Who can resist a good sale? When prices are slashed, there’s usually a great financial opportunity.
This carries over to financial planning, too. Essentially, right now taxes are on sale. Smart investors should take note of tax cuts implemented by the Trump administration and use them to their advantage.
Under the 2017 Tax Cuts and Jobs Act, our tax brackets have been reduced. For example, the 15% tax bracket went to 12%. The 25% tax bracket went to 22% (opens in new tab). Under the taxes-on-sale concept, we have approximately seven years before they are scheduled to sunset in 2025.
So what to do?
IRAs and 401(k)s Come with Future Tax Bills
For the majority of retirees, their largest assets are mostly in pre-tax dollars, either through a traditional IRA or a 401(k) plan through their work. We tell people, “Hey, it’s great that you have a million bucks in an IRA, but think about what you’re really carrying here.’’
As you enter retirement, your biggest debt probably isn’t a mortgage. It’s actually the debt to Uncle Sam. That million-dollar 401(k) you own absolutely looks great, but know that about $150,000 to $300,000 of that sum will actually be owed to the government.
Now let’s tie everything together. The amount of that debt is controlled by the tax brackets. Smart investors will know that and will find a way to pay off and buy out that debt at the lowest possible cost. In light of the tax-bracket adjustments, we obviously want to employ that strategy for all of our clients, because it should add up to big savings in the long run.
How can we make it work? For the sake of an example, let’s say you’re married and your income is $120,000. Currently, the 22% tax bracket goes up to $165,000 for married joint filers (opens in new tab), so that leaves about $45,000 worth of wiggle room for money that can be taken out of your IRA or 401(k).
We’re not going to spend that money, mind you. We’re going to convert it.
3 After-Tax Strategies
There are three main strategies to leverage what will now become the after-tax dollars:
This is probably the most popular option. When we take the $45,000 and convert it into Roth IRA assets, that money becomes completely tax-free forever — to you, your wife, your kids, to everyone, forever and ever under the current law.
There’s a bit of bad news, though. You do have to pay taxes on that transaction. That might mean the $45,000 becomes $35,000 after taxes. But if you have cash on the side to settle the $10,000 tax bill, you can convert the whole $45,000. There’s also a five-year window to consider during which you can’t take out any of the gains without a tax obligation.
Investment Advisory Services are offered through SHP Wealth Management LLC, an SEC registered investment adviser. Insurance sales are offered through SHP Financial, LLC. These are separate entities, Matthew Chapman Peck, CFP®, CIMA®, Derek Louis Gregoire, and Keith Winslow Ellis Jr. are independent licensed insurance agents, and Owners/Partners of an insurance agency, SHP Financial, LLC. In addition, other supervised persons of SHP Wealth Management, LLC are independent licensed insurance agents of SHP Financial, LLC. No statements made shall constitute tax, legal or accounting advice. You should consult your own legal or tax professional before investing. Both SHP Wealth Management, LLC and SHP Financial, LLC will offer clients advice and/or products from each entity. No client is under any obligation to purchase any insurance product. SHP Financial utilizes third-party marketing and public relation firms to assist in securing media appearances, for securing interviews, to provide suggested content for radio, for article placements, and other supporting services.
Matthew C. Peck has his Certified Financial Planner and Certified Investment Management Analyst certifications and is co-founder of SHP Financial. He is insurance licensed and has passed the Series 65 exam.