Strategic Tax Planning For A Diversified Retirement Portfolio


Strategic Tax Planning For A Diversified Retirement Portfolio



“Two things are unavoidable in this world; death and taxes,” said Benjamin Franklin. America’s famous actor Will Rogers took the sentiment a step further when he said, “The difference between death and taxes is that death doesn’t get worse every time Congress meets!”

Rogers’ quip fairly sums up how we Americans feel about paying the government a portion of our hard-earned income – we don’t like it. It is, however, “unavoidable” – come April 15, we have to ante up to the IRS and our state’s department of revenue.

To make an impact on keeping these tax bills down, consider how you have your retirement investments allocated. There could be room for savings because where you put your money makes a difference in how it’s taxed. Through diversification and some informed tax strategies, you could potentially reduce the amount you have to shell out each year to Uncle Sam.

For a refresher, remember that most of your retirement accounts fall within three separate silos. First are your after-tax assets, such as money market accounts, mutual funds, and checking and savings accounts. Second, you have your pre-taxed assets – things like IRAs (including rollover, traditional, SIMPLE and SEPP), pensions and 401(k) plans. And third are your tax-free assets. Here we have items like Roth IRAs, 529 plans for college savings and some designated life insurance policies.

Now that we know the three different tax types of assets you may hold, let’s dive into how you could save on your tax bill through diversification of these holdings. It may seem daunting at first, but you could potentially reap significant benefits if you make an informed plan.

Let’s consider two examples – one with strategic tax planning for retirement, and one without this type of plan. For simplicity in our illustration, we’ll imagine our hypothetical couple isn’t receiving Social Security benefits since those are taxed differently and at different thresholds.

So, we have a couple who want to live on $100,000 per year during their retirement. To accomplish this, our couple will tap their accounts they have saved in the three tax silos. Our couple decides to draw $50,0000, or 50%, from their pre-taxed silo (meaning their 401(k)/IRA dollars) and $50,0000, or 50%, from their tax-free bucket.

For simple math purposes, the $50,000 from the pre-tax accounts is taxed at 12% (based on the 2018 married couples tax bracket), which results in a net income of $44,000. The remaining $50,000 from the tax-free accounts is taxed at 0% (if taken after age 59½, or following the rules of the vehicle, of course). Add the net amount of both withdrawals, and you get $94,000 in income.

Now, let’s have that same couple withdraw differently. This time, our couple decides to take the entire $100,000 from their pre-tax accounts – say, their 401(k) plans and rollover IRAs. Again, for simple math, let’s say they’re taxed at 22%. Their net income this time is $78,000, which is much lower than their income goal of $100,000. In essence, this strategy means the couple would have to draw more of their nest egg to get to their desired annual income.

Because this couple didn’t plan for tax implications, they lost a fair amount of their retirement income to tax collectors. Now, if they had spread withdrawals over our three silos, particularly to ones that were already or rarely taxed, they could have saved more of their income.

In the first scenario, our couple came out way ahead – they saved $16,000 in tax liability through strategic planning! If we take this difference each year and multiply it over a 25-year retirement lifespan, our couple could potentially accumulate another $400,000 in wealth. And not because they saved more, but because they smartly efficiently managed their assets for tax diversification.

Of course, many different factors can come into play in your unique scenario. The above is just a snapshot of how tax diversification and a blend of accounts can work for your bottom line and financial wellbeing.

In addition to these powerful strategies, I have some more good news. From what I see in my profession, the vast majority of retirees end up in a much lower overall tax bracket.

That’s because when you stop working, FICA (more commonly known as the tax we pay for Social Security) and Medicare taxes go away. These are huge taxes – about 7% or so on the first $132,900 that you earn per person.

This point is also true on the state level. In Georgia, for instance, a 65-year-old in the state gets a $65,000 deduction on their state income taxes. Plus, Social Security benefits aren’t taxed, and income from retirement accounts is only partially taxed.

What’s more, you have a chance to control your taxable income by controlling your IRA or other retirement account withdrawals. So, in large part, you get a say now in how much tax you’ll owe. Unless you have a large pension that you receive as part of your retirement income, your taxes could likely decrease during retirement.

To better understand your options and the power of tax diversification in your portfolio, consider working with an advisor to guide you through the maze of options. We’re always here to help and can assist you in finding the right fit for your retirement needs.

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This information is provided to you as a resource for informational purposes only and should not be viewed as investment advice or recommendations. Investing involves risk, including the possible loss of principal. There is no guarantee offered that investment return, yield, or performance will be achieved. There will be periods of performance fluctuations, including periods of negative returns. Past performance is not indicative of future results when considering any investment vehicle. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.


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