You Saved for Retirement. But Did You Plan for the Taxes?
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| By David Phillips |
For decades, Americans have been encouraged to save for retirement, put money into their 401(k), contribute to their IRA and take advantage of the tax deduction to allow those dollars to grow tax deferred.
If you do that consistently throughout your working years, the hope is that someday you will have a comfortable nest egg waiting for you.
That is well-intentioned advice. But after more than five decades of working with families, I’ve found it only addresses half the retirement planning equation.
People often spend far more time thinking about how to accumulate money in their retirement accounts than they do about how that money will eventually be distributed.
Unfortunately, failing to plan for that distribution can create significant tax consequences for both retirees and the people who eventually inherit their accounts.
Your IRA, 401(k), 403(b) and other qualified retirement accounts are different from many of the other assets you own.
If you have $1 million in a traditional IRA, for example, you do not necessarily have $1 million available to spend or to leave to your children.
All distributions from traditional retirement accounts get taxed as ordinary income.
The income taxes may have been postponed for many years, but they did not disappear.
Those taxes will appear either when you access the funds personally or you’re forced to take distributions at age 73 through Required Minimum Distributions (RMDs).
Otherwise, your beneficiaries inherit the account and then access the money voluntarily.
Or they’ll be forced to take receipt of the balance of all funds after 10 years.
That’s based on the rules established in 2020, with the passage of the SECURE Act.
Uncle Sam Wants His Cut
That is why I encourage clients to look beyond the number printed on their retirement statement and consider the after-tax value of those dollars.
I’ve met many retirees whose Social Security, pensions, investments and other income already provide everything they need.
Nevertheless, eventually they are required to take money from their qualified retirement accounts because of RMDs.
When that happens, there is an important question worth asking: If you are required to take money you do not currently need, is simply paying the tax and depositing what remains into another account really the best use of those dollars?
Sometimes it may be. In other situations, there may be planning opportunities worth considering.
Not too long ago, a retired 72-year-old doctor named John called me. He wanted help with his retirement and estate planning.
As soon as my team and I started to review his estate, we saw one glaring problem.
Because of shrewd investing, income deferrals and time, his IRA was valued over $11 million.
That sounds like a good problem to have, right? But there’s more to the story.
Dr. John and his wife Rachel are the same age. Both receive maximum Social Security income.
They have two children and will soon be forced to take $415,094 in RMDs at age 73.
This huge income will be added to their Social Security and other investment income. Which means they will be taxed at the highest tax rate.
Dr. John and Rachel live a relatively austere lifestyle. As such, they will surely leave a huge inherited IRA.
This would result in an enormous income tax bill that they will be forced to pay.
Fortunately, the doctor recognized that there are options.
He’s now focused on a few key strategies that will help him, Rachel or their children mitigate a huge tax liability.
More about those solutions in a moment. First …
What Happens When Your Children Inherit the Account?
This is where retirement planning and estate planning come together.
Many people assume their planning is complete once they have named their spouse or children as beneficiaries.
Naming beneficiaries is important, yes. But this doesn’t answer the larger question of what will happen to those accounts after you die.
Because of the SECURE Act, the rules have significantly changed for inherited retirement accounts.
For adult children who do not have special needs, the previous ability to stretch distributions over a beneficiary's lifetime is no longer available.
The entire inherited IRA and all other retirement accounts must now be completely distributed within 10 years.
Consider what that could mean for your family.
Just as in the case of Dr. John and Rachel, your children may inherit these accounts while they are in their 50s or early 60s. Which, in most cases is during their highest-earning years.
If the inherited IRA is substantial, they will be thrust into the highest tax bracket.
This will impact income taxes on their regular salaries, investment income and other sources of income.
You have spent decades carefully accumulating your estate. However, without a thoughtful distribution strategy, your heirs may inherit both the account and a huge tax obligation.
That is rarely the legacy parents intend to leave.
A Beneficiary Form Is Not a Distribution Plan
One of the comments I have heard many times over the years is, "David, I have already taken care of my IRA. My spouse and children are listed as the beneficiaries."
Sure, that’s a good start, but I wouldn’t consider it a complete distribution plan.
Proper planning requires us to look beyond who receives the money and consider how efficiently those dollars can ultimately reach the people and causes we care about.
It also means considering what opportunities may be available during our own lifetime.
Depending on your circumstances, that might include:
- Evaluating Roth conversions,
- Finding a more productive use for RMDs you don’t need,
- Incorporating charitable planning, or
- Considering life insurance and other estate planning strategies that may help reposition taxable retirement wealth.
There is no single solution that is right for everyone.
Your age, income needs, tax situation, health, account balances, family circumstances and estate planning goals all matter.
The important thing is having a specific personalized strategy rather than simply accepting whatever happens by default.
Start With the End in Mind
Imagine spending 30 or 40 years carefully building a retirement account without ever asking how you will eventually get the money back out.
Yet that is essentially what many Americans do.
If you have substantial assets in traditional IRAs, 401(k)s, pensions or other qualified retirement accounts, ask yourself these important questions:
- How much of this money will I actually need?
- What could my future RMDs look like?
- How might those distributions affect my taxes?
- What happens when my children inherit the account?
- Are there charitable causes that I would like to help out?
- Are there decisions I can make today that could potentially create a better outcome?
Those are the questions, when truthfully answered can turn a retirement account into an actual retirement strategy!
Finish the Plan You Started
You worked hard to accumulate your retirement savings.
I believe the distribution side of the equation deserves just as much attention.
That is one of the reasons I recently updated my special report, “The Bombshell Battle Plan: How to Defend Against the IRS' Secret Weapon.”
In it, I take a closer look at the challenges surrounding qualified retirement accounts.
I also share strategies designed to help families think differently about RMDs, taxable retirement assets, retirement income, Roth conversions, income tax offsets and the wealth they ultimately leave behind.
One such strategy is found on page 22 of the report. It’s one of the strategies Dr. John and Rachel added to their estate.
It is called “The Perfect Conversion — The Roth on Steroids Strategy.”
With this tool, they used some of their inevitable RMD to fund a Joint and Survivor Life Insurance policy.
With their designed medically approved leveraged plan, they will create over $5,000,000 of TAX-FREE cash that their children can use it to pay the income taxes that will be due when they inherit the IRA.
Dr. John and Rachel also implemented “The IRA with a Twist Strategy,” described on pages 38-42 of the report.
This allows them to designate specific charities to receive a percentage of their IRA balance (if any is left) at the passing of the surviving spouse.
Since this move would disinherit their children, they plan to use some of the proceeds from the Joint and Survivor Life Insurance to replace the IRA asset that is gifted to the charities.
If a significant portion of your wealth is held in an IRA, 401(k) or another qualified retirement account, I encourage you to do what Dr. John and Rachel did.
You too can have us prepare a personalized Retirement Analysis for you. Click here to begin the road to proper planning. All Weiss Ratings Daily readers receive a $100 discount.
And if you’re ready to get started right away, you can download my newly updated Bombshell Battle Plan report today for just $19.95 and start to put some of those ideas into motion today.
You've already done the hard work of building your retirement nest egg.
Now make sure you have a thoughtful plan for what happens next to those dollars.
Live Well, Leave a Legacy!
David T. Phillips, CEO
Estate Planning Specialists
P.S. I want to help you spot a problem BEFORE it’s too late to do anything about it.
That is precisely why I wrote “The Bombshell Battle Plan: How to Defend Against the IRS’ Secret Weapon.”
The purpose of the report is not to promote a product or prescribe a one-size-fits-all solution.
Rather, it was designed to help retirees understand the challenges created by large, qualified retirement accounts, RMDs, inherited IRAs, and the SECURE Act.
More importantly, it introduces planning concepts that will help families preserve more of their hard-earned wealth for the people they love.
If a significant portion of your net worth is held inside IRAs, 401(k)s, 403(b)s, or other qualified retirement accounts, mastering these simple concepts now could be one of the most important planning decisions you can make.
