I’ve written a lot about the bitter-sweet of accumulating large amounts in your 401k or IRA account. The single biggest challenge I dealt with regarding my retiring and retired clients is this issue. If you have saved well and have significant amounts in those type of before-tax accounts, there may very well be an uncomfortable tax drain in your future; I can guarantee that there is one coming for your beneficiaries. The question is ‘what to do about it?’ In my “Guide to a Tax-Free Income,” I wrote of the ‘Retirement Traps’. They were all traps that ensnare the retiring man and woman with the deadly grip of taxes during their life, in their income, and upon their death. The short term feel-good of saving on our yearly tax returns winds up biting us in unthinkable ways just at the time in your life when we want to begin enjoying them.
We can reason all we want and from several vantage points about saving taxes now and enjoying the benefit of building deferred earnings. If you can create the result of a tax-balanced financial portfolio, it is my opinion that you’ll enjoy the fruits of your life- long labors to a much greater degree. This large 401k, or ‘Beast’, will have amazing power over your life. During retirement every dollar you want to spend from these accounts for your enjoyment will have a tax bill associated with it – and perhaps at increasing tax brackets in the future. At age 70 ½ you will be forced to take sums of money and pay taxes on them. And at the death of you and your spouse, your heirs will pay taxes on the whole ball of wax.
Here are a few strategies for taming the best.
Harvest your tax bracket:
Our progressive tax system comes with tax brackets that increase the rate of tax as you receive more taxable income. Many people are somewhere in the middle of their current tax bracket each year. That means that you could have withdrawn ‘some’ more money from your IRA (after age 59 ½) and not paid at any higher tax bracket. The obvious strategy here is to work with your tax preparer and systematically, every year, take as much as you can out of your IRA, even if you don’t need to spend it. There are several vehicles to re-invest into; oftentimes we like to see folks make this shift into a Roth IRA where all earnings/gains become totally tax free for your life and your heirs.
Shift to a greater benefit:
Who isn’t concerned about the cost of long-term nursing or assisted living expenses? Only those who already have funds set aside or insurance coverage for that. The problem with traditional long-term care coverage is that the premiums are not guaranteed and eventually will increase. A relatively new financial product uses a special cash value life insurance contract to guarantee that long term care premiums never increase and that there is value later in case there were no nursing home expenses. If you have an IRA that you’re never going to spend down, another strategy would be to make annual shifts from the IRA into something like this. You will pay taxes now, but you’ll receive tax free benefits for long term care and your heirs later. Otherwise, every distribution from your IRA for those expenses creates added tax liability at a time when life is already complicated.
Create a legacy for your kids:
When you die and leave your big IRA to your kids, they get to pay taxes on it and then do whatever they will with it. So, a more creative strategy I’ve used is to ‘harvest’ the IRA annually and shift that gift to your kids into a vehicle that creates a totally tax free retirement income for the kids when they retire. This takes 10 or 15 years for the buildup to be significant, but it’s a great way of getting to see the benefit of your family charity while you are living. It is also a great strategy to use when the kids are not very financial savvy they aren’t saddled with hundreds of thousands or millions to figure out how to manage and you’ll have some assurance that they’ll have income for later in life.
Stop making it worse:
The longer you wait to act, and the more you put into these before tax accounts, the worse the problem becomes. Each of these ideas needs to be considered as part of an organized game plan for your future. Please don’t run out and buy financial products before you develop an organized detailed strategy that works uniquely for your life.
There are several strategies you can implement that don’t require purchasing any financial products, rather merely changing how you’re doing something that continues to create the issue.
