How to pay the LEAST Amount of Tax On IRAs and 401ks
If you’re 50 or older, this is going to help you pay the least amount of tax over your lifetime. Most people don’t figure this out until it’s too late, and then they’ve missed an opportunity to do this, but you’re here so you’ll have some options.
One of these strategies is best if you’re between 50 and 72, and the other is best if you’re over 70. Let’s get into it.
Time Is On Your Side
If you’re between 50 and 70 and you’re getting serious about planning your ideal retirement, and you like the idea of not paying more tax than you need to (or really not paying any tax on IRAs in the future), there are two routes you can take.
But first, if you’re still working, the first step is to take a look at your tax rates now and then look at the projection of what they could be in the future. I like using the DIY retirement plan or my favorite retirement calculator to help figure this out. You could find that simply upping the contribution to your Roth portion of your 401(k) or maybe your Roth IRA makes sense for you.
You might be thinking, “Well, I’m in a high tax bracket right now as I’m earning an income and I’ve got a wage, so it’s going to be lower in retirement.” Remember that time is on your side.
If you put 10K into a Roth now and your effective tax rate was 20%, you missed out on 2K of tax deduction this year, but let’s say that that 10K grows to over 30K over the next 15 years. That 30K is in a traditional IRA, and even though your tax rate might be lower in retirement – let’s say 10%. If you were to take that out in retirement, you might pay 3K in additional tax.
Even with all this info and these ideas on what to do, there’s a lot of factors that are unique to you and that you should evaluate before doing anything like this. I do recommend meeting with a financial professional.
Are You in a Roth Conversion Sweet Spot?
The second thing to do if you’re still working is think about upping your non-retirement accounts. Not adding to your Roth, not adding to pre-tax 401(k), but think about the non-retirement accounts. If you can build up a substantial non-retirement account and are not working or you’re close to not working, you may be in that Roth conversion sweet spot, which just means that once your income goes away, your taxable income may be very close to zero. If you haven’t started social security or you can hold off taking your IRA distributions, this could be a good time to convert to Roth.
Let’s move onto the next one.
If You Don’t Want to Pay Mandatory Distributions
If you’re between 50 and 70, this one is still important because even though you’re not 70 now, or you’re not required minimum distribution age yet, you will be in the future.
Retirees at or above the required minimum distribution age (72) right now have to take out mandatory withdrawals from their pre-tax accounts (i.e. IRAs, 401(k)s, 403(b)s). Even if they don’t need the money, they still have to take it out. I kind of look at this as the government saying, “We gave you these years of tax deferral where you didn’t have to pay tax on the income and the capital gains and things like that. Now it’s time to pay up.“
They want you to take money out and start paying tax on it. If you’re getting close to RMDs and don’t want to pay tax on mandatory distributions because you don’t need them, and you could see yourself wanting to help out a charity or a cause that you care about, you can actually avoid paying tax on some or all of that RMD if you send it straight to the charity. It just has to be a 501(c).
Now, if you don’t take your RMD out in the year that you’re supposed to, you could get penalized up to 50% of that year’s distribution. This is called a qualified charitable deduction. Just make sure that you talk to your tax preparer or CPA to make sure everything is recorded correctly on your tax return.
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Disclosures: Securities offered through LaSalle St. Securities LLC (LSS), member FINRA/SIPC. Advisory services offered through LaSalle St. Investment Advisors LLC (LSIA), a Registered Investment Advisor. Streamline Financial Services is not affiliated with LSS or LSIA. LSS is affiliated with LSIA
When you reach age 72, you’re required to withdraw money from your tax-deferred accounts, whether you want to or not.
These accounts include your IRA, your 401k, and any other tax-deferred accounts you may have.
The reason why we have RMDs (required minimum distributions) is because the government is basically saying that you got all these years of tax-deferred growth in your IRA accounts and now we want you to start taking out that money so that you have to pay tax on the withdrawals.
Thankfully, the required withdrawal amount will go down in 2022, which means that you can pay less tax at that point, too. But currently, if you have a $1,000,000 IRA, your required RMD at age 72 is around $39,000. With new RMD tables in 2022, you’re going to be expected to take out about $36,000. A difference of $3k to 4k in withdrawals means saving about $500 to $1,000 on taxes, depending on your tax bracket.
Those of you who are under age 72 still have some time to design your tax plan and withdrawal plan. Now you can start to control your taxes in retirement by planning ahead.
Here is a list of videos to help you make that plan:
Remember to always review these tips with your wealth manager or your tax advisor. If you don’t have someone you can talk to, then click here and I’ll either point you to a tax person, or have a free meeting to talk about your retirement plan.
There are so many retirement investing strategies out there. It can quickly become overwhelming. So how do you pick the perfect retirement investing strategy for you?
Here are a couple of common strategies that you may have heard
Take your age and subtract that number from 110. The result is the percentage you should be invested in stocks or stock funds. For example, if you’re 60, then take 110 minus 60. And according to this popular strategy, 50% of your portfolio should be invested in stocks.
Another style that a lot of advisors recommend is based on risk tolerance; how much risk can you handle? To help illustrate this point, here’s an anecdote I recently heard from Ron Bullis:
A man is sitting with his doctor who has just told the man that, unfortunately, he has cancer. Then the doctor holds up an iPad with a questionnaire on it and says, “hey, can you fill thisout so that we could find out how much chemotherapy you’d become comfortable with?” And the man looks at the doctor, confused, and says, “well, obviously, I want the least amount of chemo that I need to get rid of the problem that I have.”
And that’s kind of how we look at risk, too. Why would you want to take more risk than you need to, even if you’re comfortable with it. It would be better to have a successful retirement plan and sustainable retirement plan with the least amount of risk possible. And, actually, a lot of clients come to us who are invested more aggressively than they need to be, because of how they filled out this risk-tolerance questionnaire with a previous advisor.
So how should I be invested in retirement?
This is not solely based on an age rule of thumb or your risk tolerance. The way we’ve seen retirees do it right is to create an investment plan based off of their income plan. This is how we plan for our clients at Streamline, too. So, the income plan comes first, and once you know how much you need and when you need it, then you see how you should be invested and how risky you should be. For many clients, after we’ve designed this income plan, we can clearly see that they don’t need a high level of risk in their portfolio for them to accomplish their goals in retirement.
A great retirement withdrawal strategy that we’ve seen work is the three-bucket strategy. This method helps clients rest easier in crazy markets or bear markets. One of the keys to this withdrawal strategy is making sure that you have enough in conservative assets to cover a few years of expenses. That way you don’t have to worry about bear markets dragging down your portfolio assets when you need to withdraw money. Click here to see a video that more fully explains this strategy.
And as always, just make sure that you check with your accountant or financial advisor when planning retirement investment strategies. It’s so important to get a second opinion before you do anything. If you’d like help developing your best investment strategy, reach out to me for a free planning meeting to see what makes the most sense for your specific situation.
How much do I need to retire? is a common question that I hear, and it’s a really important one.
Recently, I was reading a blog from popular financial person Dave Ramsey, and he was weighing in on the subject of retirement. I think Dave helps so many people when it comes to debt elimination and figuring out the baby steps in saving. He does great work there, but when it comes to retirement planning, in my opinion, you might want to think twice about implementing some of the advice that he gives. I’m going to go over it with you today and why you might want to be careful and what you can do instead to put yourself in a better position.
First of all, realistically, you don’t want to implement anybody’s advice without meeting with them and considering your specific situation. I would much prefer doing that versus listening to someone on YouTube, or somewhere else, on what you should be doing with your money. So, talk to someone that you trust.
Anyway, as I was looking at Dave’s blog and what he thought about this, he says that if you’re able to live on 8% of your nest egg, and if your mutual funds can do 12%, you’ll have 4% to cover inflation. Okay; that makes sense – if you want to live on 40K, he says, you need $500,000 in the bank. So, take your total nest egg and divide it by 0.08 to get that number you’ll need to live on each month.
This is, in my opinion, a little bit risky. And here’s why:
The Sequence of Return Risk
What this means is that someone who retires in 2007 and someone who retires in 2010 are going to have drastically different outcomes of their retirement. If they were taking the same amount and their investments did the same thing, the outcomes, because of the withdrawal rates, have a big difference.
Applying this to our example: if you’ve got 500K and you’re taking out 40K, an 8% withdrawal, and you’re averaging 12% somehow, but let’s say it’s 2007 and then the financial crisis happens. What if the investments, because you’re invested aggressively, get cut in half but you still need 40K to live? Now you’re taking out 16% and that could really crash a plan, so that’s something to be careful about.
Aggressive Investments
Regarding this idea of the 12% rate of return on mutual funds, if you’re achieving that sort of return, my thought is that you’d have to be invested pretty aggressively. Many people who are in retirement don’t feel comfortable taking that sort of risk and going along with the rollercoaster that comes with investing in equities – especially looking at 2020 and what happened in March – because there’s fluctuations that happen.
People in retirement don’t always want to do that, so a lot of times we’ll bring up the three-bucket strategy as a possible retirement withdrawal strategy.
Unexpected Expenses
Let’s look at an example of a 500K nest egg to start that first year in 2020. And in this scenario, achieving a 12% return and taking out 8%, that plan looks successful and you’re actually growing your assets in retirement; fantastic.
But what if you were off by 5K of expenses; what if you really needed 45K per year instead of 40? That’s a big difference that drastically impacts your plan. And what if you were right: you needed 40K a year. But what if instead of 12% you only got 10%, how does that impact the plan? Those are just a couple of reasons why you might want to be careful when planning and make sure that you talk with a professional to map it out and think of all the different scenarios.
And if this isn’t the best way, then what is a good way to go?
Decide how much you need each month
Estimate how much you might be having come in from social security and other pensions, other guaranteed income sources, and then subtract that from the monthly amount in step one
Take the number from step one and minus the number from step two, and then divide that number by 0.04, which is a more reasonable 4% withdrawal rate
But again, this is still basic. The 4% withdrawal rate isn’t bulletproof, it’s an opinion, it’s a financial withdrawal strategy out there. I recommend meeting with someone and specifically looking over your scenarios, just yours and not anybody else’s. A lot really depends on the money that you have invested and the withdrawal rate that you’re using.
As advisors, we’ve helped hundreds of people plan retirement, and we know that the more specific you can get in your plan, the more peace of mind you’ll have in retirement. If you’re interested in more peace of mind, reach out to me and I can help create your streamlined retirement blueprint, or I can give you The Perfect Retirement Plan that can help walk you through steps to take for your own retirement plan.
Your retirement plan is not valuable, but the continual process of planning is, so step one is to create a flexible, adaptable retirement plan, not a static one.
What I mean by adaptable is a successful and secure retirement plan with investable assets each year until well into your nineties, as with the example shown in the video.
Now we know that life isn’t static and you and I both know that things change, life changes. So your plan should be able to change too and to adapt on the fly.
Now, what if the unexpected happens; an additional expense that we didn’t plan for? How does that impact a decision made today or next year? How does that impact the long-term plan?
Let’s say that you sell your business earlier than planned and you retire early. How does that impact the long-term plan?
Or you’ve got a family, you’ve got grandkids, you want to take them on vacations while you still can. How does that impact if you were to spend $20,000 per year to go to the lake house or go to North Carolina, whatever it may be.
So there’s all these different things and things we don’t even know that are going to happen yet.
The main point is that when life changes, let’s change the plan. And if we have an idea of what could come, let’s see what sort of impact that has on the long-term plan. So I hope that gave you a good picture of how to create a plan that’s flexible and that’s adaptable.
These 5 mini-plans make up every successful retirement plan. A retirement plan is not something to take lightly. What you put away now, and where you put it, can greatly impact how much security you will have later on in life when you are looking to retire. When developing a retirement plan, there are a lot of aspects to consider. What will your income look like? How will taxes play into it? What happens if later on in life you face medical complications. There is no way of knowing these things ahead of time, but there are plenty of ways to plan for them so that when the time comes, you will be able to face surprises down the road with some peace of mind. There are five mini plans that we include in an overall retirement plan to help round the plan out and cover all necessary bases.
Income Plan
This plan is important to ensure that when you are ready to retire, you can count on a reasonable and stable income to cover your month to month expenses. There are a variety of components to this plan including, but not limited to: social security, maximization, spousal planning, and investment income. This plan is foundational to retirement, as it ensures that you will be able to maintain a comfortable lifestyle, even when you are no longer actively working.
2. Investment Plan
All our investment plans are based on your Income Plan. The two work in unison.
The traditional retirement planning industry commonly decides how to invest your money based on your “risk tolerance”. We think this a deeply flawed approach that leads to higher than needed worry during major market corrections.
Instead, if we can find the right cashflow needed from investments, we can map out the next 10 years need and design the income plan so you don’t market fluctuations do not affect your income plan.
3. Tax Plan
Whether you are retired or not, you better believe that you will owe your dues to Uncle Sam. However, it is important to plan for this, and to ensure that you will never end up paying more than needed in your taxes. There are a variety of strategies that we can implement in this plan from withdrawal strategies to Roth conversion strategies.
4. Healthcare Plan
This is the less glamorous, but unfortunately common, side of retirement. Healthcare costs tend to rise pretty consistently upon retirement, and therefore, a healthcare plan is an essential aspect of an overall retirement plan. There are a variety of factors that will impact your healthcare plan. One of the main factors people face is medicare planning in addition to any supplemental and long-term planning.
5. Legacy/Charitable Plan
This is the part of the plan that most people prefer not to think about, however, it is a part that requires thorough consideration. When a person passes away, their money and assets will have to go somewhere. It could end up at any of these three places: to their heirs, to a charity, or to the government. It is important to put consideration into where you would like for your own assets to go, and to set up a plan to ensure that your wishes are granted when that time comes. In addition to estate planning, is the wealth transfer plan. This plan simply alerts those who will be receiving assets upon your death so that they can be prepared to receive it when the day comes.
There are a variety of essential parts to a retirement plan, and at times this can seem overwhelming. If you are looking to increase security upon retirement, our team of experienced financial advisers is happy to help you develop a plan that best fits your unique needs, income, and interests. Contact Streamline Financial Services today, to meet our team and learn more about our unique approach to each of these essential mini plans.
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