When people start planning for retirement, they often focus on one major goal: accumulating enough money to retire comfortably when they’re ready.
Unfortunately, this is often where the planning stops, which means some pretty important things can get left out, including:
- Determine how to convert these accumulated assets into a reliable stream of income that will provide the desired lifestyle.
- Explore tax strategies that will help you retain and pass on more of what you’ve worked so hard to save.
Creating a plan that distributes your investments in the most tax-efficient way possible can help you reach your retirement goals and beyond, but it’s no easy task. And if you procrastinate, you could miss out on some of the significant tax savings provided by the Tax Cuts and Jobs Act 2017, as many of its provisions are due to expire at the end of 2025.
Here are three tax strategies that could strengthen your retirement plan in the future.
Converting Traditional IRA Dollars to Roth IRA Dollars
Worried about future tax rates, especially when Required Minimum Distributions (RMDs) kick in at age 72? Converting your traditional IRA to a Roth IRA could help reduce the tax burden for you and your heirs. Here is an example :
Our office is currently working with a client who would like to withdraw approximately $60,000 per year from an IRA when she turns 72. Along with her other sources of income, that’s all she expects to need. But based on what she currently has in her account and with an estimated growth rate of 6%, the amount the government is asking her to withdraw could be closer to $90,000 or even more.
Luckily, her assets are structured so she can earn income from non-qualified accounts over the next few years while she converts the money from her traditional IRA into a Roth. She’ll have to pay taxes on the money as she moves it, and she’ll have to be careful not to run into a higher tax bracket in the process. But thanks to the Tax Cuts and Jobs Act, she can convert the money at a lower tax rate of 3% until the end of 2025. Once the money lands safely in this Roth account, her savings can grow tax-free for her and her heirs. .
Using Charitable Donations to Reduce Taxable Income
Worried that the sale of a highly valued asset will skyrocket your taxes? A specific type of charitable remainder trust, called a charitable remainder trust, or CRUT, could help mitigate the impact.
A CRUT is an estate planning tool that provides income to a designated beneficiary (usually the person creating the trust or a family member). Then, after the death of the beneficiary, the remainder of the trust is donated to a charitable cause.
We looked at the tax-saving potential of a CRUT for a client who is still working, owns multiple rental properties, and is in the 35% marginal tax bracket.
If our client were to take some of the real estate he owns and donate it to a CRUT instead of selling it as he had planned, the tax benefit would be twofold: he would receive an immediate charitable donation tax deduction and eliminate capital gains from selling the property.
The trust would also produce income during our client’s lifetime, and upon their death, the remaining balance of the trust would be donated to the charity of their choice. It would sell the property, eliminate some taxes, maintain an income stream, and create a legacy, all with one strategy.
Getting the most out of company stock with a NUA distribution
Do you own highly valued corporate stocks as part of an employer-sponsored retirement plan? If you’re worried about the potential tax burden in retirement, thereYou may want to consider the benefits of implementing a net unrealized appreciation (NUA) distribution.
Under NUA rules, employees who own company shares in a 401(k) can transfer those shares to a brokerage account and pay tax only based on the cost of the shares at the time of the distribution. . Then, later, when those shares are sold, rather than paying ordinary tax rates, the account holder will pay taxes at more favorable long-term capital gains rates.
We currently have a client who could benefit from a NUA distribution, linked to a CRUT, and potentially convert some of his remaining 401(k) balance into a Roth. In other words, when considering these tax saving strategies, it’s not necessarily a decision.
However, it can be complicated, so it’s wise to work with experienced financial professionals who can help you understand future income needs, the source of that money, and potential taxes in retirement. Your financial advisor can also work alongside your tax specialist to ensure that you comply with all IRS rules regardless of the strategy you choose. Additionally, you will want to involve an estates attorney if you are creating a trust.
Don’t let concerns about complexity hold you back. Today’s lower tax rates can be an important tool in mitigating future tax liabilities while maximizing future income. Time is running out to take advantage of these historic savings.
Kim Franke-Folstad contributed to this article.
Senior Financial Planner, Decker Retirement Planning
Neil Fenning is a Senior Financial Planner at Decker Retirement Planning (deckerretirementplanning.com) in Renton, Washington. He enjoys helping clients navigate their way through the risks and rewards of retirement. Neil holds a bachelor’s degree from Western Washington University.
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