different tranches. The other thing, I wrote a blog post about this years ago—not that long ago—but it’s called the church IRA. Maybe you just add your church or favorite charity as another kid. And so you slice and dice that. So that IRA is smaller and smaller when it’s inherited, because maybe the church gets a sixth or a quarter or a third, and you’re taking away from the kids, but you’re also taking the highest taxed amount away from the other kids. So that’s a thought.
01:02:59
Sean: There are different ways where this can be good, but just think about it. If it was a single heir and they’re taking out $400,000 a year, it’s generally out to be taken out over 10 years. So maybe they start taking out $400,000 a year. Well, $400,000 is wildly in excess of the income of the vast majority of Americans and may even be in excess of the income of the vast majority of most listeners to the ChooseFI podcast, which tends to be a more affluent audience. So yeah, I get it; there might be some tax inefficiencies there, but it’s tax inefficiencies on somebody who is doing remarkably well financially.
01:03:36
Sean: So look, I’m not here to say you can never do tax planning, including Roth conversions to benefit the next generation—far from it. But I think we have to step back and say, what is the fundamental job of that retirement account? And the fundamental job of that retirement account is not to manage someone else’s tax liability. It’s to get you and your spouse to and through retirement with financial success.
01:04:01
Brad: I think that’s the perfect way to leave this episode. Gentlemen, this has been fun. So I mentioned your book earlier, Tax Planning to and Through Early Retirement. I highly suggest it to everybody. Cody, people can find you at MeasureTwiceMoney.com. Sean, you have your firm at MulaneyFinancial.com. Is there anywhere else you guys want to send people?
01:04:17
Sean: For me, you can go to my blog, FiTaxGuide.com. It’s sort of my internet home. You can find articles I’ve written, links to the book—all that sort of good stuff.
01:04:26
Cody: And for me, you can go to also the YouTube channel, MeasureTwiceMoney.com. You can see step-by-step calculations of how these types of things work. Watch real retirees talking about their retirement and all these fears and anxieties that come with it.
01:04:39
Brad: All right, guys. As always, thank you. I think you might be our two most frequent guests ever on the ChooseFI podcast. Love having you both on. Love your expertise. Sean, I know you don’t love that term, but nevertheless, I love your expertise. So I’ll put that word in your mouth for you.
01:04:52
Brad: But as always, to everyone listening, this is really important stuff. And I think it’s important to seed your brain with just this knowledge, okay? This might not be applicable to you today, but it’s the mindset of there’s no imperative. There’s nothing you have to do in early retirement or traditional retirement. There are a range of options. And your life is going to be different than mine, is different than Sean’s, is different than Cody’s.
01:05:17
Brad: And you have to do what works best for you, but not listening blindly to influencers who are telling you, you have to do X because this is the tax planning item du jour, right? It doesn’t work that way. You just need to understand the whole range of options. And again, not let fear guide you. And I think that’s what these guys did so wonderfully this episode. I think this is a really valuable one. And as always, thanks for being here along the ride.
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