Tax Minimization Strategies
At Decker Retirement Planning, one of the most important things we do for people, who are close to retirement or currently retired, especially for those who are 70 or younger, is incorporate tax minimization strategies that can literally save them thousands and thousands of dollars.
We’re not CPAs, but we’ve seen a lot. We’ve developed checklists as well as proprietary algorithms to help our clients implement tax-advantaged retirement planning techniques.
Dividend and Interest Income on Lines 8 and 9
As part of our tax-efficient analysis, the first thing we do is a line-item review, specifically lines eight and nine on your tax return, which show your dividends and interest, including dividends re-invested within your mutual funds. (This is money you never see but you pay taxes on.) We try to fix this inefficiency by either re-purchasing those mutual funds with other types of retirement accounts or by turning the spigot on so you’re actually receiving the income and spending it.
Granted, this is not huge for some people, but a lot of people have dividend re-investment strategies within their mutual funds, sometimes as much as $6-7,000 on lines eight and nine. That’s a couple of thousand dollars in taxes we can avoid for clients every year. Any good advisor should do this for you.
Required Minimum Distributions
Many people still don’t understand how RMDs (Required Minimum Distributions) work and how much RMDs can cost them in terms of taxation. Starting at age 70.5, anyone who has tax-deferred, qualified retirement accounts like traditional IRAs, 401(k)s, 403bs, 457b, SEPs, etc., must begin drawing money out of these accounts and paying income taxes on it, whether they need the money or not.
These funds must be withdrawn, not by April 15, but by midnight of December 31st each year or be subject to taxes due plus a 50% penalty. You must draw precise percentages out of different types of accounts based on IRS rules, and the calculations are not always simple, especially if your holdings are numerous or complex.
We’ve seen too many people with an investment portfolio pie chart come in and be backed into a corner by RMDs that they never fully understood. As a fiduciary, we help our clients organize their assets, so they can minimize their income taxes due, taking responsibility for RMDs to the point where, if there’s a mistake and a client owes a penalty, we pay it, not them. At Decker Retirement Planning, we want RMDs off the table as an anxiety item for retirees.
Depending on when people start working with us, sometimes we can do what’s called Roth conversions, which can reduce taxes. If those aren’t possible or won’t help mathematically, we help ensure there’s not a big lump sum tax liability that lands in their portfolio the fourth quarter of every year. We will feather RMDs in as part of their spendable income throughout the year, so they don’t pay more taxes than they should.
The Retirement Plan Structure Itself
The only way to really figure out how to reduce taxes in retirement is to map out your entire retirement out by year—even down to the month. This isn’t a pie chart. It’s a spreadsheet; a spreadsheet based on math. We show people what their retirement actually looks like by creating a road map and a guide, which we both follow together through the decades of retirement, all the way up to age 100+. We have found that it’s priceless to most, especially since the number one fear in the United States among people over 55 is running out of money before you die.
So many things can go wrong if you don’t correctly map retirement. No one can look at a pie chart and tell how much money they can draw from their income for the rest of their life. You cannot chase a magic withdrawal rate and hope your retirement lasts.
Our approach was developed by Brian Decker, our firm’s founder. Your customized spreadsheet allows you to visually see how much money you can draw and from where. We show your optimized Social Security benefit. There are dozens of ways to file, and we will run the numbers for you. We have a column to show any rental income or any pension income you will receive, and we show your portfolio income for the rest of your life, along with a COLA (Cost of Living Adjustment). That’s all on the left side of the spreadsheet.
And all of this is minus taxes.
On the right side of your spreadsheet, we show the organization of your assets and how to draw income appropriately from those assets. There, you’ll see the different parts of your portfolio, including liquid, emergency cash—money set aside in cash (savings and checking) for unexpected life events like a car or roof repair. Because we’re math-based fiduciaries, we always look for the highest return, even when we don’t make a dime, because your best interests are our focus. We do the research and give you the names of multiple FDIC-insured banks that are paying today’s highest rates—2% as of this writing.
Laddered, Principal-Guaranteed* Accounts
Then, we show you your laddered principal-guaranteed* accounts. (*We use the highest guarantee in the world, which is a reserve guarantee.) Buckets one, two, and three are laddered, principal-guaranteed accounts that distribute income to you over the first 20 years of your retirement.
Drawing the first 20 years of your income from these principal-guaranteed accounts, rather than fluctuating accounts at risk in the stock market, is foundational for our clients, and this method allowed Brian Decker’s clients to sail through the 2008 recession without losing money.
As a math-based, pure fiduciary firm, we have a relationship with an actuary, who tells us on a regular basis, what the highest-return, net-of-fee, guaranteed-principal accounts are. As of this writing, bucket two intermediate accounts, which are 5 to 7 years out, are averaging over 6% and longer-term accounts over 7%, although we will always show much more conservative estimates on your spreadsheet.
In each bucket, we always optimize for taxes in retirement based on your unique situation because we choose from taxable as well as tax-free account options.
When our clients do choose to keep a portion of their portfolio in the market (bucket four), it’s for money they won’t need for another 20 years or that they want to leave to heirs. Even then, we use a two-sided strategy utilizing money-management algorithms designed to take advantage of both up and down markets. This method actually saw returns in 2008.
“It really bothers me that this is a surprise to so many people. For the last 20 years, the highest returning net-of-fee risk managers out there are all computer trend-following models designed to make money in both bear and bull markets. Our models have specific downside principal protection measures in place if the markets do rollover hard, like we thing they will in the next 18 months.”
-Brian Decker
Roth Conversions
For people that come in to us at around 55 to 60 years old, we have 10 to 15 years before RMDs kick in at age 70.5 to find ways to reduce their taxes in retirement. Roth conversions can save thousands of dollars in taxes, if they are done correctly using proper math.
Being proactive with IRA to Roth conversions, in our opinion, is the largest tax-saving strategy for most people in the United States.
For example, let’s say you have a qualified, tax-deferred retirement account, like an IRA, worth $350,000. If that grows at an average of 6% over 20 years, that’s $1.2 million. This is a very simple question: “Would you like to pay taxes on $350,000 or $1.2 million?” Because you really do have a choice.
A lot of people get confused thinking they can’t convert from an IRA to a Roth account because their income level is too high. But, this is not contributing, it is converting. There’s no income limitation on the amount you can convert from an IRA to a Roth. You will just have to pay income taxes when you convert it, so the calculations are critical. Your personal situation is also important, because Roth conversions are not always indicated. For instance, if you have health issues and your longevity is in question, we will have to do the math to see what your breakeven is.
In fact, at Decker Retirement Planning, we have actually built proprietary algorithms around this, to be able to calculate not only how much you should convert now, but also project out into each subsequent year, giving us a three-dimensional scope of the net tax results. We believe this ability is unique to our firm. We’re not just looking at some tax statements and winging it.
A lot of CPAs will always defer and default to waiting until you’re actually retired to do conversions, thinking your income is going to drop. But, for many of our clients, their income doesn’t drop. Some CPAs are never on board converting from an IRA to a Roth because they just don’t understand the kind of returns we get with our computer trend-following models.
A CPA might rightfully say that if you’re in the 24% tax bracket and you have portfolio returns averaging 6%, it will take four years to break even before you make any incremental gains on that account. But, the returns we’re getting using our two-sided strategy have been much higher.
Our clients have made money when the markets are down—sometimes over 10%. The most recent average annual return, for the 6 managers that we’re using, was over 16%, net of all fees. With returns like that, we can justify the IRA to Roth conversions, because the breakeven even at 24% tax bracket is about 18 months instead of 4 years. That allows our clients to receive the benefit of an IRA to Roth conversion even when most CPAs will insist that it doesn’t make sense.
Because Decker Retirement Planning is a math-based firm, we also know, to the dollar, how much each client should convert from an IRA to a Roth each year without raising their bracket. So, for example, if a client is in the 24% tax bracket and has room of about $70 – 80,000 before they bump their bracket based on that year’s AGI (Adjusted Gross Income) then we might convert approximately $60,000 in that tax year.
Note: One more thing to understand about IRA to Roth conversions is that we don’t do them into your laddered principal-guaranteed accounts because the rate of return is too low, and you’ll be taking the money too soon. A Roth account does three things. It grows tax-free, it distributes income back to you tax-free, and it passes to your beneficiaries tax-free. So, it’s a golden account, and we only use bucket-four risk money to do them.
Chances are that our clients, who are living longer than ever, and may spend 20 or 30 years+ in retirement, will see their tax rates go up in the future. This is a big deal. We want them to have that future money tax-free, if at all possible. Taxes in retirement can often be reduced—with proper planning.
