The Wealth-Building Power of Roth Optimization With Chris Battaglia & Larry Kotlikoff

It's my great pleasure to introduce a very special friend, Larry Kotlikoff. He is an economist at Boston University, works on a range of topics, bestselling, coauthor of get what's yours, the secrets to maxing out your social security and author of 20 other books. He's written for essentially all major media outlets.

He has a great newsletter and podcast at larrykotlikoff. substack. com and most recently he's the, he's published the award winning money magic, uh, an economist secrets to more money, less risk and a better life. He's founder of Maxifi. com and [00:01:00] MaximizeMySocialSecurity. com, which are software tools that do lifetime financial planning, including lifetime social security benefit optimization. Please welcome

my good friend, Larry. Larry, how are you?

Larry Kotlikoff: Great, Chris. Great to be with you. Thanks for having me.

Chris Battaglia: Well, it's, it's great to have you back. And today's a special day because we're going to be doing a demo of your Roth conversion tool in Maxifi Planner, which is an economics based financial planning tool. Perhaps just give our audience a quick heads up

on what that really means.

Larry Kotlikoff: well,

economics

based planning, uh, is is focused on taking your resources that you have uh over your lifetime you know not just your current assets, but your current and future earnings, your future self security benefits. And then there's some off the top, uh, expenses that you need to make, like for taxes and housing and maybe alimony payments, special expenses.

And so the net of all that, and your net available resources [00:02:00] allows you to make discretionary spending. Maxifi is focused on, figuring out how much you should spend and save so that you can have a sustainable discretionary, uh, living standard per household member. So that's part one, which is we're trying to help people, act like squirrels, squirrels.

save in the off season in the good season for the winter. Uh, so they can have the same number of acorns to eat every day. And the same same thing with us. When we're working, we save in order to be able to have the same living standard or maybe somewhat lower because we're not sure we're gonna live that long.

But basically, we want a smooth ride to our living standard. We also need to figure out how much life insurance We need to protect our survivors living standards so that they have the same living standard. And then

we have to, we want to think of an economic space planning about ways to [00:03:00] safely raise a household's living standards so they don't, they don't leave money on the table.

That means taking the right

social security benefits at the right time. It means minimizing their lifetime taxes. By being very smart about how, they handle their retirement accounts, and that includes Roth conversions, our software. We've just come up with a new, Maxifi Roth conversion optimizer, which is extremely powerful and is coming up with, dramatically different, results, uh, powerful results.

And I had thought, were in the cards and I want to talk to you guys about everybody about that. And then we also have, uh, analysis of investment risk and return with respect to your living standard. So it's completely different, really, from conventional planning and the way it approaches things.

We're not trying to hit some target that you'd like to set for your retirement spending. My target for retirement spending is a billion dollars a day. It's just not real list realistic. So economics is really reality based planning. I recommend [00:04:00] it to everyone.

Chris Battaglia: I appreciate the background. I mean, one of the things that occurs to me is that your software is truly different in that sense. I don't know of anything else that's out there. That's why I'm so excited to do this demo with you. But you're solving for a lot of problems. or a ot of um Lifetime, um, milestones, if you will, with the software and timing matters a lot. And it occurs to me that the tax implications and timing is a nonlinear problem to solve for. And you've done a remarkable job, uh, with the software by taking people through the various steps to determine whether or not it makes sense to do Roth conversions. And if it does make sense, um, how to time them and, and how to execute them. I'm also very eager to see what the software can do to maximize lifetime income with Maxifi Planner by using this new tool that you have on the on the Roth conversions. So if we can, um [00:05:00] I know you're prepared to do a demo for us. Why don't we get right into that and then we can have a discussion about how the demo actually affects someone in real life.

Larry Kotlikoff: So, just to begin with, this is, uh, Our website for Maxifi Planner, it's, uh, if you just go to Maxifi with an I, Maxifi. com, you'll see the, uh, the website. We have all kinds of press. We've been in business for 31 years.

And, uh, just, just to connect with what Chris was saying, uh, financial planning is a very precise business. You can't do it casually. It's not quick and dirty. It's like, uh, you know, figuring out exactly the right medicine. You have. We all have some kind of financial disease. We're not saving enough. We're not buying enough life insurance.

We're not diversifying our investments correctly. We're not dealing right with taxes and social security benefits. But to then get the right medicine, you need to, [00:06:00] uh, Have some real knowledge and ways to make sure that that medicine isn't going to make you sick or It's going to make you healthy and with with financial planning Everything kind of interacts with everything else So the hallmark of our software is getting everything to be internally consistent.

But having said that let me now just uh, Go and do the demo, a financial planner who's running our software would, uh, see a client list, uh, and I'm going to, and then they would add clients and there's a wizard type inputting, uh, system.

But I'm going to do this, look at a client that I'm calling the Roth conversion demo overview. That's the name of the client. And I'm just going to look at the client's inputs that I've entered. I've, uh, this is a fellow named John. He's 65. He has an earnings. He has no earnings. He's retired. His [00:07:00] maximum age of life is 100.

We plan to, for people to live that long because they might. He's already retired. Retired at 62. Thank you. Uh, he's, um, got a social security earnings history, which, uh, lots of easy ways to import it. Anyway, uh, he is got a 40 5K pension. Uh, what about, uh, his strategy? Well, he is gonna take social Security at 70 and, uh, he's got a million and a quarter in an IRA and a million and a quarter in regular assets.

that he can use to pay for any Roth conversions. And he lives in Michigan and pays rent of 3000 a month. No kids, single he's, uh, we're going to assume that he can earn that he's investing in inflation index bonds, earning 2 percent real, uh, long term inflation index bonds are yielding that today. So if I run his, uh.

Based plan. The first thing it does the program [00:08:00] is figures out that John can spend on a sustainable basis in today's dollars. About 102, 000 every year, and, uh, this calculation is the typical squirrel, um, you know, saving during the, uh, the good times and, uh, having enough acorns in the winter, and you can see that during his retirement, he's not, he's not spending everything day one, he's spreading out his, uh, uh, his spending power, you know, Which are his lifetime resources of 4.

4 million, and he's spending that on discretionary spending and fixed spending and that that corresponds to the taxes and the housing costs and what the program is doing is, uh, smoothing that discretionary spending capacity, but doing such, uh, doing this in a kind of a back and forth way to make sure that the taxes and the path of taxes [00:09:00] and the path of spending, which are interdependent, Are mutually consistent.

So, uh, and this lifetime budgeting for somebody who might have an accounting background. This is a double book, keeping entry. Uh, you see that all the different components of the outlays equal the different components of the resources in total and present value. But now, if I. Uh, decide I want to, uh, max, maximize this plan.

I've already have this, uh, fellow, uh, taking a social security at 70 and that turns out to be the optimal thing for him to do. So I don't need to maximize over social security, but I can click on optimize over Roth conversions. And then I can also optimize over when he would start his first withdrawals from his retirement from the IRAs that have not been converted.

And if I hit continue. One other question, which is, do I want to consider all conversion plans or do I want to consider plans that never reduces [00:10:00] spending? Because remember, when you convert, you're taking an IRA that's taxable when you take the money out and you're putting a different label on it. You're calling it a Roth.

But the amount that you're of that IRA that you're going to convert and call on a Roth IRA, you have to pay taxes on it so that if your cash flow constraint that could make your spending drop so you can maximize subject to your spending, not dropping in the short term, or you can maximize with your spending, not dropping, maybe You know, 12%.

So, so we were conscious and sensitive to, uh, cash flow considerations. And that's very important because so many households are cash flow constrained. And I'm not going to claim that Roth optimization is the thing to do for every household. But this is the thing to do. Running this program is a way to figure that out.

But for for John, as we're going to see, uh, it can help quite a bit. Uh, I'm going to [00:11:00] just pull up. I hit that button. I ran John for all the possible cases of Roth optimization, and we're looking for the one that's producing the highest that the largest lifetime tax savings that's minimizing his lifetime taxes and present value and therefore maximizing his lifetime spending capacity, and I'm talking here about his discretionary spending, and if I since I've already run the program, I'm just going to click.

Uh, and show you the results, uh, click on the plan. I ran already and you can see that I made him with no risk. 160, 777

in present value and the dotted line here that you see. Is his discretionary spending under the base plan and under the maximize plan? You see that he's cash flow constrained. He has to spend a little bit less because he has to pay these taxes Of to do the conversions and then [00:12:00] after uh, Uh, he starts taking Social Security and getting that pension.

Uh, he gets to spend close to 12K more a year rather than just 102K. He now gets to spend 114K. So where's all this coming from, this additional 160, 000? And this, by the way, is taking into account the idea, the assumption that Tax Cut and Jobs Act, which is set to expire after next year, is kept in place.

the federal taxes for John go down by doing that conversion, uh, if, by the way, if the old, if the current tax law were kept in place, this would be closer to a 220, 000, uh, increase. Because we have tax rates going up in the future compared to today, and it would behoove him to do a lot of conversions right in the short run in order to not be facing higher taxes in the future.

And, uh, anyway, [00:13:00] so his federal taxes go down in present value. 118 K state taxes from Michigan state taxes drop four K, but Medicare part B premiums, the premiums. which are another progressive tax schedule. Really, they are very important. They dropped 38, 000. So about 20 percent of the total gains are coming from the Irma side.

Let me show you what the program is saying he should do. He has about a million and a quarter, and he has a million and a quarter in an IRA. And this is saying that over time, he's you can basically convert everything. And he should convert it on this schedule. So the program is very precise and looking at all the possible different, uh, conversion plans each year and figuring out the annual amount each year that in combination with the other annual amounts and the total amount that's going to be converted, uh, over his lifetime, you get the highest lifetime tax [00:14:00] savings, and that's 160, 000 in present value.

And that means that he gets to spend 160, 000 more. And the, and that, and, you know, this, this path was showing you the best he could do, uh, in terms of smoothing that through time, uh, given that he's cash flow constrained, I could have optimized this subject to this thing never drip dropping down below where it was before.

And it would have been a. somewhat lower, uh, green line right across, but it would still be a gain, uh, with, with no cashflow problems. So just looking at the, uh, conversion pattern here, you're seeing, uh, things that are, you know, changing and it seems kind of remarkable that a, he would do so much go so big and go so big pretty quickly.

It's over eight years. And it's a, you know, not exactly the same amount of a year. If I specified the same amount [00:15:00] of a conversion, given the total, uh, every year, I would have smaller gains and you can do this in our software. You can double check because you can set up manual conversion plans and see that we have, you know, I'm not saying that our algorithm is finding the absolute maximum to the dollar.

A conversion plan, but it's getting we haven't found anything that's off by 10 K or more, but not not to say. I mean, this is like finding the top of Mount Everest and some part of Mount Everest is might have a little bit of a bump. And so exactly where the top, it might be very flat at the top. So finding exactly the very tippy peak of Mount Everest is very tough.

But let me tell you this. If I. I ran this case where I squeezed all the conversions into just three years smoothly and his lifetime gains weren't [00:16:00] 160. They were about 140, 000. So he actually about 120, 000, he lost about 40, 000 by not getting the timing. And, uh, I think this is conservative because we're, first of all, Assuming tax rates don't go up and, uh, but we could also assume, you know, then we know that the country is quite broke and you have the option in the program under settings and assumptions.

When you look at the profile here, you can click here and tell the program under this tax, uh, tab. That federal taxes, maybe not in the next four years, but at some point in the future, federal income taxes, FICA taxes, state income taxes, they're all going to go up by different, by whatever percentage you want to specify, that would make the conversion look even better.

So I think this is, if anything, biased towards, uh, uh, downward in terms of how much should be converted, but they are converting. [00:17:00] And, uh, he's converting, in his case, he's converting pretty much everything. everything actually. And, uh, in other cases, and he's doing it over the eight years, other cases I've seen, it's very individual specific, but for some people, the best thing to do is to convert everything in in the next two years.

As crazy as that is sounds, let me give you the analogy. If you're taking, um, penicillin for a very bad infection and the doctor says, take it for a week at, at, uh, this dosage and you decide you want you're going to take a low dose for a month because maybe it upsets your stomach.

Uh, that's like having to pay a lot of taxes on your, uh, on immediate conversions or early conversions. Well, you're not going to get healthy if you take the wrong dosage, if you don't take your medicine. Uh, and that's very analogous here. [00:18:00] With medicine, that's a not there's a nonlinear thing. You either go big or you stay sick. Here, if you don't go big, you're not going to do it quickly. Uh, you're not going to get the full gains from the Roth conversions and you could actually even raise your lifetime taxes. So, let me stop there, Chris, and, uh, hope that conveyed the basic idea.

Chris Battaglia: Yeah, no, it definitely did. I know, uh, first of all, kudos to you and, uh, and the development team, Larry, um, with a really fantastic tool, um, nearly perfect, I would say, you know, certainly one of the things that we, um, that we talked about, um, in our, in our preparation also was the possible reduction of RMDs or elimination of RMDs.

Number one. Maybe you can just, um, explain that a bit. And also Larry, your example shows someone who has got sizable tax tax exempt assets [00:19:00] alongside taxable assets. And if I'm looking at the demo correctly, they're funding those, um, tax events or those tax trigger triggers with the conversions with assets they have in a taxable account.

If I'm seeing it correctly, what happens if, Most or all of their assets are in a tax exempt account like an IRA.

Larry Kotlikoff: Okay. So the program would say, uh, look, if you don't want to take any reduction to your living standard. It might be that the Roth, the optimal Roth conversion is not to do anything. Uh, or it could be that you, you specify that you're willing to take up to a 20 percent hit and see what, uh, what the lifetime tax savings, uh, can be and therefore what The

higher living center will be later on after you're out from under the cash flow constraint of having to pay Those extra those extra taxes on the conversions Uh, but then there's other things you can try you could just [00:20:00] try As you're converting then there's the ability to take out the Roth money to help you pay uh Taxes so you could but then there's

also taking additional Uh IRA IRA withdrawals in order to help you to pay taxes.

You can do that In the program as well. Uh, that's more of a manual thing that you would do. I'm not saying that Roth conversions are gonna help everybody. If they're severely cashflow constrained and they don't want to take any, uh, withdrawals early, then Roth conversions may not be for them.

But for, I think most people, some degree of Roth conversions. It's going to be in their best interest the way to do that may require take some additional money from your IRA in order to help you pay the taxes. And the program lets you do that, lets you, lets you explore that.

Chris Battaglia: Well, an excellent, uh, an excellent demonstration. I guess the big [00:21:00] takeaways are that. You've done a remarkable job for solving a nonlinear problem here with, uh, essentially running, um, your Roth conversion tool on the set of assumptions that's already maximized your Lifetime discretionary spending, and then the software, you know, determines what, if anything, can be gained by those conversions, uh, you know, with those assumptions with, um, paying taxes in a, in a sort of a staged event or a staged timing that increases, um, lifetime income, people can find, Maxifi planning software.

How, how do they get it?

Larry Kotlikoff: If you go to Maxifi. com, you click sign up. So we're selling this to individual households, do it yourself first. But, um, we're also selling this to advisors, uh, who have clients are hearing about, uh, this word of mouth is spreading because I believe, uh, and of course I'm biased, [00:22:00] so everybody should take this with a grain of salt, but I think this is the only tool to get Roth conversions right.

Because it's very sensitive business. It has to be done very precisely. You can't use fixed tax rate assumptions. The answer is not to try and fill in tax brackets so that you have the same federal income tax bracket. This is, you do

things today, like take all your penicillin and it's going to, you know, keep you healthy for potentially forever. And that's the story here. If you do go big in the short run, you're not going to have to worry about paying taxes on Social Security benefits. You're not going to have from taking withdrawals. from Ross, because that will not affect your Social Security benefit taxation under the income tax. You also won't have to worry about your withdrawals impacting your, uh, your Medicare Part B premiums, the Irma premiums that are highly [00:23:00] progressive. The answer is that everybody should give it a try. Advisors should try, be trying this for their clients because otherwise they're kind of doing a disservice to their clients and not giving this a shot. The cost of this is about a quarter of what a license with one of the major software tools, uh, costs and also.

this program can be used for all aspects of financial planning. You could have an 18 year old who's trying to decide where to go to college, how much to borrow and what to major in. You could have an 85 year old who's got some social security and some assets. They have to figure out how fast to spend down those assets, given that they could make it to 100.

Somebody who's 35 has to decide whether or not to take a new job, a job offer. They live in Missouri, Missouri, where there's a state income tax, Washington, Washington State, Seattle, there's a better job in the sense of a higher salary. A worse 401k housing prices are higher, and, uh, they can't work as [00:24:00] long, which one's better? Well, the program can do side by side comparisons.

So that's all separate and apart from Roth conversions, uh, or social security optimization. So,

Chris Battaglia: Fantastic.

much appreciated, Larry. Um, thank you for doing the, demo definitely proves in my mind, uh, go big or go home is something that you can actually quantify now, right? You can , run your assumptions through Maxifi Planner, hit the, uh, Roth conversion tool to see how much, if anything, um, It improves your lifetime discretionary income. Thank you again for joining. We look forward to having you back in a future episode of Power Your Advice. At some point, I'd like to dig deeper on the policy end of things, uh, with regard to, uh, retirement planning, investing. I know you have a lot to say about that, but in the meantime, we urge our viewers to check out Maxifi planner

and the new Roth conversion tool.

Thanks again, Larry.

Larry Kotlikoff: Thank you so much, Chris.

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