It’s all about the taxes.
That’s the key concept for retirement savers, especially since IRAs and 401(k)s are tax-deferred only — and not tax-free.
“These funds have not yet been taxed, so you need a plan to minimize these taxes [so you] you can keep more of your hard-earned retirement money,” Ed Slott, a certified public accountant in New York and an expert on IRAs, told Yahoo Finance. “It’s about what you keep.”
This planning has always been at the core of Slott’s retirement tax planning strategies. “Always pay taxes at the lowest rates,” Slott told Yahoo Finance. “People miss this crucial point and often pay much more tax in retirement – when you need the money most.”
Slott is the author of the new book “The Retirement Savings Time Bomb Ticks Louder: How to Avoid Unnecessary Tax Landmines, Defuse the Latest Threats to Your Retirement Savings, and Unleash Your Financial Freedom.” Here’s what he recently told Yahoo Finance about minimizing taxes in retirement, edited for length and clarity:
Read more: 3 ways retirees can save on taxes
Yes. Scary title for your new book, Ed. What is the pension savings bomb, why is it ticking louder?
The time bomb is the tax embedded in every tax-deferred traditional IRA and 401(k) account. I’m not talking about Roth IRAs and 401(k)s.
The reason I say it’s ticking louder – I always felt like it was ticking – but now it’s really loud is because at some point taxes are going to go up to pay for this country’s huge debts. People complain about taxes. But the top federal tax rate from 1946 through 1963 was 91%. In 1964 this dropped to just 77%. I was only 10 years old at the time, but I heard the whole country doing a happy dance. Look where we are today. The top rate is 37%.
Provisions in the 2017 Tax Cuts and Jobs Act (TCJA) that lowered individual tax rates are scheduled to expire on December 31, 2025, unless Congress decides to extend them. So you have less than two years to take advantage of the current rates before they possibly go up again.
What is the fundamental principle of all good tax planning?
Always pay taxes at the lowest rates. People don’t do it because they don’t want to pay taxes before they have to. So the idea of switching to a Roth IRA bothers them. The way I see it, you have to use these two years to get money out of those taxable accounts. Start trimming those IRA balances while you can take them out at the lowest rates and move them away from the IRS and into what I call tax-free territory in a Roth account.
What is the biggest threat to retirement dreams?
Future taxes. I am concerned about the increase in tax rates for retirees.
Can you explain savings protection versus investing?
I view retirement as a football game. The football game can easily be divided into the first half and the second half. The first half is the accumulation phase. Everyone is familiar with that. That’s when you do all your work. You build, you save, you invest, you sacrifice to have more.
The problem is that when most people reach halftime, they think it’s the end of the game. They come in and say, ‘Ed, I’m retired. Look how much I have saved for retirement.” They think the game is over. Meanwhile, the IRS comes out to play in the third and fourth quarters. They don’t play anyone, so they win. Investing and saving is the first half, but protecting that money is the second half.
For most people, their largest asset, other than perhaps their home, is their IRA and 401(k) account, and those are loaded with taxes. So it’s the second half of the match that counts. Many games are won or lost in the last five seconds of the game by a kick as time runs out. It’s the same here.
You could really screw up in the second half of the game by paying large amounts of taxes, excessive and unnecessary taxes, or losing due to unnecessary penalties, or not knowing simple rollover rules or early distribution rules.
The stock market is booming and retirement savers are happy. Isn’t that a good thing for pension savers?
That’s more money that you’re going to hand over to Uncle Sam at some point. Remember, much of your IRA or 401(k) isn’t yours. It has a mortgage on it, like a mortgage on a house, a debt owed directly to the government. Most people should probably stop contributing to traditional 401(k)s and IRAs and go for Roth 401(k)s or Roth IRAs.
Customers constantly tell me: ‘When I retire, I will end up in a lower bracket because I no longer have an income.’ They are missing the point that if they do nothing, the IRA will continue to grow. And at 73, the new required minimum age for distribution, they will be forced to take it out.
What is the biggest mistake people make in distribution planning?
Do not take out any more when the interest rate is lower, out of short-sightedness. You have to look at the long term and pay taxes. If you can get it at low rates, that’s really the secret. But people don’t do it, because who wants to pay taxes first, you absolutely have to do that. But if you don’t, you will be forced to do so at age 73. You want your plan, not the government’s plan, when your options fall by the wayside.
It pays to start receiving benefits before you need to to take advantage of these low rates. Do a Roth conversion, or put it into some kind of tax-free vehicle, like life insurance. Once you put that money into tax-free vehicles, they grow and compound for you.
What is the best option for most people when they retire?, or do they move to another job when it comes to their employer-provided retirement account?
It’s generally the IRA rollover. But there are other options. You can keep it in your 401(k), or roll it over to a new company’s 401(k) plan when you get a new job, or take a lump sum distribution. The IRA rollover gives you the most control.
What are your best tips for people making mandatory minimum distributions this year?
Invest it. There’s no reason why you need to spend it unless you need it for living expenses, and you can withdraw more than necessary and spread the taxes over more years from these low bracket amounts.
Once you’re in RMD territory, you have to take that RMD, and it can’t be converted to a Roth IRA. So take the RMD and then take a little bit more, if you can, and convert that portion. The idea is to get that taxable IRA balance as low as possible. Because if it just builds, you get these taxes.
Can you talk about the idea of charitable giving and your RMD?
Your RMD is your best asset to give to charity. Take advantage of the Qualified Charitable Distribution (QCD). Give the charity your taxable bills. The charity does not pay taxes.
Some people have favorite causes or charities or want to give to their alma mater. You should make do with taxable IRAs. And one of the best ways to do that is with a direct transfer from your IRA to charity.
The QCD is available to IRA holders who are age 70 ½ or older at the time of distribution, according to IRS rules. You can donate up to $105,000 total to one or more charities directly from a taxable IRA. That would be a reason to roll over to your IRA and not keep it in your employer’s plan, because you can’t do a QCD from an employer plan like a 401(k).
You spend it tax-free and give it to charity, something you would have done anyway. It’s a great way to take money out of your IRA and fulfill your charitable intent. And if you do it correctly, with the timing of it, it can offset your RMD.
One caveat: I would only do it if you are already giving. I never say: give to charity for a tax benefit.
Kerry Hannon is a senior columnist at Yahoo Finance. She is a career and retirement strategist and author of fourteen books, including ‘In control at 50+: how to succeed in the new world of work” and “Never too old to get rich.” Follow her on X @kerryhannon.
Click here for the latest personal finance news to help you with investing, paying off debt, buying a home, retirement and more
Read the latest financial and business news from Yahoo Finances
