If you’re like many people getting ready to retire, you’re concerned about the prospect of running out of money before you die.
That puts you in good company, because a recent survey found that 63% of Americans are more afraid of running out of money than they are of death.
Unfortunately, this concern may be preventing you from focusing on an equally important issue, which is overpaying taxes. In my experience, many of the taxes you pay in retirement could be reduced or even avoided. Failing to take advantage of these legitimate tax reduction strategies might suggest that they love the IRS more than they love their families. I hope this isn’t you.
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OK, I’m sure you definitely love your family more — at least I hope you do. The thing is, you may not be showing that right now with how your finances are set up to provide for your family in retirement and after you pass away.
The first factor that might deplete your resources during retirement and in your legacy planning are the 2017 Trump tax cuts, also known as the Tax Cuts and Jobs Act (TCJA), which will usher in higher tax rates if Congress and the president fail to take steps to extend them. Then there may be unforeseen issues that can occur for married couples when the first spouse dies. Finally, if you aren’t careful, you might “gift” your children a large tax bill when you and your spouse pass away.
Here are three reasons why it might look like you love paying taxes more than you love your family.
Reason #1: You’re ignoring that the sunset of the TCJA will increase tax rates.
If provisions in the TCJA are allowed to expire at the end of 2025, tax rates will increase. That means you may want to engage in Roth conversions, where you pay taxes now on traditional IRA balances at the current lower rates.
Strategic Roth conversions could also greatly help you in retirement. That’s because traditional IRAs are taxed at ordinary income rates — you don’t get any capital gain tax benefits when transactions are made within a traditional IRA.
Converting as much of your traditional IRA to a Roth before you retire can also help lower your overall tax bill. That’s because up to 85% of your Social Security may be taxable. Receiving too much taxable income in retirement may propel you into a higher tax bracket than you might realize. That can impact your Medicare premiums, which are income-based.
Approaches such as Roth conversions can also help with legacy planning.*
Reason #2: You’re preparing to potentially burden your spouse with less income and higher tax rates.
The tax system incentivizes marriage, and an unfortunate side effect of that for older adults is that recently widowed retirees, especially women, who both tend to live longer and earn less than their husbands, will experience the “widow’s penalty.” What this means is that they will most likely be bumped into a higher tax bracket by being squeezed out of a more advantageous one available only to married couples, despite their income declining.
This usually happens because the required minimum distributions (RMDs) on an IRA that is transferred to the surviving spouse might put them into a higher tax bracket. You may be able to avoid an unfortunate tax situation through Roth conversions, where you pay the taxes upfront.
Reason #3: You’re preparing to dump a highly taxable asset on your children.
The SECURE Act of 2019 put limits on the distribution rules for inherited IRAs to most children and non-spouse heirs that don’t, fortunately, apply to spouses. Non-spouse beneficiaries have 10 years to close out the account. More specifically, the clock starts ticking on the new year after their parent(s) die and ends 10 years from that date.
They can take it as a lump sum or in distributions over the decade, but that 10 years is the hard limit. Oh, and if the parent had already started RMDs, the child must continue on that same path — though the IRS will be generous enough to allow them to choose a different amount.
The 10-year limit does apply to Roth IRAs as well as traditional ones, but since you already paid the taxes on the Roth, your kids won’t be stuck with a large tax bill. Roth IRAs have different rules and contribution limits, of course, but conversion is generally a beneficial way to help you deal with some of the financial fallout from inheritance.
A final word
Don’t leave your retirement and legacy planning to chance. Instead, take the steps outlined above to minimize the negative impact of taxes on yourself and your loved ones.
Asset Investment Solutions, LLC is a registered investment adviser. Registration of an investment adviser does not imply any level of skill or training.
Licensed Insurance Professional. We are an independent financial services firm helping individuals create retirement strategies using a variety of investment and insurance products to custom suit their needs and objectives. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
Investing involves risk, including the loss of principal. No Investment strategy can guarantee a profit or protect against loss in a period of declining values. Any references to protection benefits or lifetime income generally refer to fixed insurance products, never securities or investment products. Insurance and annuity products are backed by the financial strength and claims-paying ability of the issuing insurance company.
The information contained herein is based on our understanding of current tax law. The tax and legislative information may be subject to change and different interpretations. We recommend that you seek professional tax advice for applicability to your personal situation.
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