Retirement Income Strategies
December 05, 2019
By Heidi Huiskamp, Founder and CEO of Huiskamp Collins Investments, LLC
Every week, I hear people complain about taxes. Nobody likes paying them, but the reality is that we are currently enjoying a period of historically low tax rates. Some families were dismayed when they had to write a check for 2018 taxes rather than receiving their usual refund, but that’s because employers generally withheld less from wages and employees saw bigger “take-home” paychecks. Look around you: if you’re a “Boomer,” you and your contemporaries are retiring at a rate of 10,000 per day and driving up the absolute number of U.S. citizens who will be eligible for Social Security and Medicare benefits. Sure, you paid into those systems, but with low interest rates (lower returns on those trust funds needed to pay future benefits) and greatly increased life expectancies (longer time frames to receive benefits), chances are that we will all draw more in Social Security and Medicare benefits than the actuaries ever expected. It’s political suicide to say so, but Social Security and Medicare are the biggest entitlements we have and are only going to grow until paying those bills becomes unsustainable. The Heritage Foundation recently estimated that at current tax rates and current expenditures on all entitlements and just servicing our national debt, tax revenues will be exhausted by 2030. That’s only 10 years away! It’s all a big math problem and there’s only one way to solve it: taxes are going to have to increase.
Since very few retirees will receive a pension, most individuals will fund their retirement with a mix of Social Security benefits, liquidations and/or income thrown off from taxable accounts and income taken from IRAs or 401(k)/403(b) Plans rolled into IRAs. If your company retirement plan was built-up “pre-tax,” the balance will be rolled into a Traditional IRA and your distributions will be fully taxable at your ordinary tax rate. Some retirees will not need to tap their retirement plan benefits right away during retirement for living expenses, but distributions must begin at age 70-1/2. Note, too, that Traditional IRA account balances transferred to beneficiaries upon the death of the saver will be taxable to that beneficiary or beneficiaries. As noted above, a case can be made that those tax rates in question could be higher than tax rates today.
I’m only 56 years old and want to work well into my 70s, but I have already started tax and estate planning based on my belief that my future tax rates in retirement and the tax rates of my heirs may be higher than they are today. Through a strategy of Roth IRA Conversions, I am systematically setting myself up to transition my taxable retirement assets to non-taxable retirement assets which I can access for income needs later and then leave as tax-free assets to my heirs. By choosing to pay taxes on assets now at historically low rates, I am attempting to shield myself against any future rate increases.
How does a Roth IRA Conversion work? It’s easy! If you currently have a Traditional IRA, you’ll need to set up a Roth IRA and just do a bit of paperwork. I transfer assets every January from my Traditional IRA to my Roth IRA in order to get maximum tax-free growth potential throughout the year and then pay quarterly estimates to the IRS for the amount of my tax liability that is reflective of the transfer. Again, the applicable tax rate is my ordinary tax rate. My goal is to have all “pre-tax” IRA assets transferred to my Roth account well before I turn 70-1/2 and avoid Required Minimum Distributions and the resulting taxes altogether. By choosing to pay taxes now, I hope to enjoy many more years of “tax-free” growth of my assets in my Roth account. Please note, too, that if you made any nondeductible contributions to your Traditional IRA, that part of your conversion will be tax-free.
There is no age limit or dollar amount maximum to a Roth conversion. As long as you have the means to pay the necessary taxes, you can convert as much or as little of your Traditional IRA to your Roth IRA in a given year as you wish. It’s best to pay the taxes with taxable assets, though. Taking tax-free distributions from your Roth IRA to pay taxes defeats the strategy of leaving those dollars to grow tax-free as long as possible.
If you are over 65 and receiving Social Security benefits, you can benefit from a Roth conversion, but you need to be strategic. In 2019, if your Adjusted Gross Income (AGI) is over $ 85,000 for an individual or $170,000 for married couples filing jointly, you will pay a Medicare high income surcharge and you may increase the portion of your Social Security benefits subject to taxes. If you’re anywhere close to one of these thresholds, pay attention to the top of your applicable tax bracket and only convert a portion of your Traditional IRA that will not cause your to exceed the AGI subject to the threshold or throw you into a higher tax bracket. Your investment and tax professionals can help with this.
Do you have more questions about retirement income strategies or investing in general? I’d love to help! Please call me at 563-949-4705 or email me at email@example.com.
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