The $250,000 Mistake Most Retirees Never Know They Made

0:00Tyler Gardner:The retirees who do this well don't have better portfolios than retirees who don't. They have a better practice. The same way that some people have a journaling practice or a meditation practice. They have a tax practice. And man, does it compound over 30 years into hundreds of thousands of dollars of difference. This is the part the financial industry has done a terrible job of selling. The annual tax practice is the highest ROI work a retiree can do. Hello, friends. This is Tyler Gardner welcoming you to another episode of your Money Guide on the Side, where it is my job to simplify what seems complex, add nuance to what seems simple, and learn from and alongside some of the brightest minds in money, finance, and investing.

0:47Tyler Gardner:So let's get started and get you one step closer to where you need to be. quick note before we dive in august pre-order incentive for my book real wealth is now live and this one is my favorite so far pre-order this month tell me you did at tylergardner.com book and i will send you a draft chapter of a new book that i'm already working on and no not even my editor at norton has seen this writing yet this sneak peek is yours to keep delivered to your inbox in early September. Pre-order today, and you're locked in for every monthly incentive through December 1st. Tylergardner.com slash book. Now let's get into it.

1:28Several years ago, I sat down with a very nice retired couple.

1:32Tyler Gardner:Let's call them Jim and Linda, because every example couple in personal finance is named Jim and Linda. Now, they came to me convinced they had done everything right. They had saved aggressively, they had maxed every tax deferred bucket the IRS had ever invented. And by the time they walked into the meeting, they had about$3.5 million in a traditional IRA,$180 ,000 in a Roth, and a paid-off house. Jim was 71. Linda was 69. They both looked at me with the kind of calm financial satisfaction that comes from doing 35 years of correct things in a row. And one of the first questions I asked them, is have you done any Roth conversions?

2:15Tyler Gardner:They had not. We did a quick calculation on a notepad. I told them, as gently as I could, that they had just spent the last six years, the years between Jim's retirement at 65 and the RMD start at 73, sitting on top of the single greatest tax arbitrage available to retirees in the modern U.S. tax code, and they hadn't quite taken advantage of it. conservative estimate of the missed opportunity just in undone Roth conversions during those six years, somewhere between$180 ,000 and$250 ,000 in lifetime federal taxes that were now going to be paid for absolutely no good reason, except that nobody had ever taught them how to do Roth conversions.

3:03Tyler Gardner:Linda looked at Jim. Jim looked at me. The room got a little quiet. Welcome to part three of the Decumulation series, and it is, by my count, the most expensive episode you will listen to all year. Not because it costs you anything, as always, this is all free, but because the cost of not understanding what's in it, compounded over the rest of your life, is actually staggering. Today, we're going to address three topics that very few people I know explain properly and simply Roth conversions, RMDs, and the Irma Cliff. So sit back, you might want to bring a pen, maybe a glass of wine, and I'll do my best to simplify what needs to be simplified.

3:51Tyler Gardner:Part 1. Why your traditional IRA is a beautiful thing for both you and the IRS. I want to start by reframing how you think about your traditional IRA, because the standard framing is kind of wrong, and the wrong framing leads to the wrong decisions for 30 straight years. The standard framing, and I've been very guilty of this, goes like this. Ooh, my traditional IRA is worth$1.2 million. Therefore, I have$1.2 million. I am a person with$1.2 million in retirement savings. And this is, I'm sorry to report, not quite true. What you actually have, if your traditional IRA holds$1.2 million, is, depending on your future tax brackets, somewhere between$720 ,000 and$960 ,000 in spendable money.

4:50Tyler Gardner:The rest belongs to the federal government. They just haven't asked for it yet. You're holding it for them. You are, in fact, a slightly fancy escrow account on behalf of the U.S. Treasury, and the Treasury will eventually send someone over to collect. You might have heard others refer to this as the wrapped tax bomb, and I think it's the single most useful mental model for understanding traditional IRAs. Every dollar in there is going to be taxed at your ordinary income rate the moment it comes out. Not your cap gains rate, not some special retirement rate. Your full, regular, no discount, no coupon, ordinary income rate.

5:34Tyler Gardner:Whatever the tax brackets look like in the year you withdraw, that's the rate. And unfortunately, we don't have control over what those rates might look like in the future. This matters because most retirees look at their traditional IRA balance and they feel rich. And they are, just not quite as rich as the screen suggests. The screen is showing you the gross. The IRS is collecting the difference between the gross and the net. And the longer you wait, the bigger that difference tends to get. Because the money keeps growing, which means the tax bomb keeps growing along with it. Here's the practical implication.

6:11Tyler Gardner:The objective of retirement from a tax planning standpoint. is not to avoid paying taxes on the traditional IRA. That's impossible. The IRS will get its share. The objective is to choose when the IRS gets its share and at what tax rate. Thinking back to last week's episode, remember we want always to fill out the 10 and 12 % brackets to the dollar if we can to take advantage of lower rates when we can. So when looking at the traditional IRA, heading into retirement, you have basically three options. Option one, pay tax now voluntarily at today's known rates while you're in control of your income.

6:56Tyler Gardner:This is called a Roth conversion. Option two, pay the tax later involuntarily at whatever rates exist when the IRS demands it. This is what happens if you do nothing. Eventually, at 73 or 75, depending on when you were born, the RMDs start and the bill becomes mandatory. Option three, you die and you let your kids pay it at their respective tax rates on an accelerated timetable. This is usually the worst option for most families for reasons we'll get into later. So the whole game becomes option one versus option two. Which one is cheapest for you, your spouse, and your heirs collectively given the realistic range of future tax environments.

7:41Tyler Gardner:And almost nobody asks the question this way. Most retirees default to option two, do nothing, let RMDs handle it, because option two requires no additional action, and humans are biased towards whichever option requires no additional action. The IRS, I should note, is delighted by said bias, as this bias, or indecision, or inaction, if you will, results in roughly$1.4 trillion of the federal tax base. Don't be the bias. Be the active decision. I've said it before and I'll say it endlessly. Whether you do or don't take advantage of Roth conversions, you always want to be in control of the things you can control in finance and investing.

8:26Tyler Gardner:And when and how the federal government collects taxes is one of the things you actually can control. This episode is brought to you by Gelt. Most of you listening probably already work with someone for taxes, but if you're a solopreneur, a real estate investor, or a high net worth individual whose CPA has gone completely radio silent since April, this is for you. A great CPA gets in touch with you. They call in July asking if you've thought about something, they don't wait until next March just to react. The moves that actually reduce your tax burden happen right now. PTE elections, S-corp timing, K-1 cleanup, and prior year retirement contributions.

9:11GELT is built around exceptional tax professionals focused on your strategies and your relationship, powered by cutting-edge technology that handles the rest. Designed for those who demand talent and welcome innovation and know the difference between ordinary and extraordinary everywhere. Gelt is taking on new clients this quarter, including an extension rescue program for anyone who filed an extension and needs a deadline safe handoff. And for new clients, they will help model your prior year retirement contribution opportunities and help you fund what's still on the table before October 15th.

9:45Visit joingelt.com slash Tyler to get started. That's joingelt.com slash Tyler. This episode is brought to you by Facet. If you know who Frank the Tank is and your idea of a nice little Saturday involves heading to Home Depot, this is for you. Because I see you, Gen X, and I want to make sure you're ready for retirement. And if you're currently looking for a financial planner, there are three things a percentage-based financial advisor is hoping you never think about. Number one, it is not necessarily harder to manage more money, yet these advisors will often charge you more just because you have more.

10:20Same asset allocation plan, same phone calls asking how the kids are doing, and yet the fee continues to grow. Number two, and the line they feed you, the we do better when you do better, it sounds great until you realize that the fastest way for them to do better might be to put you in riskier assets than you wanted or needed. Your risk tolerance and their incentive structure need to be properly aligned. And number three, notice how they never tell you the fee in dollars, only the percentage, because once it's not in dollars anymore, it doesn't feel like dollars anymore. FACET works differently.

10:50One flat annual membership fee based on the services you need. No percentages, no commissions, just a dedicated team of CFP professionals who help you figure out what you want your money to say about your life. Head to facet.com slash Tyler to book your intro call, and you'll still have time to make it to Bed Bath and beyond. I'm not a member of FACET.

11:10Tyler Gardner:I have an incentive to endorse FACET as I have an ongoing fee-based contract for cash compensation, as well as a percentage of equity in FACET based on this endorsement. FACET is an SEC registered investment advisor. All opinions are my own and not a guarantee of a similar outcome. Part 2. What a Roth conversion actually is. A Roth conversion is, mechanically, very simple. You take some amount of money, let's say$40 ,000, out of your traditional IRA, and you put it into your Roth IRA. The IRS treats this as a taxable distribution. You owe ordinary income tax on the $40 ,000 in the year you convert it.

11:48Tyler Gardner:The money now lives in your Roth, where it will never be taxed again, ever, by anyone. That's the entire transaction. Pay the tax now, never pay again. And on the surface, this might look like a wash. Why would I voluntarily pay tax today on money I don't have to pay tax on until later? Well, the answer is the entire reason this episode exists, and it has three parts. Reason one, the years between when you retire and when RMDs start are almost without exception. The lowest tax rate years of your entire adult life, maybe minus your 20s. And so sorry, we might have missed that window. Your earned income has dropped to zero.

12:30Tyler Gardner:You might not be collecting Social Security yet, or you're collecting only a portion of it. Your taxable investment income is whatever you've structured it to be. You are, for a beautiful window of roughly eight years, in the lowest tax bracket you have ever inhabited as an adult and will ever inhabit again. These are the cheap years, the conversion window, and once they're gone, they're gone. RMDs start, social security ramps to full benefit, and you're pushed back into higher brackets for the rest of your life. The eight-year window between retirement, roughly 65, and RMD age, roughly 73, is a structural gift from the tax code that exists for exactly one reason, to be exploited.

13:16Tyler Gardner:Reason two, the odds of tax rates going up, It's not zero. I want to be careful here because I have no political agenda and predicting tax policy is fraught. But the structural facts are these. The US federal debt is at historic highs. Social Security and Medicare do face significant funding pressure over the next 20 years. The current bracket structure, the one we got from the 2017 Tax Act, is scheduled to sunset after which rates revert to the pre-2017 levels, which were noticeably higher. Even if Congress extends the current brackets again, the long-term trajectory of federal tax rates over a 35-year retirement is usually up, not down.

14:00Tyler Gardner:A Roth conversion in this environment is essentially the financial equivalent of locking in today's mortgage rate when you think rates are going to rise. You're prepaying at a rate you can see for an obligation you'll have to pay at a future rate that you can't see. Reason three is the one very few people talk about, but we did in the last episode, the bracket fill effect. If you're already going to be in a 12 % bracket this year because of other income, you have a fixed amount of unused capacity in that bracket. The difference between your taxable income and the top of the bracket, and that's roughly$100 ,000 for a couple in 2026.

14:42Tyler Gardner:That unused capacity is, in a sense, worthless unless you use it. The IRS does not let you carry forward your 12 % bracket capacity into the next year, use it, or lose it. A Roth conversion is the most efficient way to use it. You convert exactly enough traditional dollars into Roth dollars to fill the 12 % bracket to the top. You pay 12 % on those converted dollars, a rate you might never see again, and you move them permanently out of this wrapped tax bomb and into the never-taxed-again Roth. The combined effect of these three reasons is staggering. A couple converting$40 ,000 to$60 ,000 a year during the eight-year window between retirement and RMDs can move$320 ,000 to$480 ,000 of traditional IRA money into a Roth at an average tax rate of 12%, where it will never be taxed again.

15:42Tyler Gardner:The same money sitting in the traditional IRA until forced out by RMDs and tapped during a 22 % or 24 % bracket year would have been taxed potentially at double the rate. That's a lifetime tax savings of$35 ,000 to$60 ,000 for the work of filling out one form per year, genuinely the highest hourly rate available to retirees in the legal tax planning universe. Part three, how to actually execute a Roth conversion. The five things you've got to know. I included this following action list because my guess is you've already heard, hey, you should take advantage of Roth conversions. My guess is you haven't heard as frequently how to actually do them and the steps you need to take.

16:29Tyler Gardner:But good news, the actual mechanics are simpler than the financial industry makes them sound. And surprise, that's because, as always, complexity sells and they'd like to charge you 1 % of your assets to do this stuff for you. End rant for now. Step 1. Call your custodian directly. If your IRA is at Fidelity, Vanguard, or Schwab, log in and search Roth Conversion. There's literally a button. The custodian moves the money internally from your traditional IRA to your Roth IRA. No IRS form, no third party, done in one to three business days. Step two, if it were me, I would have both accounts in the same custodian first.

17:14Tyler Gardner:If your traditional IRA is at Vanguard and your Roth is at Schwab, you'll be coordinating a cross-institution transfer that could take weeks. But if it's same roof, it's the same week. So for me, I would consolidate before I started converting, and I would consolidate before I retired in the first place. Step three, and again, this is not advice, but you really should look into this. Do not have taxes withheld from the conversion. This is the single biggest mechanical mistake I see many people make. Any dollar withheld goes to the IRS and never makes it into the Roth. So if you can pay the tax separately out of your taxable account or savings so you can keep the full conversion amount inside the Roth.

18:03Tyler Gardner:Why is this so important? Because remember, there are annual limits throughout your life to Roth contributions, but there are not annual limits to Roth conversions. So you want to fund that baby with every additional dollar you can. Step four, the tax bill arrives in April, plan for it. The custodian will then issue a 1099R at year end. You report the conversion as ordinary income on your own return. Large conversions may require a quarterly estimated payment to avoid an underpayment penalty. your CPA will or should flag this, just don't be surprised. Step five, each conversion starts its own five-year clock.

18:51Tyler Gardner:You generally can't withdraw the converted amount without penalty for five years, even if you're over 59 and a half. So track each conversion year separately, and it's usually in our best interest to start early and do this annually to create a type of ladder system. That's the playbook. One button, one tax bill, one five-year clock per conversion. The conversion takes three minutes. The strategy, which bracket to fill, how much to convert, what year, that's where the effort comes in. Part four, the math of bracket filling made all too visible. Bear with me because I want to do an actual numerical example with you this week because abstract talk about brackets and conversions is the kind of thing that washes over people.

19:37Tyler Gardner:So let me show you what this looks like in real numbers. We've got a couple, married filing jointly, both 66 years old. Retired, sources of income for the year are as follows. Combined social security, roughly$48 ,000 of which roughly 85 % is taxable at the federal level. Pension or other taxable income, zero. Interest from cash positions, let's say it's$4 ,000 a year in a money market fund. Capital gains realized from the brokerage account, let's say it's$6 ,000 in short-term gains, which would be taxed as ordinary income. Their total taxable income before any conversion is just over$50 ,000.

20:19Tyler Gardner:After the standard deduction for a couple over 65, which in 2026 is about$32 ,200, including the additional age-related deduction, their taxable income net of the deduction comes down to around$18 ,600. The top of the 12 % bracket for married filing jointly in 2026 is$100 ,800, which means this couple has$82 ,200 of unused capacity in the 12 % bracket. Tax rate-wise, it is the cheapest empty space they will ever have access to again in their lives. If they do nothing, the capacity goes unused. They pay zero in federal tax this year, which feels wonderful in a way that crash dieting feels wonderful for about 90 minutes.

21:06Tyler Gardner:And they have moved exactly zero out of their wrapped tax bomb. Now, if instead they execute a Roth conversion of$82 ,000, moving 82 from the traditional IRA to the Roth, they'd pay roughly$10 ,000 in federal taxes this year, about 12 % on the conversion. They are now$82 ,000 lighter in the traditional IRA and$82 ,000 heavier in the Roth, and that$82 ,000 will never be taxed again for the rest of their lives or their heirs' lives. Now, if they do this for eight years, from age 65 to 73, the conversion window we just talked about, they will have moved$656 ,000 out of the traditional IRA at an average tax rate of 12%, paid roughly$80 ,000 in conversion taxes total, and saved themselves and their heirs somewhere in the neighborhood of$100 ,000 to$155 ,000 in additional taxes they would have otherwise paid at higher bracket rates later.

22:09Tyler Gardner:Net result? Pay$80 ,000 of taxes now, buy back$100 ,000 to$155 ,000 dollars of tax savings over the next 30 years. This is, I want to emphasize, completely legal, documented in the U.S. tax code, requires no creative accounting, and is endorsed by basically every fee-only financial planner in the country. It is the most boringly correct retirement move available, and so few people do it because so few people have had it explained to them in a way that makes the numbers visible. So now you've seen the numbers, and now they're all too visible. This episode is brought to you by Fabric by Gerber Life.

22:50Last year, I sat down and came up with my own financial order of operations, things you should do with your money and in what order. I had seen too many lists that focused on you and not enough lists that prioritized those who depend on you. Fabric by Gerber Life is term life insurance you can get done today, made for busy parents like you, all online, on your schedule, right from your couch. You could be covered in under 10 minutes, often with no health exam required. If you've got kids or anyone who depends on your income, and especially if you're young and healthy, the time to lock in low rates is now.

23:27And if you've got life insurance through work, that's a great start, but might be less than what your family ultimately needs and could disappear if you change jobs. Term life insurance from Fabric follows you wherever you go. There's no risk as there's a 30-day money-back guarantee. You can cancel at any time. And Fabric by Gerber Life has nearly 2 ,000 five-star reviews on Trust Pilot with a rating of excellent. So join the thousands of parents who trust Fabric to help protect their family. Apply today in just minutes at meetfabric.com slash Tyler, meetfabric.com slash Tyler, and use my link so they know I sent you.

24:04M-E-E-T fabric.com slash Tyler. Policies issued by Western Southern Life Assurance Company, not available in certain states, prices subject to underwriting and health questions. This episode is brought to you by Thrive Market. Here's something you might already know about me. I genuinely love to cook. It might be my favorite creative act of the day, but I'm also a raging introvert, and the grocery store is where creativity goes to die. The parking lot jockeying, the cart traffic, the fluorescent lighting calibrated to make every human look like they need immediate medical attention. It's psychological warfare with a loyalty card.

24:46The usual answer would be delivery, but I live in rural Vermont, where delivery is a thing that happens to other people. And we've tried some meal prep services, but the quality of ingredients just wasn't what I want going into my body or my cooking. Thrive Market solved the entire equation. It's an online membership grocery, five bucks a month, and they've already restricted over a thousand ingredients. So I'm not standing in my kitchen googling whether some unpronounceable additive is fine. The vetting is done before I ever click add to cart. Member pricing runs up to 30 % off with free delivery on qualifying orders, and most members make their membership cost back in their first two orders.

25:25Mine paid for itself in peace and quiet alone. So if you're ready to build your ultimate summer cart, join Thrive Market with my link, thrivemarket.com slash Tyler, for$20 off your first three orders, plus a free gift. That's thrivemarket.com slash Tyler.

25:43Tyler Gardner:Part 5. The RMD Trap and the Single Most Underappreciated Date on a Retiree's Calendar. Okay, now we get to the part that explains why all of this matters as much as it does. RMD stands for Required Minimum Distribution. It is the IRS's mechanism for ensuring that the wrapped tax bomb eventually detonates whether you want it to or not. Starting at age 73, for those born before 1960, and starting in 2033, age 75, for those born after January 1st, 1960, thanks to a series of laws called SECURE and SECURE 2.0, because Congress seems to be a little unoriginal with naming things, you are legally required to withdraw a minimum amount from your traditional IRAs every year, calculated based on your account balance and your remaining life expectancy as estimated by an IRS table that does not, as far as I can tell, care whether you eat your vegetables.

26:43Tyler Gardner:The first year RMD for a 73-year-old based on the current IRS uniform lifetime table is approximately 3.77 % of your traditional IRA balance, which means if you have$2 million in your traditional IRA, your first RMD is roughly$75 ,400. The next year, that rate will go up slightly to about 3.92 % and so on, climbing every year for the rest of your life. By age 85, the RMD percentage is around 6.25%, and by 95, it's over 10%. The IRS doesn't just want their money back, they want it back at an accelerating pace. Now, what does this mean in practice? Well, this is why I call the conversion window the cheap years.

27:31Tyler Gardner:The same couple from our earlier example, the ones with 2 million in their traditional IRA who didn't do conversions, at age 73, they must now withdraw 70 ,400 minimum, And that$75 ,400 lands on top of their Social Security and any other income, pushing them squarely into the 22 % federal bracket and possibly higher. That same$75 ,400 could have been converted eight years earlier at 12%. The RMD doesn't just create a tax bill. It creates a tax bill at the worst possible rate because by definition, the RMD is on top of everything else you're already earning. It's the marginal dollar. It's the dollar at the top of your bracket.