How to prevent taxes from skewing retirement horizons – San Francisco Bay Times
By Brandon Miller, CFP–
Every Waymo that passes makes me wonder when self-driving cars will become a reality. And what will they look like? If we won’t have accidents, will cars need bumpers, seat belts and airbags? And the mirrors? “Are the objects in the mirror closer than they appear” will they no longer make sense?
Even without convex mirrors distorting our perception, there are plenty of other illusions ready to trip us up. Take retirement account balances, for example. It’s great to see the numbers increase in your IRA and 401 (k), 403 (b) or other tax-deferred account, especially when the stock market has jumped during the pandemic, which makes you feel more secure. comfortable with a comfortable retirement.
But that big, beautiful number on your statement doesn’t reflect your giant IOU to Uncle Sam. A million dollar balance might only be worth $ 700,000 by the time you pay your tax bill. So, unlike the aforementioned mirror, your retirement horizon may be further away than it appears.
Before you complain about that tax bill, remember that this is the deal you made with the IRS when you opened your account. In exchange for the potential for faster growth from an initial tax break and paying no tax on the winnings when they are earned, you agreed to pay taxes at the rate that was in effect when you withdrew the money.
“Current rate” is the sticking point here. You might think you’ll be in a lower tax bracket when you retire, but honestly most people don’t want to lower their standard of living if they can afford not to. Plus, who knows what Congress will do with tax rates in the future?
Do not despair. We still have Roth accounts, one of my favorite financial planning tools. Unlike retirement accounts funded with money you haven’t paid taxes on yet, Roth accounts require you to pay taxes up front. Why would you do that? Let me count the ways.
The main reason is that Uncle Sam doesn’t ask for more after you pay the initial tax bill. Gains made on Roth accounts are tax free. In other words, every penny displayed in your Roth balance is yours.
Another advantage of Roth is the control of taxable income. This is important because the IRS requires you to start withdrawing money from traditional retirement accounts at age 72. The Minimum Distributions Required (RMD) are based on your account balance and cause you to reduce your IOU to Uncle Sam. The higher your balance, the more you are required to withdraw.
Withdrawals are considered taxable income, which determines how much tax you pay on Social Security income and what you owe for Medicare services. Depending on the amount of your RMD, you could go from less than $ 150 per month to over $ 500 per month for Medicare Part B (based on 2021 rates). That alone is a good reason to keep your taxable income under control.
Roth benefits are easy to obtain through membership fees and conversions. Contributions are fairly straightforward as you pay taxes before the money goes into the Roth account. Every $ 100 deposited may be as little as $ 70 now, but tax-free growth can quickly fill the gap.
Conversions can be a bit more like waxing, where you hate to do it but love the results. Paying your tax bill up front, all at once or over a period of several years, guarantees how much you will pay in taxes and lets you know to the penny how much you have for retirement.
To highlight this, let’s say you have a million cash accounts and a million in a traditional IRA. Converting the IRA to a Roth account could result in a tax bill of $ 300,000. Pay this bill from your cash accounts and the total amount of $ 1 million in your Roth account may continue to increase, tax free, I stress again. Yes, you have $ 300,000 less in cash. But your tax bill, which would have continued to increase with your traditional IRA account balance, no longer exists. This is the ultimate short term pain in financial planning and long term gain.
So, to recap: tax-free growth offers taxable income control and peace of mind. Do I need to say more about the beauty of Roth or the value of seeing your true net worth without distortion? This is something even Waymo’s fleet of camera-equipped cars cannot capture.
Brio does not provide tax or legal advice, and nothing contained in these documents should be taken as such. The opinions expressed in this article are for general information purposes only and are not intended to provide advice or recommendations specific to an individual or on any specific safety. It is only intended to provide education on the financial industry. To determine which investments might be right for you, consult your financial advisor before investing. The past performances discussed during this program do not constitute a guarantee of future results. All indices referenced for comparison purposes are unmanaged and cannot be invested directly. As always, remember that investing involves risk and possible loss of principal capital; please seek advice from a licensed professional.
Groupe Financier Brio is a registered investment advisor. Registration with the SEC does not constitute an endorsement of Brio by the SEC, nor does it indicate that Brio has reached any particular level of proficiency or ability. Advisory services are only offered to clients or potential clients when Brio Financial Group and its representatives are duly authorized or exempt from licensing. No advice can be given by Groupe Financier Brio unless a customer service agreement is in place.
Brandon Miller, CFP®, is a financial consultant with Brio Financial Group in San Francisco, specializing in helping LGBT individuals and families plan and achieve their financial goals.
Posted on December 2, 2021