Creative Tax Strategies Can Stretch Your Nest Egg

One of the biggest mistakes retirees can make is ignoring the bite taxes can take from their hard-earned savings.

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How you tap into your various accounts can make a big difference in what you may pay in taxes and what you manage to keep during a retirement that could last for decades. And yet, not all financial professionals make tax planning a priority when building an income plan.

Instead, it seems most financial professionals rely on conventional wisdom and one-size-fits-all strategies, including telling clients to spend down their assets in sequential order — starting with their taxable brokerage accounts, then their tax-deferred retirement accounts and then any tax-exempt accounts.

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The idea behind this approach, of course, is to let your tax-deferred money continue to compound for as long as possible before you start taking it. And for some retirees, that makes sense.

But if you happen to spend all your taxable money too quickly and then suddenly need extra cash — whether the water heater goes out, or you need to replace the roof, or some other curveball comes along — the only place you can go is your IRAs. And that can have some surprising tax consequences.

Let’s use a married couple, Joe and Jenny, ages 66 and 65, as an example. Let’s say they have $500,000 in a 401(k), $125,000 in taxable cash accounts and $54,000 in a Roth, and they plan to retire in a year. They know they’ll have to spend conservatively, but they want to enjoy their retirement, and they want a plan that will make their savings last.

As a hypothetical example, using Retirement Analyzer software, we will plug in an inflation rate of 3.28%, an annual rate of return of 6% and a withdrawal rate of $30,000 per year net to illustrate the point. Some financial professionals would tell them to spend the money in their taxable accounts first, then their 401(k) and then their Roth. And if they do that, they could run out of money as early as ages 88 and 87.

While that may sound OK, Joe and Jenny could live longer than that. They just don’t know.

The good news is they may be able to do better just by switching things up a bit — flipping the withdrawal sequence and pulling the money out of their Roth account first, then their 401(k) and then their taxable accounts.

All things being equal — the same withdrawal rate, same inflation, same rate of return — their money has the potential to last six years longer, taking them to ages 94 and 93.

Suddenly, unconventional thinking sounds pretty wise.

And they could get even more creative.

If Joe and Jenny used a “multiple accounts strategy,” pulling simultaneously (instead of sequentially) from their savings in a tax-efficient manner, their money could last until they’re 100 and 99 years old, respectively.

Now, that creates an entirely different retirement strategy!

By taking some money from all three savings “buckets,” instead of using one at a time, they could put less stress on their portfolio, and they wouldn’t have to give up as much to Uncle Sam.

It’s not a magic bullet, and it’s not necessarily the best fit for everyone, but it might be what’s best for Joe and Jenny — and for you. But it takes someone who is willing to run the numbers to come up with this type of plan.

A financial professional who puts a priority on tax efficiency can strengthen and lengthen your retirement income plan. Make it your priority to ask about this important concern.

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This is a hypothetical example provided for illustrative purposes only; it does not represent a real-life scenario, and should not be construed as advice designed to meet the particular needs of an individual’s situation.

Investment advisory services offered through Elevated Capital Advisors, LLC, a Registered Investment Adviser. Insurance products and services are offered through Elevated Financial Services, LLC.

Kim Franke-Folstad contributed to this article.>

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Sean P. Lee is a managing partner and Investment Adviser Representative with Elevated Retirement Group. Since 2002, Lee has helped families reach and maintain their financial goals. Lee has been featured in The Wall Street Journal’s Market Watch, The Deseret News, The Salt Lake Tribune and USA Today. He has also been featured as a local financial adviser on Utah’s NBC station, KSL 5.