Really quick before we get started, I would like to show you, this is what I call the standard of care. It's something I use with clients to describe to them different options we need to consider in terms of planning. And today we're going to look specifically on this one called With the IRAs. This is part of a video that I put together called Financial Planning In 10 minutes, I encourage you to go spend the time and go through it. You will get a better idea of everything that I'm talking about here and I think it would be worth a visit. But here we go into the world of IRAs, Roth and traditional IRAs.
Okay, so first off, I want to spend just a few minutes describing to you the real difference between a traditional IRA and a Roth IRA, because not a lot of advisors talk about it, but here's the secret, the difference between Roth and traditional IRAs. The main difference is the tax rate when you take the money out. So it's the tax rate in the future, which we can't really predict. Well, it's difficult to get a handle on it. So I'll show you the numbers on this in a minute, but let's put it this way, if the tax rate that you put the money in, say your tax rate is 25%, and if the tax rate that you put your money you're taking money out is 25%, there is no difference if you use a Roth or a traditional IRA. If you invest the same in each account, there is no difference.
Here's the secret. If you put your money into a Roth and your tax rate is X, we're doing some algebra here, and in the future the tax rate is x plus, then the Roth wins Y because you pay the tax before if you put your money into a traditional IRA at X, and when the time when you take the money out, your tax rate is X minus lower. The traditional IRA wins. So I also, I'll go through the numbers on that. I also want to talk to you for a bit about the Tax Cuts and Jobs Act. How in 25 months this will go away and your rates will go up. How much I'll show you in a future slide. And for retirees with required minimum distributions, that's at the age of 72. The start. Here's a planning idea that dovetails with the ending of the Tax Cuts and Jobs Act. Okay? Here's how cash flows work between
Traditional IRAs and Roth IRAs. So here's the story. It's about Jack and Jill. Jack and Jill are both 55 years old and they are married. They filed jointly and they had a conversation one day and Jack said, I want to put my money into a traditional IRA. And Jill said, I want to put my money into a Roth IRA because I think I'll make more money. Well, okay, they decide to put in the $6,500 a year, which is, well, there's some rules in it, but generally speaking, $6,500 a year is what you could put into an IRA. And at age 65, they were both going to withdraw it and they're going to go on a cruise. It's going to be a nice cruise. So here's the cash flows on a traditional IRA and also on this assumption, they both make 5% a year on their investment gains.
Here's the 5%. Now this goes through, this is how my planning grid works. Again, look at the financial plan. In 10 minutes, you'll get a better background as to how this works or why this works. But really quick, here's the numbers. Every year, now this is Jack. He puts in $6,500 a year. He gets a tax break, he gets a write off. So the cash flows are zero every year because the money comes in. The money goes directly into the traditional IRA. There's no tax consequence that year. You could see here on the inflow, 6,500 in tax break, 6,500 out net, $6,500 goes into the account. We're assuming they make 5% a year. There's the money that they make per year. There's that line. Every year, the balance goes up in 2033. In 10 years time, Jack has $96,000 in the account. He goes, Jill, look at me.
I have $96,000 in the account. Jill goes, wait a second, you haven't paid tax. Well, here you go. In 2033, when they get ready to go on this cruise, first he has a tax bill of $35,000 because just so you know, we're using the tax bracket of 37% here. It's just a number there really in this illustration. So net, he ends up with $61,086. Alright? Then Jill has a goal. This is what Jill does. Jill. Jill earns $6,500. Yes, but every year she has $2,400 in tax to pay. So net, every year she puts just about $4,100 into her Roth account. Same income pays the tax lower amount goes into the Roth IRA. Every year she makes the same 5%.
At the end, she ends up with, you guessed it, $61,086. Well, so at the end they both open up their accounts. She goes, I have 61, 0 86. He goes, I have 61, 0 86. Guess what? Same tax rate in versus out. It doesn't make a difference for a Roth or a traditional. Again, if rates are higher in the future for you, potentially use a Roth if rates are lower for you and potentially use a traditional IRA. Do advisors know what your tax rate's going to be in the future? No. So I always like to put a little in both because as you get older, then you have options where to pull the money from place. You already paid tax place, you haven't paid tax yet. So next up, tax cuts and Jobs Act, and here's why we're talking about this.
Okay? In 2017, the tax Cuts and Jobs Act was passed and the brackets went down a lot and this was actually very stimulative of the economy. It's great, but they set a window until such time as in 2026 said, you know what? That's enough. That's too much fun. You can't have any more fun. Tax rates are going to go back up in 2026. Now what does this mean to you? Well, here's the old brackets. Here's a big one. Between 15 and 25%, between 75 and 1 53, that's a whole big jump. It went from 15 to 25, 12 to 22, but on a much wider bracket with a lower rate. So what does this mean to you? Well, I've combined these two brackets together to show you what the difference would be all else equal in your tax rates.
These numbers here are actually come straight from those brackets that we just looked at. These are the different break points combined between the two sets of brackets. Now what does this mean? In 2023 income up to $90,000, just under $90,000, your tax rate, your combined tax rate is a tax amount. Taxable income would be $10,000. Under the previous, the 2017 rates, which are going to be the 2026 rates, your total tax would be 13,840. That is an increase of 34%. Get ready folks. So you can go through this and take a look at your different income rates.
If your income up to $360,000, well 74 today in tax, 2026 95 in tax. Now, some people might say, well, in the future your tax rates might go down. That's highly doubtful. But what did we say before? If your tax rate is here and in the future, your tax rate is here, look at a Roth. That's the point here. Look at Roth conversions. Now do I think tax rates are going to go down in the future after this? Well, this is the one slide I like to share. This website's called usdebtclock.org. Go on it. And you could see numbers changing very, very quickly. If you look at the top left number, the US national debt of $33 trillion, do you think in the next 20 years, once these rates sunset, that we are going to have lower tax rates? I doubt it. I wish I didn't think that and I wish it wasn't the case, but that's what's going on.
So really the conclusion in here is that potentially in the next 25 months, you could save up to 34% in future taxes, not 34% rate. 34% in a gross amount of tax. So right now you could potentially pay tax on a Roth conversion at a lower rate than you might in the future. So that is taking your traditional IRA withholding taxes from it, directing your brokerage firm to withhold taxes, and you take the balance and you put it into a Roth IRA. That's a Roth conversion. Any questions, send me a note. I'm happy to talk about it. Now, here is an idea for retirees with required minimum distributions. At the age of 72, you start taking what they call RMDs. Why? Because the IRS wants their tax money from you after age 72, and it goes all the way up till the end. So for example, if you are age 72, you have a $1 million IRA, you would have a required minimum distribution that year of $37,000. Now, instead of taking it as income, you can tell the brokerage firm, I want you to withhold 100% of this $37,000. So what does that mean? That $37,000 goes directly to the IRS. If you are in a 22% bracket, you could potentially then direct your brokerage firm to convert $133,000 to a Roth IRA.
Now, what is the advantage of a Roth IRA given as a legacy as opposed to a traditional IRA? This is a whole different subject too. If you give your children an inherited traditional IRA, they will have to make distributions out of that, and there's a whole schedule on that as well. And that's another subject we could talk to in the future. But if you give your, and they'll have to pay tax. Now, the traditional IRA, if your legacy has it, these RMDs could bump them into a higher tax bracket. So I don't know if you want to pass that burden on something to think about in terms of planning. But if someone inherits a Roth IRA, they will have distribution requirements, but they will not be paying tax on it. So another thing to think about, one warning here. Be aware that a Roth conversion may change your tax bracket.
It may push you into another bracket. What do you want to do? You want to consult a tax professional before doing this. You might want to ask for a tax projection before you do the conversion. There's a lot of moving parts in here, and not least of which is the fact that with the reversion to the old tax regime, you will have a greater write-off for state and local taxes. So there's a whole lot of moving parts here. Get a tax projection, talk to your tax projection, your tax professional. So again, this is what I use. I have a whole bunch of subjects I'm going to put some videos on and hopefully you'll spend some time learning some things off of this and I'd love to have any conversations. If you have any questions at all, if you get a chance, please do take a look at a Financial Plan in 10 Minutes.
This is something I talk about towards the end. What's it all about? The key I see for financial planning is to help someone start from the beginning and food, clothing, shelter, move them, move them up. The pyramid of Maslow's hierarchy of needs until they get to the point where they understand, yes, this is what it's all about. Is it retirement? Is it a thing, is it a goal? Or is it just the ability to feel at peace in the fact that you've done some good planning for you, for your family, for your legacy, for your community? For me, that's the essence of financial planning. So thanks for your time. Hope you learned something. Any questions, please let me know. Cheers. Bye.
