A central part of retirement planning is accumulating assets for your golden years. This includes contributing regularly to a retirement account and investing the money appropriately. While this is undoubtedly an important first step, an important second consideration that many investors neglect is how to minimize expenses during retirement, thereby increasing the nest egg. can be kept for a long time.
One of the major ongoing costs is customer taxes. Even though they no longer receive a paycheck from their employer, retirees still have to pay taxes on income earned from retirement accounts and other income. Below are some strategies that can help advisors work with clients to plan for ongoing taxes in retirement.
Don’t waste your low tax year. It’s important to take advantage of years with low or no income. It doesn’t matter if it was because of unemployment, a bad year economically, or something else. The key is to plan for your long-term tax obligations rather than just focusing on the short term. In low-tax years, investors should consider converting pre-tax dollars to a Roth IRA. In this case, you’ll have to pay taxes on the conversion amount, but the long-term tax-deferred growth and the ability to withdraw the funds tax-free can be advantageous in retirement.
Additionally, IRA owners can actively withdraw distributions from their accounts in low-tax years. Please note that the Required Minimum Distribution (RMD) is the bare minimum you need to obtain. If someone is in a tax-advantaged situation, taking more than they need can minimize taxes on later distributions.
Consider a dynamic exit strategy. By the time investors retire, it is common for them to have multiple accounts with different tax statuses. Funds must be withdrawn in a manner that minimizes tax liability. A good rule of thumb is to withdraw money from your taxable account first. Then, you withdraw the funds from a tax-deferred account like a traditional IRA. Finally, withdraw your funds tax-free from your Roth IRA. This process allows retirees to avoid tax-advantaged withdrawals and allow their funds to grow over time without paying taxes.
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However, there are always exceptions to this rule. Dynamic withdrawal strategies allow for changes as your personal financial situation changes. For example, if someone is concerned about being hit with higher taxes in a given year, it may make sense to take funds from a Roth IRA first that year. The key is to assess your situation annually to avoid higher taxes.
Qualified Charitable Distribution (QCD): A QCD is a direct transfer of funds from your IRA to a qualified charity. QCDs count towards meeting his RMD, but unlike regular withdrawals from an IRA, the donor does not pay taxes on these dollars. This helps keep the retiree’s taxable income lower, since the distributions don’t count toward adjusted gross income. The maximum annual amount that can qualify for QCD is $100,000.
Rebalancing using donor-advised funds (DAF): A DAF is an investment account designed to support charitable organizations. Donors can receive an immediate tax deduction when contributing cash, securities, or other assets to a DAF. These funds can be invested for growth tax-free until the donor decides to distribute them. Grants can be made immediately or on a long-term basis to eligible public charities.
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DAFs are especially useful when investors own securities that do not have a cost basis or highly valued stocks. In such a scenario, you can avoid paying capital gains taxes by moving the position into his DAF. If you are looking to rebalance a client’s portfolio and the client has a philanthropic bent, the client can reduce a large position, avoid paying capital gains taxes, move it to a DAF, and potentially can fix tax deductions on contributions.
Exception still working: The “still working” exception allows RMDs to delay retirement plans from employers who are still employed. Therefore, this does not apply to your old 401(k) from your previous employer. It also does not apply to IRAs, SEPs, and SIMPLE IRAs. If you use the “still in service” exception, your RMD begins in the year you leave service. The date he must start taking RMDs is April 1st of his retirement year.
There are no official details from the IRS regarding the definition of “still working.” Therefore, working part-time may be enough to take advantage of this strategy. It is important to note that this exception is not available if he owns more than 5% of the stock of the company in which he still works.
Geographic arbitrage: Geographic arbitrage is when someone makes money in a part of the country where the cost of living and taxes are high and then retires to a cheaper part of the country where taxes are lower. This could allow retirees to benefit from income in big cities and keep that money longer in cheaper, tax-advantaged parts of the country. I often tell my clients that one of the best ways to save money is to think carefully about where you live. For example, someone who worked all their life as a lawyer at a large firm in New York City or San Francisco may want to consider eliminating their lifetime income and moving to a place with no state income tax, such as Florida, Texas, or Nevada. . . This type of transfer can result in significant changes to any retiree’s cash flow.
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Jonathan I. ShekmanAIF®, is President and Chief Investment Officer of. Parkbridge Wealth Management and is based in New York. His practice includes working with clients’ other trusted advisors to help facilitate and manage a variety of tax, estate, and financial planning strategies to achieve clients’ goals. We work on every aspect of the plan.
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