How to Maximize Your Retirement Income and Minimize Taxes

Is there a way to maximize your IRA wealth and minimize the tax you pay? Yes, with a ROTH IRA! ROTH contributions are after-tax dollars, and the withdrawals are tax free. A ROTH conversion strategy when well planned, increases your IRA wealth, and, therefore, your retirement income, and decreases your tax bill over the long term.

There are key issues to consider for the most tax efficient way to grow your IRA wealth. As noted by a nationally recognized financial planner, Michael Kitces, the question – to convert or not to convert a ROTH, in essence, is a tax equivalency question. The analysis must include a comparison of the taxpayer’s present and future tax rates.

The important question is this: will your average income tax rate remain the same, increase, or decrease in the future?

a) In general, the ROTH IRA is more tax efficient than the traditional IRA when your income tax rate is expected to be the same in the future because of the impact of future inflation on IRA withdrawals.

b) If your income tax rate is expected to be higher in the future, you will save significant taxes on a ROTH conversion strategy. Why? With a conversion strategy, you pay the tax upfront on the conversion and take tax free distributions in the future. For example, if one’s tax rate today is 22%, for married filing jointly taxpayers with income of $80,000, your future expected tax rate is 25% when you retire in twenty years, and your withdrawals will be $4000 per month for twenty years, you will save 12% in tax or $1440 annually in your retirement years. Presuming a modest investment growth rate of 5% per year, your tax savings realistically will be $50,000!! You may be wondering how this is possible. You are effectively paying lower rates now than what you would pay in the future. The new income tax law has lowered income tax rates for many taxpayers. In 2018, the current reduced income tax rates are set to expire in 2025. If you believe that there is a high likelihood that income tax rate will rise in the near future, it is best to plan for that now.

c) If you expect your tax rate will be lower in the future, you would be best served by remaining with your regular IRA; you will pay lower tax in the future when you withdraw from the regular IRA compared to a ROTH.

The IRA and ROTH comparison should also include the potential impact of the Net Investment Income Tax (NIIT) and the Alternative Minimum Tax (AMT).

For married filing jointly taxpayers, the NIIT is charged when their adjusted gross income (AGI) is in excess of $250,000. The AGI includes all income including tax exempt income before including itemized deductions.

To determine whether the AMT will impact to you, calculate both the regular tax and the potential AMT tax. The AMT tax computation has changed with the new tax law for 2018.

With a ROTH conversion analysis, it is best to review your strategy on an annual basis and compare it to the tax savings over your lifetime. If your conversion(s) would bump you up to a higher tax bracket, it would better to convert to ROTH IRA over several years rather than in a single year. The lifetime tax savings calculation can be estimated with conservative assumptions as noted earlier in this article.

The wealth you create also depends on how you are investing in a ROTH versus a traditional IRA. It is important to consider investing in equity type of investments (common stocks or investments that hold stocks) in a ROTH IRA account, because the account will grow tax free and the withdrawals will be tax free!

Many equity investments grow significantly in value over time including providing annual dividends to the investors:

In a ROTH IRA account, if you are 59 ½ years or older, in most cases, you do not pay any income tax on your distributions.

AND there are substantial estate planning benefits. Your heirs are not taxed on their distributions when they inherit the ROTH. If you have legacy goals, it is best to leave the most tax efficient assets for your loved ones. A ROTH IRA legacy gift eliminates the income tax your heirs will pay upon your passing and into the future.

Keep in mind inherited ROTH IRAs require minimum distributions based on the value of the account and the life expectancy of your heir.

With a regular IRA, since you will be paying ordinary income taxes, not capital gains taxes, on your withdrawals, consider investing in interest producing investments like bonds and keep equity investments in a taxable account to minimize your after-tax growth when you take withdrawals. Equity investments in a taxable account, if held over twelve months, will be taxed when sold at a lower tax rate of 15% for many taxpayers.

Wealth planning involves many decisions including income tax benefits depending on how your investments are held, be they in taxable accounts, regular IRA, or ROTH IRA accounts. The wealth that ROTH accounts can build is awesome and minimizes the tax you pay along the way.

We welcome your comments on this topic and offer a complimentary meeting to discuss your questions on these important tax and wealth management plans.

An Important Message

While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents. Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general educational information only.