By Allyn Hughes, CFP®, ChFC®, CLU®, CAP®
Common wisdom among many is that tax payments are unpleasant and should be deferred as long as possible.
This sentiment makes financial sense for some, but for many new or soon-to-be retirees this thinking could cost tens or hundreds of thousands of dollars during retirement.
When considering the combined income sources and assets available via Social Security or pensions, 401k or IRA rollovers and other investment accounts, different “order of spending” or “withdrawal” strategies can be used to maximize the total assets in a retirement portfolio. Unfortunately, to do this you must often think differently about paying taxes.
Longevity continues to improve for much of the world. Many Americans are living well past 83, the rough “breakeven” age where it is more optimal to wait until age 70 before starting Social Security. Starting to receive Social Security benefits earlier reduces the size of monthly payments. Larger payments starting later eventually are worth more over a lifetime if you live past 83.
Many pre- or newly retired people have substantial assets in their former employer’s 401k or in IRA Rollover accounts. If they choose to defer taking Social Security, often they will need to spend down part of their retirement savings to fund their living needs between when they retire and age 70 when they start Social Security.
During these years many of these people have little earned income, so they tend to be in low federal income tax brackets. Because taxes can be low during these years, they may have a wonderful opportunity to transition money from tax-deferred accounts (IRAs) to Roth accounts and take advantage of lower federal income tax rates than they had in the past.
Executing Roth conversions during this period provides three important advantages:
- it allows retirees to convert money from IRAs to a Roth at a lower marginal or average tax bracket than they had while they were working,
- the money in the Roth grows tax-free during the balance of the owner’s life and until it must be distributed over the life expectancy of each of the inheritors of this Roth account (usually in the next generation),
- the money that is converted from the IRA or other tax-deferred account will lower the amount of the Required Minimum Distributions (RMDs) that must be taken from these accounts after age 70½.
Planning is Critical
The retirement income optimization tools we use show that many retirees who follow these steps may end up with hundreds of thousands of additional dollars over their retirement, depending on their life span.
To take advantage of this opportunity, fully utilizing low tax brackets is critical.
For more information about these techniques, contact us and we can provide you with an analysis of your personal situation.
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