It’s all about taxes.
That’s a key concept for retirement savers specifically because IRAs and 401(k)s are only tax-deferred — not tax-free.
“These funds have not been taxed, so you must plan to minimize these taxes (so that you) can save more of your hard-earned retirement money,” said Ed Slott, a certified public accountant in New York and an expert in IRAs. to Yahoo Finance. “It’s what you keep that counts.”
This planning is always the core of Slott’s retirement tax planning strategy. “Always pay taxes at the lowest level,” Slott told Yahoo Finance. “People miss this critical point and often end up paying more in taxes in retirement – when you need the money the most.”
Slott is the author of the new book “The Retirement Savings Time Bomb Ticks Louder: How to Avoid Unnecessary Tax Landmines, Defuse the Latest Threats to Your Retirement Savings, and Ignite Your Financial Free.” Here’s what he recently told Yahoo Finance about tax cuts in retirement, edited for length and clarity:
Read more: 3 ways pensioners can save tax
Yawis. Scary title for your new book, Ed. What is the pension savings bomb, why is it getting louder?
The ticking time bomb is the tax placed on every tax-deferred traditional IRA and 401(k) account. I’m not talking about Roth IRAs and 401(k)s.
The reason I say it is moving fast – I always felt it ticking – but now it is really fast, at some point, taxes go up to pay the huge debt this country is facing. People complain about taxes. But the highest federal tax rate from 1946 to 1963 was 91%. By 1964, it had dropped to just 77%. I was only 10 years old, but I heard that the whole country was doing a happy dance. Look at where we are now. The highest rate is 37%.
Provisions in the 2017 Tax Cuts and Jobs Act (TCJA) that lower individual tax rates are scheduled to expire on December 31, 2025, unless Congress acts beyond that. So, you still have less than two years to take advantage of the current rates before they go up again.
What are the basic principles of all good tax planning?
Always pay tax at the lowest rate. People don’t do it because they don’t want to pay taxes before they have to. So, the idea of converting to a Roth IRA bothered him. As I said, you should use these two years to get money from that taxable account. Start trimming those IRA balances when you can get them out at the lowest rates and move away from the tax people into what I call tax-free territory in the Roth account.
What is the biggest threat to your retirement dream?
Future taxes. I am concerned about the tax rate going up for retirees.
Can you explain the protection of savings instead of investment?
I look at retirement like a football game. Football games are easily divided into first half and second half. The first round is the accumulation phase. Everyone already knows. That’s when you do all the work. You’re building, you’re saving, you’re investing, you’re sacrificing to have more.
The problem is, most people, at half an hour, think they’re done. They’ll come in and say, ‘Ed, I’m retired. Look how much money I have for retirement.’ He thought the game was over. Meanwhile, IRS came out to play in the third and fourth quarters. Nobody plays, so win. Investing and saving is the first half, but protecting that money is the second half.
For most people, their largest single asset, other than their home, is their IRA and 401(k) accounts, and those are taxable. So the second half of the game is important. Many games are won or lost in the last five seconds of the game on some kicks as timeouts. Same thing here.
You can really blow in the second half of the game through paying a large amount of taxes, excessive and unnecessary taxes, or lost to unnecessary penalties, or not knowing the rules of simple rollover or the rules of early distribution.
The stock market is booming, and retirement savers are happy. Isn’t that good for retirement savers?
The rest of your money will fork over at some point to Uncle Sam. Remember, most of the IRA or 401(k) you don’t have. There is a mortgage on, like a mortgage on a house, the loan goes directly back to the government. Most people should stop contributing to their traditional 401(k) and IRA and switch to a Roth 401(k) or Roth IRA.
Clients tell me all the time, ‘in retirement, I’ll be in the bottom bracket because I have no income.’ They miss the point that by doing nothing, the IRA continues to grow. And at age 73, the new required minimum distribution age, they will be forced to withdraw.
What is the biggest mistake people make with distribution planning?
Not taking more when rates are lower is short sighted. You have to take the long view over the long haul and pay taxes. If you can get out at a low rate, it’s really a secret. But people don’t do it because they want to pay taxes before you really have to. Otherwise, you’ll be forced to at age 73. You want your plan, not the government’s, when your options fall by the wayside.
It pays to take distribution before you need to take advantage of these low rates. Do a Roth conversion, or put it into some type of tax-free vehicle like life insurance. When you get those funds into a tax-free vehicle, they will grow and compound for you.
What is the best option for most people in retirement?, or they go to a different job when it comes to employer-provided retirement accounts?
It is generally an IRA rollover. But there are other options. You can save in a 401(k), or roll over to a new company’s 401(k) plan if you get a new job, or take a lump sum distribution. Rollover IRAs give you the most control.
What are your best tips for people who will be taking the required minimum distribution this year?
That investment. There is no reason to spend unless it is necessary for living expenses, and you can take out more than you need and start spreading the tax over the years more than this low bracket.
If you’re in RMD territory, you’ll need to take those RMDs, and those can’t be converted to a Roth IRA. So take the RMD and then take a little more, if you can, and convert that part. The idea is to get that taxable IRA balance down as low as possible. Because if you just build it, you will have that tax.
Can you tell us about your charity and RMD ideas?
Your RMD is your best asset to your charity. Take advantage of Qualified Charitable Distribution (QCD). Give your taxable account to charity. Charities do not pay taxes.
Some people have a favorite cause or charity or want to give to their alma mater. You must do so with a taxable IRA. And one of the best ways is to transfer directly from an IRA to a charity.
QCDs are available to IRA holders who are age 70 1⁄2 or older when distributions are made, according to IRS rules. You can contribute up to $105,000 in total to one or more charities directly from your taxable IRA. That would be a reason to roll over to an IRA and not stay in an employer plan because you can’t do QCD from an employer plan like a 401(k).
You get out at zero tax and give to charity, something you would have done anyway. It’s a great way to get money from your IRA and fulfill your charitable intent. Plus, if you do it right, over time, it can offset your RMD.
One caveat: I’ll only do it if you’ve given it to me. I once said give to charity for a tax break.
Kerry Hannon is a Senior Columnist at Yahoo Finance. He is a career and retirement strategist, and the author of 14 books, including “In Control at 50+: How to Succeed in the New World of Work” and “Never Grow Old To Be Rich.” Follow him in X @kerryhannon.
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