Keep It Tax-Free
First up, thanks to all of you who took the time to write in last week about the retirement coaching series. Your input was great, and we will start with the first one next week. Look for it in this spot.
The topic this week: Beating taxes on your RMDs.
The RMD (required minimum distribution) that hits everyone’s tax-deferred accounts – IRAs and 401(k)s – at age 70 1/2 can be a real problem and an expensive one, too, if you miss it or don’t plan for it.
Everyone must take a minimum amount out of their tax-deferred account after age 70 1/2 that is based on the account value and your life expectancy. This can cause all kinds of tax problems if the unexpected amount bumps you into a higher tax bracket or if you don’t do it. There are hefty penalties. How does a 50% penalty sound?
For those of us who have done a good job saving for retirement, these RMDs have become a problem. But here’s something that might make them a bit more palatable.
You do not have to take cash out of your account to meet the RMD. You can transfer the annual amount required in stock. You do not have to liquidate holdings to meet the required minimum.
This gives us a little wiggle room and a way to legally beat some taxes.
Consider transferring shares out of your account rather than cash. Here’s why.
Let’s suppose you have a $5,000 RMD. If you transfer cash out of the account, you are hit with regular income taxes on that amount. Done. End of conversation.
But if you transfer shares that have dropped in value, whose current market value is equal to the required $5,000, and the shares have a good chance of appreciating down the road, you can get out more future value than just the RMD and only be taxed on the current market value of the stock.
The companies that come to mind right now are energy and energy services. Some are off 30% to 50%, and I know at some point down the road almost all of them, except the weakest, will recover.
A stock that is off 30% to 50% when it is transferred out of a tax-deferred account allows you to withdraw 30% to 50% more future value. When the stock runs back up – let’s say by 30% – you just beat the taxes by about $1,500 on a $5,000 RMD.
Yes, if you liquidate the position outside of the IRA you still have capital gains taxes. But as long as that rate is less than your personal income tax rate, you win. You pocket the difference.
And as the amounts increase, obviously, so do the savings.
I wish there were a way to avoid this issue completely but I haven’t found it, not yet. So, until then, this will have to suffice.
As with all tax issues, consult your accountant or tax preparer and make sure this will fly for your particular situation.
Believe me, you don’t want the IRS on your back over a RMD! A 50% penalty on the amount you were required to withdraw, plus the tax due, is a real kick in butt at a time when you can least afford it.
That’s it. Look for the first retirement coaching Two-Minute next week. Thank you again, and I’ll see you next week.
One of Retirement’s Costliest and Least Addressed Issues
One of the costliest and least addressed issues in retirement is taxes. Everyone’s focus is on saving enough to retire, but few look at how taxes will affect their income over 20 to 30 years of unemployment.
And it’s a big problem.
Most people have their money in three places:
- After-tax accounts, like savings and money markets
- Taxable investment accounts
- And tax-deferred accounts, like IRAs/401(k)s.
The fourth, and the one that could save you a bundle, is the Roth IRA. It’s funded with after-tax dollars, your money grows tax-deferred and the distributions are tax-free.
Now that’s a deal, if you earn less than $191,000 a year. That’s the cutoff to qualify for one.
But anyone can convert a conventional IRA to a Roth, if you can afford the tax bill that will result. The amount converted is fully taxable at your current tax rate. That can get expensive at any tax bracket above 15%.
But, and here’s where it gets good, if you convert it after you retire, you will most likely be in a much lower tax bracket. So you get a lower conversion tax bill.
And, don’t kid yourself, you will pay the taxes one way or another; either as after-tax money at your current rate going into a Roth or as taxable distributions when it comes out of your IRA.
And, with a Roth, there are no yearly RMDs (required minimum distributions) starting at 70 1/2. And these RMDs are becoming a big problem for the well-funded retirement. You literally lose control over how much you withdraw each year and that can cost a bundle in taxes and bump you into an unplanned higher tax bracket, too.
So, the ideal situation is to convert to the Roth in the first few years of retirement when you are likely to be in a lower tax bracket. Pay a much lower tax bill than you would if you were either contributing after-tax dollars to a Roth or converting at a higher tax bracket, have no RMDs and get tax-free income in retirement.
But here’s where you have to plan around one Roth regulation. You must leave the money in a Roth for five years after a conversion before you can get the tax-free benefit.
This is workable for most people, because most planners will tell you to draw down taxable accounts, savings, CDs and investments outside of IRAs before touching the tax-free or even tax-deferred money.
If you can get five years out that money, this Roth idea can be a good deal.
Talk to your tax advisor about converting your IRAs to a Roth after retirement, ideally in the lowest tax bracket. And stop giving your money to the Washington bureaucrats. They got enough when you were working.
The Greatest Fear
The greatest fear in our culture used to be public speaking, followed by the fear of death. But a new one has taken over the top spot for those over 55: the fear of running out of money in retirement.
And, for the majority of our population, this is a very real fear. Most have nothing saved.
But, a recent change in the tax laws has made it possible to buy a type of annuity, called a longevity annuity, in your IRA and 401(k), that can guarantee income for life, reduce your required minimum distribution (RMD) at age 70 1/2 and could reduce your tax bill in retirement.
And it is so simple.
You decide how much you want to put aside in the annuity, or how much you need to receive in guaranteed income, and at what age you want to begin receiving it. Then, you simply buy an annuity from a reputable insurance company using the money in your retirement account.
But the really big news is that the money does not have to come out of either tax-deferred accounts to buy the annuity. There is no taxable event here. That means you can buy the annuity with tax-deferred money and leave it in the tax-deferred account.
This is huge!
The money you set aside in the annuity stays in your IRA and 401(k), and will not be used to calculate your RMD at age 70 1/2: another gigantic change in retirement law.
Essentially, you now have the ability to buy a source of guaranteed income with tax-deferred money, and it stays that way until you start drawing income from it.
You can put up to one-fourth of your retirement account into a longevity annuity to a maximum of $125,000 maximum, and you must begin receiving income by age 85.
Here’s an example of how $100,000 in the new longevity annuity would work.
If you put aside $100,000 at age 55, and begin drawing income at age 75, you’re guaranteed $24,000 a year. Begin drawing at age 85 and that number jumps to about $81,000 a year. And it is guaranteed!
But, here comes the negative side of the equation. If you die before you begin drawing from the longevity annuities, you lose the money: all of it. The issuer gets it all.
There is a way around this big negative so your heirs get something back from it, but it lowers the income you receive.
It’s not perfect, but it can be a huge source of peace of mind in retirement.
Look for longevity annuities to be available in September of this year. And make sure you have all the facts before you do anything.