So you’ve decided to quit your full time job to build a blog, a youtube channel, a social enterprise, or a list of other options that starts out with little to no income. Congratulations! Right?

Little to no income doesn’t sound so good, but there is one major positive to your low income.

PARTIAL ROTH CONVERSIONS

Partial Roth Conversions With Low Income

New Bloggers, YouTubers & Social Entrepreneurs

What is a partial Roth conversion and why is it important?

To start off, there are 3 main ways to save money (taxibly speaking).

Pre-Tax - you pay taxes LATER

(the larger dollar)

Post-Tax - you pay taxes NOW

(the smaller dollar)

Taxable - you pay taxes LATER

(only on gains)

(We're assuming a long time frame for investments. Stocks tend to increase in value over time, hence money in the future is larger.)

Today

30 years from Today

Partial Roth conversions simply means moving money from your pre tax bucket, to your post tax bucket. A key to remember here is that you will owe taxes when you do this. But, you are controlling when the taxes are paid and how much.

Now onto why this is important.

I have been a financial planner since 2007 and I have talked countless times about this “tax triangle” and the importance of tax diversification. But… in the last 2 years, I have gone beyond talking about the importance, I have actually implemented partial Roth conversions for clients.

I can confidently tell you that as a professional money nerd, this is one of THE MOST POWERFUL financial decisions you can make.

Here’s why:

You control when and how much taxes you pay
You lessen your future required minimum distributions
You can pass very tax efficient assets to your heirs

How this strategy works (from 10,000 ft)

Back to you and your (temporary) low income.

Mr. (Mrs.) LowIncomeBlogger. You just left your corporate job to blog full time. You saved and lived frugally in order to accomplish this goal. Plus, you have a 401k from that old corporate job.

You’re making $3,000 / mo through your blogging income which lands you in the 12% tax bracket. The second lowest bracket.

You can open a Roth IRA and move SOME of your IRA (former 401k) into the Roth every year. If you move the amount over slowly over the course of a few years, you can convert your IRA to a Roth while staying in the same (low) tax bracket.

How this strategy works (from 100 ft)

Source: Nerdwallet.com

We'll stick with the idea that you're making $3,000 / mo and living off of savings for this example but I'll provide the data so you can use your own scenario.

$3,000 / mo = $36,000 / year.

Your Standard Deduction for 2020 is $12,400 for single filers and $24,800 for married filing jointly & head of household.

Subtract this from your income

$36,000 - $12,400 = $23,600 taxable income.

Now take the upper limit of your tax bracket, subtract this taxable income and you have the largest potential Roth conversion you could do this year and stay in the same (low) tax bracket.

$39,475 - $23,600 = Potential Roth conversion of $15,875

If you chose to convert $15,875, it would cost you roughly $1,905 in additional taxes for the year. ($15,875 * 12%)

Note: This is overly simplified to illustrate the math. Taxes are complicated and you should consult your tax advisor whenever possible.

Potential Benefits

You control when and how much taxes you pay

Let’s face it, if you’re starting a blog, a youtube channel or a social enterprise, you’re probably on the younger side of life. Meaning you are in your lowest income tax years of your life (also with the lowest tax rates we’ve ever seen).

If you waited to convert or contribute that same $15,875 later, when you're in a higher tax bracket it would cost roughly $3,492 ($15,875 * 22%) in additional taxes.

You lessen your future required minimum distributions

It may be hard to think of yourself in your 70’s but it will happen. When you hit age 72, you HAVE to start taking money out of your traditional IRA’s. I have clients right now who need to withdraw $30k-$50k or more per year.

Do you know how they got to be wealthy? Working hard and being frugal. And what’s their reward? The IRS telling them they have to withdraw tens of thousands of dollars that they don’t need, AND be taxed on that income they don’t need.

You don’t have to do that with a Roth IRA.

You can pass very tax efficient assets to your heirs

Your kids are likely to inherit either your wealth, your work ethic or both. Hopefully you die at a ripe old age. This means your kids will probably be in their 50’s or older. Their prime earning years of life…

Do you really want to pass them an account that they NEED to withdraw within 10 years? And 100% taxable to them? Nope...

Now that you're convinced to do a Partial Roth conversion, here are some TIPS

Down markets are your friend

Since Roth conversions are taxable events, moving money while the markets are down is your friend.

Imagine you have an IRA worth $20,000 and the market drops by 20% and is now worth $16,000. You can convert at the lower value, then let the recovery happen in your Roth!

You can convert specific investments

Depending on where your accounts are held, your custodian may allow you to convert specific investments.

I hold accounts with Charles Schwab and they allow specific investments to be “journaled” (converted) from an IRA to a Roth IRA.

In a diversified portfolio you will likely own US & non-US stocks and bonds as well as a handful of other asset classes. If any of those specific asset classes has a downturn, you can convert that specific asset class at it's lower value.

You can take advantage of daily pricing on mutual funds.

If you own mutual funds, they only reprice at the end of the day at the Net Asset Value.

I’m writing this during the wonderful Covid-19 Virus scare of 2020 and the markets have been down more days than they are up. Last week, the market went down 13% in one day!

At the end of the day, the mutual funds re-priced their Net Asset Value (share price) to reflect this 13% loss. The next day, if the market goes up, the price of the mutual still reflects that 13% loss for the entire day.

Depending on your custodian, when you journal shares from your IRA to your Roth, this happens instantly, allowing you to convert funds at a loss even if the market is going up.

If you're convinced that this may be a good idea for you, but don't know how to get started feel free to schedule a phone call. We're happy to help...

We're a different kind of financial firm than you may be used to.