It’s all about taxes.
This is the key concept for retirement savers, especially because IRAs and 401(k)s are only tax-deferred, not tax-exempt.
“These funds haven’t been taxed yet, so you need a plan to minimize those taxes (so you can) keep more of your hard-earned retirement money,” Ed Slott, a CPA at New York and IRA expert, told Yahoo Finance. “It’s what you keep that counts.”
This planning has always been at the heart of Slott’s retirement tax planning strategies. “Always pay taxes at the lowest rates,” Slott told Yahoo Finance. “People miss this tipping point and often end up paying a lot more tax in retirement, when they will need the money the most. »
Slott is the author of the new book “The Retirement Savings Time Bomb Ticks Harder: How to Avoid Unnecessary Tax Landmines, Defuse the Latest Threats to Your Retirement Savings, and Ignite Your Financial Freedom.” Here’s what he recently told Yahoo Finance about cutting taxes in retirement, edited for length and clarity:
Learn more: 3 ways retirees can save on their taxes
Yeah. Scary title of your new book, Ed. What is the retirement savings bomb, why is it ticking louder?
The ticking time bomb is the tax built into every traditional tax-deferred IRA and 401(k) account. I’m not talking about Roth IRAs and 401(k)s.
The reason I say the ticking is louder – I always felt like it was the ticking – but now it’s really louder is that at some point , taxes are increasing to pay for the enormous debt this country faces. People complain about taxes. But the top federal tax rate from 1946 to 1963 was 91 percent. In 1964, it was only 77%. I was only 10 years old then, but I heard that the whole country was dancing happily. Look where we are today. The maximum rate is 37%.
Provisions of the Tax Cuts and Jobs Act of 2017 (TCJA) that lowered individual tax rates are set to expire on December 31, 2025, unless Congress decides to extend them. You therefore have less than two years left to take advantage of current rates before they rise again.
What is the fundamental principle of all good tax planning?
Always pay taxes at the lowest rates. People don’t do it because they don’t want to pay taxes until they have to. So the idea of converting to a Roth IRA bothers them. In my opinion, you should use these two years to withdraw money from these taxable accounts. Start chipping away at those IRA balances while you can withdraw them at the lowest rates and move them away from the taxman and into what I call tax-free territory in a Roth account.
What is the biggest threat to retirement dreams?
Future taxes. I’m concerned about rising tax rates for retirees.
Can you explain the protection of savings versus investment?
I look at retirement like a football match. The football match is easily divided into first half and second half. The first half is the accumulation phase. Everybody knows it. That’s when you do all your work. You build, you save, you invest, you sacrifice to have more.
The problem is that most people, when they get to halftime, think it’s the end of the game. They’ll come in and say, “Ed, I’m retired. Look how much I’ve saved for retirement. They think the game is over. Meanwhile, IRS comes to play in the third and fourth quarters. They don’t play against anyone, so they win. Investing and saving is the first half, but protecting that money is the second half.
For most people, their largest asset, other than perhaps their home, is their IRA and 401(k) accounts, and those are tax-laden. So it’s the second half of the match that counts. Many matches are won or lost in the last five seconds of the game on a kick as time runs out. It’s the same thing here.
You could really screw it up in the second half of the game by paying large amounts of taxes, excessive and unnecessary taxes, or lose it due to unnecessary penalties, or by not knowing the simple rollover rules or distribution rules anticipated.
The stock market is booming and retirement savers are happy. Isn’t that a good thing for retirement savers?
That’s more money than you’re going to be paying Uncle Sam at any given time. Remember, much of your IRA or 401(k) isn’t yours. There is a mortgage on it, like a mortgage on a house, a debt owed directly to the government. Most people should probably stop contributing to traditional 401(k)s and IRAs and opt for Roth 401(k)s or Roth IRAs.
Clients tell me all the time: “When I retire, I will be in a lower bracket because I will have no income.” They don’t understand that if they don’t do anything, the IRA will continue to grow. And at 73, the new minimum age required for distribution, they will be forced to withdraw it.
What’s the biggest mistake people make when it comes to distribution planning?
Do not withdraw more when rates are lower, due to lack of vision. You have to have a long-term vision and pay taxes. If you can get it at low rates, that’s really the secret. But people don’t do it because anyone who wants to pay taxes before doing so is absolutely obliged to do so. However, if you don’t do this, you will be forced to do so at age 73. You want your plan, not the government’s, when your options are left out.
It is beneficial to take distributions before you are required to take advantage of these low rates. Do a Roth conversion or put it into some sort of tax-free vehicle like life insurance. As soon as you transfer these funds into tax-free vehicles, they increase and accumulate for you.
What is the best option for most people in retirement?, or they change jobs regarding their employer-provided retirement account?
This is usually the IRA rollover. But there are other options. You can keep it in your 401(k), or roll it over to a new company’s 401(k) plan if you get a new job, or take a lump-sum distribution. The rollover IRA gives you the most control.
What are your best tips for people who will take a required minimum distribution this year?
Invest it. No reason you have to spend it unless you need it for living expenses, and you can take out more than you need and start spreading the tax over several years from those low brackets.
Once you’re in RMD territory, you have to take that RMD, and that can’t be converted to a Roth IRA. So take the RMD, then take a little more, if you can, and convert that portion. The idea is to reduce the taxable IRA balance as low as possible. Because if it builds, you’re going to have these taxes.
Can you talk about the idea of charitable giving and your RMD?
Your RMD is your best asset to give to charity. Take advantage of Qualified Charitable Distribution (QCD). Donate your taxable accounts to the charity. The charity does not pay taxes.
Some people have favorite causes or charities or want to donate to their alma mater. You should do this with taxable IRAs. And one of the best ways to do this is to make a direct transfer from your IRA to a charity.
The QCD is available to IRA holders age 70 1⁄2 or older at the time of distribution, according to IRS rules. You can donate up to $105,000 total to one or more charities directly from a taxable IRA. This would be a reason to roll over to your IRA and not keep it in your employer plan, because you cannot do a QCD from an employer plan like a 401(k).
You get it tax free and you give it to charity, which you would have done anyway. This is a great way to withdraw money from your IRA and fulfill your charitable intention. Plus, if you do it right, with timing, it can offset your RMD.
One caveat: I would only do this if you are already donating. I never say give to charity for a tax break.
Kerry Hannon is a senior columnist at Yahoo Finance. She is a career and retirement strategist and author of 14 books, including “In control at 50 and over: how to succeed in the new world of work » and “Never too old to get rich.” Follow her on @kerryhannon.
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