Jay Abolofia, PhD economist, CFP, and President of Lyon Financial Planning, joins me to discuss your ticket to potentially major lifetime tax savings. It's MaxiFi's Roth Conversion Optimizer. The Optimizer is a powerful new addition to MaxiFi Planner. MaxiFi, developed by my software company, Economic Security Planning, Inc., does economics-based financial planning.
Economics' approach to financial planning was developed over the past century by a Who's Who of economists plus one extraordinarily brilliant physicist and computer scientist, John von Neumann. The focus of economics-based planning is raising and sustaining your living standard and properly trading off risk and return in guiding your investments. Spending is anchored to what you can afford to spend not to what you'd like to spend.
Conventional financial planning has the opposite anchor. Its first question is "What do you want to spend in retirement?" When you respond, "One trillion dollars a year.", conventional planning sets your target for you based on a crude retirement-income replacement ratio formula. The formula will invariably set you target far too high. But that's the point. It gives the planning industry the opening to market its high-yield, but also high-risk and high-fee investment management services to meet "your" target.
In considering Roth conversions, conventional planning software keeps "your" retirement spending at your target. Hence, any tax savings from conversions are assumed to be saved and bequeathed, not spent. This is a pleasant assumption for money managers, but it's highly unrealistic. Virtually all of us will spend more if we can lower our taxes.
Finding the optimal annual conversion plan is a highly complex problem involving not one but four interconnected taxes -- the federal income tax, the state income tax, the taxation of Social Security benefits under the federal income tax, and Medicare Part B IRMAA premiums. It also involves conversion-induced changes in required minimum distributions (RMDs) from taxable retirement accounts. Setting retirement spending at an arbitrarily high value and not considering the interaction between spending, taxes, and optimal conversions is a prescription for one thing -- very bad Roth conversion advice.
As Jay and I demonstrate, MaxiFi's Roth Conversion Optimizer considers the four taxes in full detail as well as the impact of conversions on RMDs. The Optimizer searches across all conversion strategies to determine precisely how much to convert each year in order to produce the largest lifetime tax savings and, thus, the largest increase in lifetime spending (including desired bequests). The results are remarkable. For most households, the optimal plan involves converting most or all of your regular IRAs in the immediate or near term. Indeed, a Go Big or Go Home outcome can entail placing yourself in the highest federal tax bracket in the short run in order to pay far lower taxes in the long run. In addition, the increase in lifetime spending from Roth conversions can be very large, indeed, as large as the lifetime spending gains from optimizing your Social Security benefit collection decisions.
Our bottom line -- everyone should run MaxiFi's Roth Conversion Optimizer to determine their best conversion strategy and make sure they aren't leaving tens if not hundreds of thousands in lifetime tax savings on the table.
Economic Matters - The podcast is hosted by Laurence Kotlikoff, a Boston University Economist, a NY Times Best Selling Author, President of maxifi.com, and Author of Money Magic.
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