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Give yourself a big pat on the back if you’ve built up a healthy retirement nest egg after years of scrimping and saving.
Congratulations, you are halfway there.
Many investors are so focused on accumulating wealth that they overlook the second part of the equation – withdrawing money so it doesn’t needlessly deplete it because of bad tax rulings.
“We spend years or decades trying to invest money in retirement plans,” said Michael Kitces, financial advisor at Kitces.com. “But how do you withdraw the money and do it in a tax-efficient way? “
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This was the gist of a recent lecture he gave to members of the American Institute of Certified Public Accountants and the Chartered Institute of Management Accountants. Here are some highlights:
Realize that you are not as rich as you think
Millions of Americans have seen their retirement accounts skyrocket in recent years. But if a good chunk of your assets is held in traditional individual retirement accounts or 401 (k) style work plans, you will eventually have to pay taxes on the balances. Therefore, you are not as rich as you might think.
Kitces provided this simple example: Suppose you have $ 750,000 in unprotected brokerage accounts and $ 750,000 in a traditional IRA. When you withdraw money from the IRA, you will pay ordinary income tax. If you calculate an average federal tax rate of 24%, you really have $ 570,000 in the IRA and $ 180,000 in deferred tax liabilities, he said. Companies need to factor it into their balance sheets, but people usually don’t think about it that way.
“Really, you wouldn’t have a $ 1.5 million portfolio,” he said.
In fact, the assets of the brokerage account would also be subject to taxes. Even a relatively low capital gain rate of 15% on withdrawals would hurt your wealth even more.
Schedule withdrawals while you have time
You might be tempted to put money aside in retirement plans and forget about it until you are due to receive the minimum required distributions when you turn 70. It would give your account even more time to grow, after all.
But that might not be the best way to go. If your account gets too big, you could trigger nasty RMDs. You will also be collecting Social Security by then, and large pension distributions could make some of your Social Security taxable.
Kitces said he often hears high-end individuals say they were getting killed by RMD taxes in their 70s. “There’s not much you can do about it now,” he told them. “But 10 years ago we could have helped you.”
People in their 60s have a golden opportunity to start withdrawing money from retirement while reducing the tax burden. This opportunity is enhanced if you are not earning much income from employment and have not yet applied for Social Security. People in this age group also don’t have to worry about the 10% penalty that typically applies to retirement withdrawals made before age 59 and a half.
“The goal is to have smaller ARIs by your 60s by reducing them to your 60s,” Kitces said.
Think in terms of ‘buckets’ of tax brackets
If you have the money in traditional IRAs or 401 (k) plans, you will end up paying taxes. The goal is to pay these taxes at the lowest possible rate.
Americans currently pay federal income tax in seven brackets, where rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37% apply. As you earn more you are pushed into higher ranges. With income from work and Social Security, retirement withdrawals can propel you up the ladder. But you could have some spare capacity each year at relatively low rates.
For example, the 12% bracket ends at $ 40,525 of taxable income (after deductions and so on) for singles and $ 81,050 for married couples. Ideally, you would want to take retirement withdrawals up to the point where you stay within the 12% range. Or, if you are richer, you would want to retire as long as you stay in the 24% range. The next rate, 32%, starts at $ 164,926 in taxable income for singles and $ 329,851 for joint filers.
“The goal is to fill the lower buckets,” without overshooting, Kitces said.
Kitces describes this strategy as an annual “use it or lose it” opportunity – one that most people probably don’t think about much. It’s especially important not to jump from the 12% to 22% or 24% to 32% range, as those are big increases, he noted.
State income taxes can also affect your opt-out decisions, but federal taxes are the main concern.
Also consider other tax strategies
In addition to the traditional IRA withdrawal schedule and 401 (k) plans – a most suitable option for people in their 60s – other tax saving strategies are worth knowing. For example, young adults should consider investing in Roth IRAs and Roth-401 (k) s. With these plans, withdrawals would generally be tax free, with no RMD. The downside is that you can’t deduct the money you contribute.
Another strategy, useful in taxable accounts, is to reap losses and maybe even gains. Harvesting refers to making losses or gains sooner than you would otherwise to minimize taxes. For example, you can harvest losses to help offset gains made in the same year. If your losses exceed your gains, you can deduct the excess up to a maximum of $ 3,000 per year, carrying any unused amounts forward to future years.
You may also want to convert the money from traditional IRAs to a Roth. You will have to pay tax now on the converted amount, but future withdrawals would be tax free. Again, you would want to manage this in such a way that the increase in taxable income does not push you into a significantly higher bracket.
“Do you have to convert everything to Roth now? No,” Kitces said. “You would explode to the upper rack.” “
Hold investments accordingly
It should be noted that some assets are best held in certain types of accounts.
For example, Kitces said, investments with high growth potential that generate few outstanding taxable distributions, such as index funds indexed to the Standard & Poors 500 or dividend-free growth stocks, often work best in low-income markets. unprotected brokerage accounts. With these, it is possible that the only taxes that could apply are on long-term capital gains.
Conversely, less tax-efficient investments are often better held in traditional IRAs. These can include high yield bond funds or emerging market equity funds that do a lot of internal trading (generating taxable earnings or dividends along the way).
As for bonds, bond funds and money market funds, Kitces argued that they can be held just about anywhere. This hasn’t always been the case, as most fixed income investments are tax inefficient, making them traditionally suited to protected accounts.
But after decades of falling interest rates, fixed income yields are not high enough to accumulate significantly. “It doesn’t matter which account you put them in,” he said.
Contact the reporter at [email protected].
This article originally appeared on Arizona Republic: How Long Will My Retirement Savings Last? You have to take into account taxes
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