Nike and Roth Conversions | Josh McAlister
“When it came rolling in, the money affected us all. Not much, and not for long, because none of us was ever driven by money. But that’s the nature of money. Whether you have it or not, whether you want it or not, whether you like it or not, it will try to define your days. Our task as human beings is not to let it.”
-Phil Knight, Founder of Nike, taken from page 379 of his memoir - “Shoe Dog”
Powerful. As I read this, so many ideas raced through my mind. I jotted down my raw emotions I was feeling – I have found that this technique can tease out the crux of my feelings or why certain words come to the surface. Below is a cleaned-up version of my chicken scratch brainstorm:
“I have seen this with many clients.” - This is not a negative thought, rather just truth. Money affects all of us – notice Phil did not say it negatively affected himself and those around them – it simply affected him.
“People will have different interpretations/emotions when reading this.” - We all have our previous experiences with money and those shapes the lens in which we view money today.
“No!” - While my notes in number 1 above try to make the argument of this quote simply being a true statement, not a negative statement, I cannot help but feel the negative connotation. Money is not bad in of itself, but all too often, unfortunately we have a predominantly negative feeling surrounding finances. The lack of positive guidance and monetary role models fuel this, and rightly so.
“Yes!” - I resonate with the ending of the quote 100%. These words represent why I do what I do, why I get out of bed in the morning, why I left the comforts of a great career at KPMG. I believe that we all want this to be a reality – but a terrifying few number of us can accomplish this on our own.
If the founder of iconic Nike has this to say about money, there is a strong argument that money does not solve problems, nor create lasting happiness. However, it is a tool that we have earned or been given. With that comes a responsibility of stewardship, which includes making consistent, sound, and rhythmic financial decisions regarding money. Nothing of importance is ever accomplished overnight – and the building of a sound financial structure is no different.
Consistent, sound, rhythmic financial decisions. This is summed up as taking the incremental steps necessary to accomplish your goals. In one day’s time from the publishing of this article, we are entering the final month of 2020, and what a year it has been. A year that I would argue, would necessitate the need of incremental steps, not an overhaul. Incremental steps involve taking advantage of every opportunity available to maximize the stewardship of one’s wealth. Along this vein, expert year-end tax planning should - no doubt - have a discussion surrounding Roth Conversions.
Roth Conversion is simply the conversion of retirement funds held within a traditional IRA or 401(k) into a Roth IRA account.
This strategy converts tax deferred (I prefer the term tax delayed) money into a Roth IRA, which grows tax-free (you never pay taxes on the funds held within a Roth IRA). By converting tax deferred funds to a tax-free Roth IRA account - income taxes due must be paid on the converted funds in the year of conversion.
Net Worth and Tax Bracket Management:
Roth conversions have incredible flexibility. An individual can do as many as he/she would like in any tax year; there are no limitations on the number of conversions in any given year and no limitations on the number of conversions done in multiple years. I like to describe Roth Conversions as simply net worth and tax bracket management – reduce the tax payment to be made in future years in the current year. All tax deferred accounts (IRAs, 401k, 403b) require a tax payment to be made once the funds are taken out of the account.
Note that all Roth Conversions must take place before the end of the taxpayer’s calendar year – most likely, 12/31.
For the purposes of our illustration, let’s assume a taxpayer will be in the 24% tax bracket when funds are pulled out of the tax delayed accounts at retirement. Throughout the course of their life, it is natural that their income levels will change (very common for business owners), and the goal will be to convert as much of their IRA into a Roth IRA at lower tax brackets than the expected 24% upon retirement. Below is an example as to how this functional works:
Many individuals would say they are worth $1.5M prior to the funds being taken out of the traditional IRA. They are forgetting the embedded tax liability within the IRA, and assuming a 24% tax bracket, their net worth is reduced to $1.32M with $180,000 that will go to Uncle Sam. Note the taxable brokerage account is not tax delayed – the $180,000 tax liability is only applicable to the IRA.
Revisiting: “I like to describe Roth Conversions as simply net worth and tax bracket management over multiple years.” If we can effectively reduce the tax bracket of the embedded tax liability within the IRA – we can increase net worth of the household substantially. See below for example:
Notice the increase in net worth from $1.32M to $1.41M by simply converting as many dollars as possible from the IRA to a Roth IRA throughout the taxpayer’s life.
Impact of Tax-Free Growth:
I really cannot think of anyone who would not benefit from a tax-exempt account. Let’s compare real dollars, net of tax for the above $750,000 IRA balance. The first scenario shows no conversions, and taxes are paid at the 24% tax bracket through Required Minimum Distributions at age 70 ½., and the second show the impact of the conversions, paid at the 12% tax bracket being completed by age 55:
That is a $187,000 compounded annual growth over 15 years – incremental steps are powerful over the long haul.
Conclusion:
By now you must be asking the question – how in the world do Roth Conversions relate to Nike?
By not acting on the little decisions to convert tax deferred funds over time – real dollars are lost. Nike, which started as a company called Blue Ribbon, was only Nike after many hard-fought years. Years of perfecting the design of a shoe, supply chain management, sources of funding, athlete endorsements, brand creation. None of this happened overnight, but through small steps year over year.
Your world might not be as big as Nike, but the resources in your world matter tremendously. If we view money as a tool to steward over the totality of our life - the first step is choosing to partner with a financial advisor who is an expert in wealth creation. If your advisor is not speaking to you about Roth Conversions raise your standard of success. Second, and the most important step – is choosing to partner with a financial advisor who has the same mission as Phil Knight: do not let money define you. Rather let it create a lasting impact that will outpace your life and build generational wealth.
