You can easily overfund your traditional retirement accounts without realizing you are creating tax problems down the line. Here are seven challenges, as well as planning strategies that can help.

Larger retirement account balances need to focus on lifetime wealth accumulation. Towards that end, taxes need to be planned not on a year-in and year-out basis but for lifetime impact. In short, you need to balance the current benefits of tax-deferred accounts against the tax liabilities those accounts will create in retirement.

Do you understand the compounding of your money and the negative compounding consequences of bad decisions? This is where modeling out the ideas can be most effective. Below are the seven challenges to discuss, including over-funding your traditional retirement accounts and the eleven planning strategies that can drive down taxes. 

What are the challenges?

1. Current tax rates are historically low. 
   • With the government in a “tax-and-spend” mode and income inequality becoming heavily politicized, you are vulnerable. Future tax rates will likely grow. And beware of the sunsetting of the TCJA (Tax Cut and Jobs Act) in 2025, when tax rates are due to increase without action by Congress.
2. Additional retirement contributions hurt, not help. 
   • You can create a problem with additional contributions to your retirement accounts. Tax liability continues to grow with continued growth of your retirement accounts, creating a perfect storm.
3. Policy risk has increased. 
   • The politicization of income and estate taxes and the pace of change has accelerated. A reconciliation bill only needs a majority vote, thereby creating planning challenges and policy uncertainty and instability.
4. Medicare IRMAA surcharges are a tax, and the costs add up. 
   • Medicare imposes surcharges on higher-income beneficiaries. The theory is that higher-income beneficiaries can afford to pay more for their healthcare. Instead of doing a 25:75 split with the government, they must pay a higher share of the program costs.
   • The surcharge is called IRMAA, which stands for Income-Related Monthly Adjustment Amount.
   • According to the Medicare Trustees Report, 8% of Medicare Part B and Part D beneficiaries paid IRMAA. The extra premiums they paid lowered the government’s share of the total Part B and Part D expenses by two percentage points.
   • The income used to determine IRMAA is your AGI plus Muni bond interest from two years ago. Your 2020 income determines your IRMAA in 2022. Your 2021 income determines your IRMAA in 2023. Your 2022 income determines your IRMAA in 2024. The untaxed Social Security benefits aren’t included in the income for determining IRMAA.
5. The widow’s penalty exacerbates the problem. 
   • When a surviving spouse moves out of the Married Filing Jointly into the Single tax bracket, tax rates are increased by about 10% and, total annual Medicare payments often stay the same or increase, despite the fact that now only one person is covered instead of two.
6. Beware of the 10-year rule for Inherited IRAs. 
   • The Setting Every Community Up for Retirement Enhancement (SECURE) Act requires a 10-year distribution period instead of the lifetime “stretch” that was previously allowed. Instead of having your lifetime to take money, new heirs after 2020 must take taxable required minimum distributions annually for 10 years, pushing them into the highest tax brackets, likely during their highest earnings years.
7. New Secure ACT 2.0 legislation. Secure Act 2.0 was recently passed on December 29^th, 2022, which has had a significant impact on retirement laws. Some of the featured changes include:

• Increased RMD (required minimum distribution) age to 73 if you turn 72 this year and 75 if you were born after 1960. The age was previously 72.
• RMD penalty decrease from 50% to 25%, and further to 10% if the missed RMD is taken and the owner files an updated tax return
• 529 plan rollovers into Roth IRAs if held for at least 15 years
• And more!

If you want to read about more of the changes that came as a result of Secure ACT 2.0, please head over to our blog post where we cover the main topics in more detail. 

What planning strategies can help?

Think of these planning strategies as pieces of a puzzle that you can put together to benefit your tax situation. You may not use all of these strategies, but it is up to you, us, and your CPA to determine what combination makes the most sense.

1. Review benefits plans and strongly consider Roth 401(k)s for all future contributions. 
   • Employer benefits plans are chock full of nuggets such as Roth 401(k), after-tax accounts, daily conversions of after-tax accounts, ESPP, and deferred compensation options, among other attractive investment options. It is important to employ Roth 401(k)s in place of traditional 401(k)s  if you expect to be in a high tax bracket during retirement or are accumulating wealth (particularly in traditional retirement accounts).
2. Create tax diversification. 
   • Shift investments from pre-tax to taxable or Roth accounts, so you have options when it is time to withdraw monies.
3. Backdoor Roth conversions. 
   • Up to $7,500 per year per person 50 years and older ($6,500 for those under 50), but be aware of the pro-rata taxes that are due on the conversion amount.
   • A "backdoor Roth IRA" is a type of conversion that allows people with high incomes to fund a Roth despite IRS income limits. Basically, you put money you've already paid taxes on in a traditional IRA, then convert your contributed funds into a Roth IRA and you're done
4. Health Savings Accounts. 
   • Invest up to $7,750 if married filing jointly; invest aggressively now and withdraw decades from now for medical expenses.
   • A Health Savings Account (HSA) is a tax-advantaged account created for or by individuals covered under high deductible plans (HDHPs) to save for qualified medical expenses. Contributions are made into the account by the individual or their employer and are limited to a maximum amount each year. The contributions are invested over time and can be used to pay for qualified medical expenses, such as medical, dental, and vision care, as well as prescription drugs. If used for qualified medical expenses, the withdrawals are tax-free.
5. Tax-loss harvesting and gain harvesting. 
   • The unsung heroes of tax planning, this is a year-round activity, not just for year-end. Consider tax-loss harvesting during market events or when selling at a gain. 
   • What Is Tax-Loss Harvesting? Tax-loss harvesting is the timely selling of securities at a loss in order to offset the amount of capital gains tax due on the sale of other securities at a profit.
   • This strategy is most often used to limit the amount of taxes due on short-term capital gains, which are generally taxed at a higher rate than long-term capital gains. However, the method may also offset long-term capital gains.
   • This strategy can help preserve the value of the investor’s portfolio while reducing the cost of capital gains taxes.
   • There is a $3,000 limit on the amount of capital losses that a federal taxpayer can deduct in a single tax year. However, Internal Revenue Service (IRS) rules allow additional losses to be carried forward into the following tax years.
6. Asset location. 
   • Place slower growth or income-yielding investments in tax-deferred accounts and faster growth items into Roth IRA accounts. Buy-and-hold investments go into taxable accounts.
7. Roth conversions. 
   • One of the most effective tools, partial or full Roth Conversions, are used to minimize lifetime taxes and maximize lifetime wealth. Roth accounts also help to keep taxable income down, which increases other deductions and decreases Medicare IRMAA surcharges, among other benefits.
8. Use it or lose it. 
   • Alter distribution strategy by taking money from tax-deferred accounts in earlier and low tax years, taking advantage of lower tax brackets.
9. Qualified Charitable Distributions. 
   • QCDs make sense for all charitably inclined clients who are 70½ or over.
   • A qualified charitable distribution (QCD) allows individuals who are 70½ years old or older to donate up to $100,000 to one or more charities directly from a taxable or regular IRA instead of taking their required minimum distributions. As a result, donors may avoid being pushed into higher income tax brackets and prevent phaseouts of other tax deductions, though there are some other limitations.
10. Consider estate planning, trusts and legacy planning. 
    • Particularly now that Congress is threatening to do away with popular estate planning strategies and where the TCJA is due to sunset in 2025 (possibly decreasing the lifetime exclusion down to $5 million plus inflation).
11. Bunch itemized deductions in one year to exceed the standard deduction. 
    • Consider making more charitable deductions in one year if it brings you above the standard deduction of $27,700 for married couple or $13,850 for single filers. Another example is paying both property tax bills for your house before the year end.

The idea here is quite basic. It is not simply about deferring taxes. It is about paying less lifetime taxes for this generation and future generations. Let’s make an appointment to discuss this further.

As always, we are available for you if you have any questions.

Best Regards,

Your SVWA Team