“I recently performed a portfolio review for one of our new clients. He and his wife both turn 72 this year, which means they’re required to start taking minimum distributions from their IRAs. Their case is an example of one of those classic good news and bad news situations.
The good news is that they’ve done very well with their investments in stocks, retirement accounts, and real estate. So good, in fact, that they haven’t needed to touch their IRAs since retiring over 12 years ago. As a result, their IRAs have nearly quadrupled in value.
The bad news is that this year they fall under the IRS regulation that requires them to begin what’s called “Required Minimum Distributions” (RMD) from their retirement accounts. They must take these distributions or pay substantial penalties even though they don’t need the money. The distributions are taxable income. This moves them into a higher income tax bracket on all their income.
Unfortunately, their previous financial advisory firm could have recommended several financial strategies that would have helped minimize the impact of the RMDs. But for this couple, it’s too late for those strategies to have much effect. Let’s look at 3 things they could have done, and maybe you can do to avoid their situation.
First, let’s distinguish between the fundamental aspects of a Traditional IRA and a Roth IRA.
- Traditional IRA
- With a few exceptions, contributions are tax-deductible.
- Accumulations are tax-deferred – that’s deferred, not tax-free.
- If you have earned income, you can make annual contributions up to $6,000 if you’re under age 50 or $7,000 if you’re over age 50.
- Penalty-free withdrawals/distributions may not begin until age 59 ½. (There are a few exceptions to this; so, consult your tax adviser first.)
- Required distributions must begin in the year you turn 72.
- The distributions are taxable as ordinary income and added to all other income, including Social Security, for determining your tax rate.
- Roth IRA
- Contributions are made with aftertax income.
- You can make annual contributions up to $6,000 if you’re under age 50 or $7,000 if you’re over age 50. (This is subject to some income restrictions; so, consult your tax adviser first.)
- Accumulations are tax-free – that’s tax-free, not tax-deferred.
- You can make penalty-free, tax-free withdrawals beginning at age 59 ½.
- You are not required to take distributions at any age.
At empiriKal partners, llc ©, we seldom recommend that our clients make investment decisions based solely on tax considerations. Yes, it’s a consideration, but investments should be based primarily on anticipated return on investment (ROI). However, when it comes to retirement planning, it’s all about taxes. Ultimately, choices between Roth and Traditional IRAs are about controlling your tax rate. The best time to control your tax rate is when you have full control over your income. This is especially applicable for business owners because, as the owner, you can determine your income.
Here are 3 things my new clients could have done, and you should consider doing to minimize tax consequences in your retirement years.
- While you’re still working and earning an income, before retirement, contribute to both a Traditional and a Roth IRA. If you can afford to contribute to both, do so. However, in low-income years, favor contributing to a Roth because your tax rate will be lower, and your after-tax dollars will go further.
- When you reach Social Security age, if you don’t need the income, consider deferring it. This will accomplish two things. Your monthly Social Security benefit will increase for every year you delay starting. And since up to 85% of Social Security is taxable (based on your income), this will reduce your taxable income.
- Because many people (especially business owners) find that their taxable income is higher when they retire, after you’re 59 ½, consider rolling over your Traditional IRA. You’ll pay taxes at your current tax rate, which may be lower than later – especially if you start taking Social Security. However, when you take distributions from your Roth IRA, they’re not taxable. Always check with your tax adviser for any exceptions or limitations.
There are full-service investment advisors who are willing to accept accounts for both large and small investors. At empiriKal partners, llc ©, we’re geared to help all ATRA members, regardless of their stage of life or portfolio size.
Let us help you rather than going it alone. If you already have an investment advisor, congratulations. However, if you’d like to learn more about what investment advisors do for their clients, please feel free to reach out to me at empirKalpartners.com for an individual assessment.
Edward Vela is an Investment Advisor and Estate Planning Specialist at empiriKal partners, llc ©, with 13 years of wealth management experience. He earned a Journalism Certification from the University of Massachusetts, a BA in Political Science, a Financial Planning Certification at UCLA, and an Executive MBA from the UCLA Anderson School of Management. You can contact Edward at 925-300-8805 or email edward@empiriKalpartners.com.
Investing involves risks, and investment decisions should be based on your own goals, time horizon, and risk tolerance. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. Past performance does not guarantee future results.
The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and content provided are for general information. This is not a solicitation for the purchase or sale of any security.