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Start Your Tax Efficient Distribution Planning Early

Financial Progress Notes

Start Your Tax Efficient Distribution Planning Early

One of the most important components of financial planning is how you manage your taxes. You make decisions with your budget, debt management, savings, investing, retirement plans, and real estate. Taxes are a consideration in all of these areas. 

The majority of your investing lives are likely  focused on how to accumulate retirement funds in the most tax advantaged manner possible.  Tax deferral is ingrained in everyone. The mantra has been “the higher the tax deduction the better.”  However, at some point there will be a need to access funds to live in retirement. Few retirement savers give as much thought to how to distribute their income.  If you are between the ages of 60 and 70, your distribution planning is even more crucial.  After age 70 you have to take out required minimum distributions. Our cash flow based system of planning may help to show you how to increase your net cash flow with tax efficient retirement distributions.

A complete financial plan should illustrate the type of accounts (i.e. taxable, tax-deferred, tax-free) to be distributed, how much money is to be taken from them, and the order they will be accessed. In addition, conversion possibilities should be reviewed to consider possible outcomes.  Tax-deferral can produce a substantial source of funds to withdraw, but all of it will be taxed as ordinary income. Depending on the tax rate environment in place when you are ready to retire, this could have a significant impact on your net retirement income.

One strategy is to convert portions of fully taxable IRAs and move them into Roth IRAs, where future growth and distributions can be accessed tax free. The major drawback here is paying taxes at ordinary income rates in the year of withdrawal. Roth IRAs also require a minimum age of 59 ½ and 5 tax years in from your first Roth contribution to access earnings tax free. However, there could be a window of opportunity to convert these funds at the beginning of retirement when tax brackets are frequently lower, but before accessing larger sums of fully taxable retirement funds after age 70.  The following graphic illustrations produced with financial planning software from RightCapital Inc. will help to give you a very clear view of this concept.


The Impact of Taxes in Retirement

Accessing Higher IRA Distributions Can Push Up Tax Brackets

Depending on your personal situation, there may be a number of low tax years to convert traditional IRAs to  tax-free Roth IRAs


Reduce Tax Liability Utilizing Roth Conversions

In this example, the blue area represents additional taxable income produced with withdrawn dollars from traditional IRAs. These funds are then deposited into tax-free Roth IRAs. With little earned income at retirement, taxable income is kept near the 15% bracket.

The numbers shown are not intended to be in any manner a predictive result, but  this concept may have the potential to produce greater levels of net retirement income over the life of a plan.   

* Proposed Strategy:  Comparison amount based on Case Study with multiple variables. Married couple, Initial ages 56 & 54, Retirement ages 65 & 65, Salary 200k & 100K, Social Security at 70 & 70, 10k mo. expense in retirement, Invested Assets at $1.5MM Qualified, $100k Non-Qualified, various asset allocations, comparing sequential withdrawal with conversion vs pro-rata withdrawal across account types without conversion, end of illustrated plan is last to reach age 92.


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