Retirement tax planning requires more than minimizing this year’s taxes. Learn how Roth conversions, inherited IRAs, and charitable giving can affect your lifetime tax strategy.
https://youtu.be/iANLKaHoBqw
One of the biggest financial mistakes you make in retirement might have nothing to do with your investments.
You could follow the tax rules correctly, file every return on time, avoid penalties, and still end up paying more in taxes than you needed to over the course of your retirement.
I’ve been a financial advisor for more than two decades, and many of the tax questions I hear start with the same concern: What does the IRS require me to do?
That’s an important question. You certainly want to understand the rules. But following the rules doesn’t necessarily tell you which decision is best for your retirement.
The better question is often: How will the decision I make this year affect my taxes five, 10, or 20 years from now?
Three recent listener questions illustrate why that distinction matters.
Question #1: Does a Roth Conversion Start a New Five-Year Clock?
“I’ve had a Roth IRA for more than 20 years, but I recently did my first Roth conversion. Does this conversion start a brand new five year clock or am I already covered because I’ve had a Roth IRA for so long now?”
The confusing part of this question is that there isn’t just one Roth IRA five-year rule.
There are two different five-year rules to consider, and they apply to different types of money.
The first applies to earnings. I referenced IRA expert Ed Slott’s description of this as the “five-year forever” rule. Once the Roth IRA has met that five-year requirement and you’re over age 59½, the earnings can come out tax-free.
Conversions work differently.
If you’re under 59½, each Roth conversion has its own five-year clock associated with taking those converted funds back out without the 10% penalty. That clock begins with the tax year of the conversion. Once you’re 59½, that particular conversion rule is no longer an issue in the same way.
It also helps to understand the order in which Roth IRA distributions are treated:
- Contributions come out first.
- Conversions come out next.
- Earnings come out last.
Those distinctions matter if you expect to withdraw money from the Roth IRA relatively soon. They can also be one reason to establish a Roth IRA earlier rather than waiting until immediately before you expect to use it.
The larger planning lesson is that “the five-year rule” isn’t specific enough. You need to know which five-year rule applies, what type of Roth money you’re withdrawing, and your age when you withdraw it.
Question #2: Should I Take More Than the Minimum From an Inherited IRA?
“I inherited an IRA from my mom. Should I just take the required minimum distribution each year, or would it ever make sense to take more than I have to?”
This is where following the minimum requirement can be very different from developing a tax strategy.
Under the situation described by the listener, required minimum distributions may need to continue, while the inherited IRA is also subject to the 10-year rule. That can create a temptation to simply take the minimum amount each year and deal with whatever remains later.
But “minimum” tells you what you have to take. It doesn’t necessarily tell you what you should take.
Imagine you’re currently in a relatively low-income tax year. Intentionally distributing more from the inherited IRA could allow you to recognize that taxable income while your tax situation is more favorable.
Now consider the opposite situation. Perhaps you’re currently in a high-income year, but you expect your income to decline soon. Taking only what’s required today may make more sense.
The important point is that you can’t evaluate the decision by looking at this year’s tax return alone.
You need to project forward.
If you leave a large balance until the end of the 10-year period and that final distribution happens to coincide with retirement, a business sale, a large bonus, or another high-income event, you may have created a much larger tax problem simply by postponing the decision.
That’s why tax projections are part of Step 3 of my Retirement Master Plan process. I want to identify potentially lower-tax years ahead of time and evaluate whether intentionally recognizing income during those years could improve the overall plan.
Question #3: Can I Make a Qualified Charitable Distribution From an Inherited IRA?
“Can I make qualified charitable distributions directly from an inherited IRA or does it only work for my own IRA?”
For someone who meets the age requirements described in the transcript, qualified charitable distributions can be made from an inherited traditional IRA as well as from your own traditional IRA.
A qualified charitable distribution, or QCD, sends money directly from the IRA to an eligible charity.
You don’t receive a charitable deduction for that distribution, but the amount doesn’t show up as income on your tax return. As I explained in answering the listener’s question, that distinction can matter because income can affect other areas of your retirement finances, including how Social Security is taxed and Medicare IRMAA surcharges.
A QCD from an inherited IRA can also count toward applicable required distributions.
For someone who is already charitably inclined and meets the requirements, that can make the QCD more than a charitable giving decision. It becomes another piece of the retirement tax strategy.
Don’t Plan Your Retirement Taxes One Year at a Time
Roth conversions, inherited IRA distributions, and charitable giving can sound like three unrelated subjects.
They’re connected by the same planning principle.
Your objective shouldn’t simply be to pay the least amount of tax possible this year. You need to consider your lifetime tax bill.
There may be years when intentionally recognizing more taxable income makes sense because of what you expect in the future. There may be other years when postponing income is the better decision. The important thing is to make those choices intentionally rather than automatically choosing whatever produces the smallest tax bill today.
That’s why I believe good retirement tax planning requires looking beyond the current tax return.
Following the rules keeps you compliant.
Planning ahead helps you decide how to use those rules as part of your retirement strategy.
Don’t forget to leave a rating for the “Retire Today” podcast if you’ve been enjoying these episodes!
Subscribe to Retire Today to get new episodes every Wednesday.
Apple Podcasts: https://podcasts.apple.com/us/podcast/retire-today/id1488769337
Spotify Podcasts: https://bit.ly/RetireTodaySpotify
About the Author:
Jeremy Keil, CFP®, CFA is a retirement financial advisor with Keil Financial Partners, author of Retire Today: Create Your Retirement Income Plan in 5 Simple Steps, and host of the Retirement Today blog and podcast, as well as the Mr. Retirement YouTube channel.
Jeremy is a contributor to Kiplinger and is frequently cited in publications like the Wall Street Journal and New York Times.
Additional Links:
Connect With Jeremy Keil:
Media Disclosures:
Disclosures
This media is provided for informational and educational purposes only and does not consider the investment objectives, financial situation, or particular needs of any consumer. Nothing in this program should be construed as investment, legal, or tax advice, nor as a recommendation to buy, sell, or hold any security or to adopt any investment strategy.
The views and opinions expressed are those of the host and any guest, current as of the date of recording, and may change without notice as market, political or economic conditions evolve. All investments involve risk, including the possible loss of principal. Past performance is no guarantee of future results.
Legal & Tax Disclosure
Consumers should consult their own qualified attorney, CPA, or other professional advisor regarding their specific legal and tax situations.
Advisor Disclosures
Alongside, LLC, doing business as Keil Financial Partners, is an SEC-registered investment adviser. Registration does not imply a certain level of skill or expertise. Advisory services are delivered through the Alongside, LLC platform. Keil Financial Partners is independent, not owned or operated by Alongside, LLC.
Additional information about Alongside, LLC – including its services, fees and any material conflicts of interest – can be found at https://adviserinfo.sec.gov/firm/summary/333587 or by requesting Form ADV Part 2A.
The content of this media should not be reproduced or redistributed without the firm’s written consent. Any trademarks or service marks mentioned belong to their respective owners and are used for identification purposes only.
Additional Important Disclosures
