I learned the hard way on my first (and last) solo winter mountain climb that a successful expedition lies not in summiting, but in returning safely home. No summit experience can be compared to the value of a climber’s remaining life on earth; therefore, mountaineering is a reasonable hobby to the extent to which life-threatening risks can be effectively mitigated. Navigating the financial dangers of a multi-decade retirement is as treacherous as mountaineering! Just as effective means exist which neutralize mountain hazards, planning strategies avail to side-step retirement pitfalls, one of which is tax inefficiency. As you strive to maximize after-tax retirement income, consider the following truths regarding tax planning and the Roth Conversion:
- Tax efficiency is achieved in two primary ways: by never missing a deduction or exemption, and by managing annual income taxes towards a consistent tax rate. This does not resemble the attempt to minimize income taxes every year, a strategy that research has proven inferior.
- An effective way to achieve a consistent tax rate throughout retirement is to choose to pay more taxes when in a low bracket (such as in early retirement), and less taxes when in a high bracket (such as during peak earnings years). In other words, choose to pay more taxes at low rates and less taxes at high rates.
- Though Roth Conversions involve paying taxes sooner than required, a net benefit may be achieved if the same money will otherwise be withdrawn later at a higher tax rate. Advanced planning software can project which tax bracket you will be in every year of your retirement, all factors considered. This is highly valuable information.
- For those with legacy aspirations, consider the tax implications for your heirs: the Traditional IRA can be among the less favorable assets to inherit due to tax and distribution rules (most regulated and highest taxed), and the Roth IRA is one of the best (less regulated and untaxed).
- Other potential Roth Conversion benefits include: may offer some insulation if tax rates rise in the future, retiree access to tax-free income (once the 5-Year Rule is satisfied), smaller Required Minimum (taxable) Distributions due to smaller Traditional IRA balances, and avoidance of higher income taxes for surviving spouses due to escalated single filer rates.
- Be sure to investigate three issues before converting to prevent resulting negative surprises: will the added taxable income from a Roth Conversion trigger an increase in the Medicare Surcharge two years from now (IRMAA), increase the portion of your Social Security income that is taxable, or cause you to lose some or all of the additional $6,000 Standard Deduction (age 65+, OBBBA)?
- Facets of the Roth Conversion to remember include the following: more shares can be transferred “in-kind” to a taxable brokerage account for the same taxable distribution when stock prices are suppressed; it is generally advisable to withhold zero on Roth Conversions and pay the tax from personal savings so the whole conversion ends up in the tax-free Roth; a delayal of Social Security benefits to age 70 maximizes the “sweet spot” period for Roth Conversions.
While asset ‘allocation’ drives investment returns, asset ‘location’ empowers investors to manage a consistent tax rate resulting in tax efficiency. Since net income is the only income available to pay retirement expenses, savvy tax maneuvers are as important to the retiree as crampons are to the winter mountaineer. Think about it, may the Good LORD bless your retirement planning efforts, and your family this Thanksgiving season.
Shaun
“Render to Caesar the things that are Caesar’s, and to God the things that are God’s” ~Matthew 22:21
“Every god gift and every perfect gift is from above, coming down from the Father of lights, with whom there is no variation or shadow due to change” ~James 1:17
Disclosures
The information contained in this material is for educational purposes only and is not intended to constitute tax, legal, or accounting advice. Tax laws and regulations are subject to change, and their application can vary widely based on individual circumstances. You should consult your tax professional or attorney regarding your specific situation before making any financial decisions.
The concepts discussed, including Roth conversions, Social Security strategies, required minimum distributions, and tax-bracket management, are general in nature and may not be appropriate for every investor. Projections, forecasts, or modeling tools referenced are hypothetical in nature, rely on certain assumptions, and cannot predict future results or outcomes. No guarantee can be made regarding future tax rates, market performance, or the success of any planning strategy.
Investment strategies involve risk, including the possible loss of principal. Past performance is not indicative of future results. Discussions related to estate planning, IRMAA surcharges, and Social Security taxation are based on current regulations, which may change at any time.
The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Old Forge Wealth Management, LLC is a Registered Investment Advisor.