Serving Cumming, Forsyth County GA and surrounding John's Creek, Alpharetta, Milton, Duluth, Buford, Suwanee, Flowery Branch, and Gainesville
Roth Conversion Done Dirt Cheap
- By Travis Echols
- •
- 24 Dec, 2022
Alex and Anita Case Study - Ages 64 and 62 - Early Retirement
With the necessary disclaimers in place, let's talk about Alex and Anita.
Alex and Anita started planning before they retired.
As a result, they learned that they could retire early and implement tax strategies that could possibly save them enough in taxes to effectively pay for retiring earlier.
With this knowledge, they decided they did not want to continue to work for a discount. They were ready to start living life on their terms and on their schedule.
They wanted to be confident that their retirement plan maintains their lifestyle without running out of money.
Reducing their taxes, improving their investments, and creating a reliable income stream in retirement was their priority.
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Their Goals and Challenges
Alex and Anita had both worked hard for decades and had sizeable nest-eggs in their retirement plans that they knew taxes would come due on later.
They had also inherited some money from a parent that had given them a good bit of after-tax money beyond their emergency cash.
They wanted to enjoy their grandchildren more and looked forward to traveling and spending a little more time at the beach.
Retiring in their early 60s allows them to access their 401k/IRA monies with no penalty, but they had to be sure of health insurance coverage until age 65 when they would enroll in Medicare.
They also wanted to be mindful of their lifetime tax liability (i.e., their estimated cumulative tax bill over their entire retirement) and not be shortsighted regarding taxes.
With early Social Security available at age 62, they needed some advice as to when each should file.
They believed that the success of their retirement was too important to be doing it themselves and the value of having professional guidance.
Finally, they wanted to be sure their investments were aligned with their financial plan and objectives.
Their ultimate goal was to live the life they love now while having a solid plan for the future.
Their Strategy
The goal was to make Alex and Anita's retirement planning process as simple, effective, and enjoyable as possible.
They wanted to avoid big mistakes and big surprises. They wanted to know they were achieving their goals with less personal time, worry, and effort.
The retirement planning process involved:
- Analyzing all of Alex and Anita’s information
- Summarizing the options available to them with their goals as the directing compass
- Establishing new investment/retirement accounts that could provide better monitoring and tax planning options
- Strategizing a withdrawal plan with a goal to optimize their lifetime income while paying the least in taxes (what they owe without leaving the IRS big tips year after year)
Being able to understand
all of their options and the tax savings available removed a lot of their worries.
They were able to move forward with their plan, confident that they would be OK.
Their Results
The solutions adopted by Alex and Anita helped them in many ways:
- They purposely delayed Social Security to get higher benefits, thinking they would likely live beyond the breakeven point of filing early.
- In the opportunity gap to Social Security, working with their financial planner and CPA, they started strategic Roth conversions, moving $65,000 of IRA money to their tax free Roth IRAs in the first year of retirement at a Federal tax rate of only 5.6%! See graph below.
- By converting $32,500 from each of their IRAs, being ages 64 to 62, their Georgia individual income tax exclusion of $35,000 per individual made their Georgia taxes zero!
- This $65,000 Roth IRA conversion amount was calculated so as not to exceed the Adjusted Gross Income (AGI) limit that would reduce their Affordable Care Act (ACA) health insurance subsidy, which substantially lowers their health care insurance premiums until they each enroll in Medicare at age 65.
- By implementing what’s called the "hatchet retirement distribution strategy"**, they had a plan for a predictable stream of income at a very low tax rate while keeping their medical insurance low -- all the while starting to defuse the ticking IRA tax time bomb in their future (or their heirs' futures).
- They established a bond ladder at relatively high short-term rates to bridge the gap to Social Security (to avoid selling funds if they are down when they need the money).
- They aligned their remaining investments to meet their long term goals, withdrawing in the order that made most sense for their objective of maximum income and minimum taxes.
- If they stay on plan with this strategy, doing it every year in the gap, it could potentially save them hundreds of thousands of dollars over their lifetime in unnecessary taxes.*
They have the confidence of knowing that their financial plan is sustainable so they can do what they enjoy doing.
Alex and Anita's retirement plan is reviewed regularly. Most importantly, new tax laws are being monitored each year to ensure they are taking advantage of any opportunities available to them.
Echols Financial Services
*DISCLAIMER. The content in this article is not intended to provide tax, legal, accounting, financial, or investing advice, or advice of any nature. Readers are advised to seek out qualified professionals that provide advice on these issues for specific client circumstances.
Please note that for any hypothetical example there are many inherent limitations. In fact, there are frequently sharp differences between hypothetical results and the actual results subsequently achieved by any particular strategy due to each person’s unique financial or tax situation. This is not a promise or guarantee regarding your situation. Any reduction in taxes would depend on your specific tax situation and should be reviewed by a qualified tax specialist.
However, this case study is not an exaggeration for many retirees who have large retirement accounts facing large RMDs at projected high future tax rates.
A vital part of holistic financial planning for retirees is tax planning. Yet so few retirees get any meaningful tax planning. As a result, many retirees get stuck overpaying the IRS year after year…and then, to make it worse, leave their heirs with a big tax problem.
Through creative tax planning, using reasonable assumptions, withdrawing from accounts in the optimum tax order, accelerating ordinary income (strategic Roth conversions) in lower tax brackets, and harvesting gains in lower capital gains tax brackets, the potential cumulative lifetime tax savings are significant.
Our financial planning process includes investment recommendations and tax guidance, but it is not meant to represent formal tax advice. We do not offer specific tax services to clients. Our goal is to bring to your attention effective tax planning strategies to coordinate with your tax preparer to reduce your lifetime taxes. (I have found over my 20 years of experience that this team approach to tax planning and tax preparation works best.)
For clarity, let’s be sure to differentiate tax preparation from tax planning. Tax preparation, also called tax return preparation, typically looks backward, one year at a time, to submit the proper tax forms and accurately calculate your tax liability (and how much you owe or overpaid).
Tax planning, on the other hand, looks at taxes in the context of your overall financial picture. A tax planner not only looks in the rear-view mirror but will look forward 20 to 30 years at your projected tax liability and ask what can be done to lower your lifetime tax bill.
By anticipating taxes, it is possible to significantly increase how much money you will have in retirement. And every dollar saved in taxes is a dollar to fund your dreams and goals. Good tax planning is one of the key areas of retirement success.
If you are retired or close to retiring, and especially if you have large retirement accounts, I urge you to consider hiring an advisor who includes this important aspect of financial planning in their practice.
**The “retirement income distribution hatchet” is a retirement distribution model in which the initial
retirement distribution rates from a portfolio are high in the early years of retirement,
but then significantly decline when deferred Social Security is claimed and decreases even further as retirees spend less later in
retirement. It’s name is based on the investment income curve resembling the
shape of a hatchet.
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Investment Advisory Services offered through JT Stratford, LLC. JT Stratford, LLC and Echols Financial Services, LLC are separate entities.
- Liquidity--Retirement assets are not being locked up or annuitized such that capital is not available for emergencies.
- Income—Using an optimized withdrawal rate, an increasing income is produced to combat inflation (unlike many pensions, bank and insurance strategies that are not inflation-adjusted).
- Growth--assets that can combat inflation over a 20 to 30-year period, giving the retiree more income and upside potential under normal and good economic times.
- Safety--manages the myriad of investment risks like market risk, inflation risk, and credit risk. Under worst-case scenarios, if withdrawal amounts are adjusted by using guardrails, the portfolio can still provide a lifetime income.
Here is an executive summary of how to build up a portfolio for retirement in seven steps.
1. Values clarification and goal-setting . Figure out the income objective and capability of your retirement assets in lifestyle terms, then financial terms. In other words, set realistic, specific, financial goals based on your core life values.
2. Asset allocation glide path . Figure out how to diversify your retirement assets among stocks, bonds, and cash, based on your age, risk tolerance, retirement goals, and changing market values.
3. Valuation-dependent efficient frontier . Figure out which areas of the markets are historically inexpensive, and which are historically expensive. Don’t take on more volatility than you need to for the growth you need or desire.
4. Multi-asset class approach . Diversify one more step for more growth and less volatility. Put more money in the specific market areas that are less expensive and less money in the specific market areas that are more expensive.
5. Tax-aware asset location and distribution . Save as much on taxes as possible by figuring out which type of investments should be held in which types of accounts. If you are drawing an income from your assets, figure out the least-costly order for making withdrawals.
6. Investment selection based on account type (qualified, nonqualified) and asset-class propensity and magnitude of outperformance (passive, factor, managed, etc. ). Figure out what kind of investment to use (index mutual fund, factor mutual fund, actively managed mutual fund, single factor ETF, multifactor ETF, passive ETF, individual stocks, individual bonds, Unit Investment Trust, closed-end fund, etc.) based on the account type, asset class, and growth and income needs.
7. Rules-guided rebalancing based on retirement glide path and multi-asset-class approach . Readjust the investment mix based on your changing personal situation and changing market values.
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Here is a summary of the details backing this approach. Also, click here for more background information regarding my investment philosophy.
1. Values clarification and goal-setting
Investment planning for (or in) retirement starts with retirement planning. You start with thinking about your life goals...your dreams...your ideal life in retirement. It could involve doing no work, working part-time, or doing seasonal work. Your ideal life could be going back to school, spending more time with family, traveling, ministry, etc.
Ask yourself questions like, "What would I want to do if I
didn't need to work for money?" or "What are the most important
dangers, opportunities, and strengths I need to address?" or“Ten years from now, if I am looking back on a successful
ten years, what will I have achieved?”
This conversation allows you to create specific
goals around your most cherished values. And your goals will be unique to you.
You then design an investment plan to help you live your ideal life.
This kind of goal-focused, plan-driven approach minimizes the
chances of making bad investment choices based on current events and emotions.
Instead, you can choose and maintain the
specific mix of investments that can best deliver the results you need--using a
disciplined, research-driven approach.
2. Asset allocation glide path
The next major question is what kind of investments do you need to meet your goals. All investments have risk. Even "safe" investments over long periods have inflation risk. No single investment delivers growth, high income, and safety of principal. The key is designing a portfolio that balances them in a way that supports your retirement objectives.
And this mix may change over time. For example, for most people, it makes sense to gradually decrease their exposure to high-growth, high-volatility assets like stocks (i.e., equities) as they approach retirement. In retirement, it is usually best to maintain a flat equity glide path, dynamically adjusted for valuation. This approach protects you from the retirement-danger-zone risks of portfolio size effect and sequence risk, while allowing you to take advantage of bear markets and market corrections. See How to Navigate the Retirement Danger Zone .
Protecting your lifetime retirement savings from excessive taxes is a crucial part of holistic financial planning. This involves protecting your IRA, 401k, lump sum pension rollover, Social Security, and any other type of retirement account or income stream from crushing tax rates.
So let's be sure to differentiate tax preparation
from tax planning
.
Tax preparation , also called tax return preparation, looks backward, one year at a time, to get the numbers right to accurately calculate your tax liability (and how much you owe or overpaid).
Tax planning on the other hand looks at taxes in the context of your overall financial picture. A tax planner not only looks in the rear-view mirror but will look forward 20 to 30 years at your projected tax liability and ask what can be done to lower your lifetime tax bill.
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If you have savings outside of pretax retirement accounts invested in capital assets (like stocks, bonds, ETFs, mutual funds, precious metals, jewelry, and real estate) which have large unrealized capital gains, this article is for you. You may be missing the opportunity to pay zero taxes NOW instead of 15% or higher rates in the future. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Originally written on Aug 2, 2018 and updated for tax law changes.
If you are no longer working and have reached the age of 72,
you probably know about Uncle Sam’s rule for you to take a Required Minimum Distribution
(RMD) from your traditional and rollover IRA(s) each year for the rest of your life. You can always withdraw more,
but this requirement is the minimum
you must take or be severely penalized. Fortunately,
this rule does not apply to Roth IRAs. (The SECURE Act of 2019 changed the starting RMD age from 70½ to 72 starting in 2020, but fortunately you can still make a Qualified Charitable Distribution (QCD) starting the year you turn 70½.)
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If you have delayed paying taxes in your pretax IRA, 401(k), or 403(b), etc, there comes a time when the IRS wants their taxes. And if you don’t give them their taxes based on their required withdrawal schedule, you'll get hit with a 50% penalty on top of what you owed.
Along with Social Security and other retirement income, this RMD can significantly raise your tax rate. Also read How to Dodge the Social Security Tax Torpedo . There are not many ways to reduce this tax burden. In the past, retirees have used various deductions including charitable cash contributions and gifting of highly appreciated assets to charities. (The latter not only gives you, the donor, a deduction but also avoids a long-term capital gains tax bill.)
However, with the passing of the Tax Cuts and Jobs Act of 2017 (TCJA) , with its almost doubling of the standard deduction, itemizing deductions won’t make sense for near as many retirees. Ah, but there is still a strategy. But first let’s better understand the RMD.
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The latest book I am reading is “ The Psychology of Money ” by Morgan Housel. Chapter 3 is entitled “Never Enough”. In this chapter, Housel talks about when rich people do crazy things. He tells stories of wealthy people who never had a sense of enough and wrecked their reputations, families, freedom, and happiness because of it. I have also talked to older couples who tell me they once had a much better retirement in view, but the quest for more led them to make unwise investment decisions that left them financially crippled in retirement. The importance of knowing when you have enough is not only vital to when you retire but also how you retire. It can affect how you invest, how you withdraw, and your overall satisfaction before and during retirement. Be sure to read to the end where I summarize a few key takeaways. Housel makes the four following observations in chapter 3 of his book. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Whether you do mini-Roth conversions over several years or big Roth conversions in a few strategic years, the Roth conversion strategy could save you tens if not hundreds of thousands of dollars over your retirement. This article will get deep into the issues of Roth conversions for retirees and the ten steps to take to be sure it is done properly. Be sure to scan or read to the end where I will give you the simple answer to getting your Roth conversion questions answered. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Making big financial decisions immediately following the death of a close family member can be dangerous. It is often best to allow some time before tackling big financial decisions. On the other hand, some people find getting immersed in the finances is helpful in coping with the loss. Whatever way is best for you, you will need to give it your
careful attention to avoid big financial mistakes. The different types of accounts have different rules. I'll address the most common types. In the case of the death of a parent or anyone other than your spouse in which you are a non-spouse beneficiary, there are many rules that you must know to make the best decision for you and your family. (In this article, I use the common parent-child inheritance, but the planning strategies can apply to other non-spouse situations.) Your decisions can have major tax and investment consequences, both now and in the future. And some of these decisions have time deadlines keyed to your parent’s date of death. Also, some of these decisions are irreversible. You can download my free Estate Planning Survivor Checklist here
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So, you don’t want to rush in and make decisions without knowing the rules, and you don’t want to wait too long and be stuck with fewer options. (In this article, I am not addressing estate taxes. As of 2021, only estates valued at $11.70 million or more are subject to federal estate tax. But there are plenty of other tax pitfalls to navigate around. I am also going to focus on liquid savings like investment and retirement accounts, versus real estate which will be for another time.) Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Delaying Social Security makes a lot of sense for many retirees; but there are common pitfalls that can cost you a bundle. As you know, the longer you delay your Social Security Retirement benefit, the higher your lifetime monthly payments are figured to be. This increase in delaying continues until age 70, after which there are no further increases for delaying. This increase for each month that you delay filing is not small, especially considering the current low interest rates. Even after full Social Security age, your payment goes up by 8% per year until age 70. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation . Here are the five big mistakes of delaying your Social Security retirement benefit. |
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Are you wondering about the impact of the
2020 election results on your retirement? If so, you are not alone. The two political parties are greatly polarized. While the Democrat party has moved further toward ethno-centric socialism, the Republican party has moved further toward nationalistic populism. The difference in the two parties’ goals for our country is wider than ever. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation . |
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Investment Advisory Services offered through JT Stratford, LLC. JT Stratford, LLC and Echols Financial Services, LLC are separate entities.
Serving Cumming, GA, Forsyth County, and the surrounding areas of John's Creek, Alpharetta, Milton, Duluth, Buford, Suwanee, Flowery Branch, and Gainesville
