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Retirement Answers is a podcast built to help you succeed in retirement. The thought of retirement can be overwhelming and downright scary for many... but it doesn't have to be!
The goal of this podcast is to provide thoughtful insights and strategies to give you the confidence you need to retire successfully. At the end of the day, my ultimate goal for my clients and podcast listeners is to live a fulfilling retirement.
Follow along as I publish a new episode each week covering everything from retirement income planning, tax planning, Social Security, insurance planning, investing, and much more.
Here's to learning everything you need to know to live out your dream retirement!
Hey, friends, and welcome back to another episode of Retirement Answers. My name is Jacob Duke. I'm your host as always. Hey, I've got a question for you. Have you ever wondered if you're saving too much money?
Jacob Duke:And you might be like, Jacob, what do you mean? How's that possible? I thought I needed to save as much as I possibly can for retirement. But really what I'm asking is not are you saving too much money in general, but what if you're saving too much money into the wrong accounts? Because after working with hundreds of people just like you, there is a common theme that I've seen over and over again, that on average, most retirees have over 75% of their entire retirement savings in tax deferred accounts like 401Ks and IRAs.
Jacob Duke:And while I don't fault you or anyone else for this, because you're likely just doing what you've been told to do, this can present some real problems in retirement. So in this episode, I'm gonna explain five primary risks of having all of your retirement savings in tax deferred accounts, what you should focus on doing instead, and how you can get there. But first, if I can really quickly, I wanna paint you just a quick picture because this is an area that a lot of people end up in. Let's say that you're 54 with $3,000,000 saved and it's all in your tax deferred four zero one ks or four zero three b or maybe rollover IRAs. So you've done a really good job of saving, but now you're getting burnt out and you're done.
Jacob Duke:You're ready to do something else, ready to move on, and really you're wanting to do anything else. And maybe it could be another job just in a slower pace capacity, or maybe just retire and be done entirely. But here's the problem. I'd argue that that $3,000,000 that's enough to retire depending on a few different variables. But here's the real issue.
Jacob Duke:If you do retire at 54, how do you actually access that money? Right? You can't access it in the four zero one k or the IRA without a 10% early distribution penalty because you would not yet be age 59.5. And for those of you wondering, yes, you can use the rule of 55, but only if you qualify by being 55 in the year in which you retire or later. And your plan specifically has to allow for the rule of 55.
Jacob Duke:Maybe you could do a rollover and use the the 72t option, but for me personally, I'm not a huge fan of that because of all the restrictions around it and just the rules that have to be closely followed. So really you have a couple options here. You can work longer so that you can qualify for rule of 55, or you can retire now and pay penalties to get the money out of the four zero one k so you have some sort of income in retirement. So by telling you this and showing you this, I want you to see that there's a big difference between having enough money retire and having the right types of money to retire. See, I don't want you to miss this because if all of your savings is in that tax deferred account type, it exposes a few risks.
Jacob Duke:And the first one that comes to mind to me is the unknown risk of future tax rates. We've had a lowering of tax rates over the last few years, and I have no idea if it's gonna stay the same or continue to go lower or actually increase over time. But here's what I don't like. I don't like not being able to control that. So if you have all of your money in tax deferred accounts, you are betting on the fact that the rates will not increase dramatically in the future.
Jacob Duke:Because if you go that route and rates do go up over time, let's say the 10% becomes 15 and the 12% becomes 20 and so forth. If those tax rates go up over time, you are exposing yourself and all of your savings to that increase. So you're unable to defend yourself against it because all of your money is exposed to that particular risk. Now, here's the problem. We have no idea what will or won't happen, but we do know is we do know what tax rates look like today.
Jacob Duke:Right? So you have a way to make an educated decision on should you pay taxes by doing a Roth conversion perhaps, or maybe saving money to the Roth side of your four zero one ks instead of the tax deferred side. Maybe there's a price to pay today. Yes, maybe you're saving into a different account type or paying higher taxes right now this year. But is there a benefit long term to doing that?
Jacob Duke:So you got to evaluate your situation to see. But risk number one is the unknown of future tax rates and the potential increase that could happen, exposing all of your life savings to a bigger chunk being taken out. Now, second risk very much coincides with the first one, and it comes down to RMDs or required minimum distributions. See, these RMDs, what they are really is they are a forced taxation on your hard earned retirement savings at some point in the future. Now, depending on your year of birth, you could start those at age 73 or 75 under current legislation.
Jacob Duke:Those are always subject to change as we saw with Secure Act and the Secure Act 2.0. Those RMDs, they are scheduled at that age and you've got to start taking money out of your tax deferred accounts. Think IRAs, 401Ks, 403Bs, any sort of tax deferred money you have, they've got to start being taken from so the IRS can get their tax money that you have deferred until that point. So the biggest problem with these RMDs is they are a forced income whether you need that money or not. So maybe you've got 3 or 4 or 5 plus million dollars saved in these tax deferred accounts and they've grown over time.
Jacob Duke:Well, what's gonna happen here is you're gonna have a 100,000, 200,000, $300,000 worth of forced distributions. And those will be taxed at normal rates. Again, going back to the first risk, they'll be taxed at the rates at the time of the distribution, not what you the tax rates are today, whatever they are in the future. So you are exposed to whatever those rates would be, and you're being forced to pay taxes on that money whether you want to take it and spend it or not. Now, couple problems here that come up immediately in my head, and we'll jump to the other ones in risk number three.
Jacob Duke:But the first one that comes to mind is whenever you're paying taxes on that much money, you're going to be biting into your eventual legacy that you could be leaving to your kids down the road. So if something like legacy or leaving a certain amount of assets to your kids or the next generation, that is important to you, then maybe evaluating how much tax should I pay today before we ever get to those RMDs in the future by doing maybe a Roth conversion strategy. What can I do today to help minimize my total effective lifetime tax rate on these dollars and the tax rate that my kids or heirs would receive in the future upon death? So that's one problem that I see here with RMDs, but also something that goes unspoken about a lot is if you are married and perhaps both of you are living into your eighties, but then one person passes away and the surviving spouse is obviously still there, but they've got all this money in their own name. The RMDs at that point are going to still continue to be nearly the same amount as a single person rather than married filing jointly, but the tax brackets are compressed.
Jacob Duke:They're essentially cut in half. And if your RMD in dollars has to be the same, effectively, tax rate is gonna jump due to the widow's tax trap. So this is another consideration whenever it comes to your taxes around all of your tax deferred money and what you can do about it. We'll talk more about how to minimize those taxes here in a second. But those R and Ds can prove to be a major risk for you, a surviving spouse or your heirs in the future.
Jacob Duke:Now, brings us to risk number three, which in general is a lack of income control. Right, see every dollar that you take out of your IRAs or tax deferred four zero one ks, it increases your taxable income. So your tax bill, going from working throughout a career, making good money into retirement, if you'd only have tax deferred assets and you've got to live on those assets moving forward, your tax bill could remain the exact same working and retired because it there's minimal drop off. You've gotta have the same amount of income to spend and enjoy, and both of those dollars are gonna be taxed the same way. Your earned income is taxed the same as your IRA distribution income.
Jacob Duke:Yes, you're not paying employment taxes on your IRA distributions, but the effective income tax rate is going to end up being the same, so there's maybe no difference there. And for some folks, going back to risk number two being the RMDs, their tax rate could end up being higher in the future compared to what it was when they were working. So every dollar taken out that increase your taxable income. And what this actually does is it kind of cascades or waterfalls into other parts of your plan. Number one, if you're trying to retire before 65, you're and trying to qualify for those ACA subsidies or the health insurance subsidies there because you're not yet on Medicare, and your only source of income is tax deferred money, and let's say you need $80,000 per year to spend, well, in order to get $80,000 out of your account, you might have to distribute 90 or 95,000 gross to get 80,000 net after taxes.
Jacob Duke:And that might push you above the subsidy income limits to qualify for those subsidies. So you could have higher health insurance premiums because your only source of income is tax deferred money. And then even after 65, you might run into this thing called IRMA, income related monthly adjustment amount. And this has to do with surcharges that could be added on top of your normal Part B and Part D Medicare premiums. Okay, so this is a surcharge that is applied if your income is above certain thresholds.
Jacob Duke:Now, I'm not going go through the thresholds here with you today, but if you are interested in what those are and want that on a neat, clean little data sheet, I've got the important numbers data sheet here for 2026 that I can send to you. There's gonna be a link there in the podcast show notes, so you can just click on that link, type in your name and email so I can send it to you, and it's completely free for you to use throughout this year. Now, there are also some different nuances around Irma that I'm not gonna dive into. I've done other episodes on that, so go check those out. But in general, by increasing your income potentially outside of your control, because of those RMDs, you might end up having this cascade effect of additional taxes or surcharges or penalties added on top of the increased tax rate itself.
Jacob Duke:So that's risk number three is the fact that you lose control of your income. You could be forced into without any of your own doing, you could be forced into higher payments on your health insurance premiums. Now risk number four is something that a lot of people don't really think or talk about, but I think it's very important, and it's the psychological barrier that comes with pre tax money. Right? So if you think about it, every dollar that you take out of your IRA or four zero one k, any sort of pre tax accounts, it's gonna actually be more expensive than the actual thing you're buying.
Jacob Duke:Let's say you want to do a $100,000 remodel on your home. Well, in order to get a $100,000 out of your IRA or your four zero one ks to do the remodel, you might need a 125, a 130, a $140,000 depending on your federal and state taxes. You could need that much money as a gross amount in order to get the net amount of 100. Now, what's the problem? Maybe the math works on that, right?
Jacob Duke:But there's actually the psychological friction that comes into play that causes you to underspend on the actual remodel in this scenario. So maybe a 100,000 was your total spend that you wanted to do, which means you gotta cut back on the remodel because you just can't get yourself to to take that $1.40 or a 130,000 out, but you planned on a 100,000 mentally. So now in order to withhold taxes on 100,000, you really are only going to net about 80,000, which means you have to cut back on the remodel and the quality of it itself, because you didn't plan for all of the tax withholdings or the taxes on top of the net amount of money you needed. So the psychological barrier that comes into play whenever it comes to spending is actually a bigger deal than most people understand. So if you think about it, you wanna go on the dream vacation, right?
Jacob Duke:But if you take more money out of your tax deferred account, you're gonna have to pay higher premiums on your health insurance before 65. And you're like, I don't know if I wanna pay the extra, I don't know, $700 a month in order to do that. Well, then are you not gonna go on vacation because all your money is tax deferred? That's essentially what's happening there, right? Yes, you want to pay as low premiums as possible on your health insurance, but when you realize that you have to pull more money out of a tax deferred account, which increases those premiums, because you wanna go on the vacation you put off for so long, it kind of bites you on both sides.
Jacob Duke:And so that's where that psychological barrier comes into play. Having all pre tax money means that every purchase, every expense is actually more expensive than you originally thought, because you have no way of getting around those income taxes. And then to sum all of this up, risk number five is that all of these things lead to, in my opinion, the biggest issue, which is just a lack of flexibility. You didn't get into retirement or reach this point in your life only to be kind of painted into a corner where you only have one option, it's to take every bit of money from this and because of that, you have minimal control over your total lifetime tax bill and all the different surcharges or increased costs along the way. That's not at all what anyone hopes for as they're in retirement.
Jacob Duke:So this lack of flexibility because of the type of money you have, it's a problem. I want you to get to do anything you want in retirement, the way in which you wanna do it, rather than have to do these things. So you wanna get to instead of have to, and when you start pulling your money out in retirement to live on, wanna you be able to control when you pull it, where you pull it and how those taxes are going to apply. So those are the five different risks that I want you to be aware of if you're in this scenario where most of your retirement savings is in a tax deferred account type. Now the question is, what do you do about it?
Jacob Duke:How do you fix it? Well, this is where tax diversification comes into play. And here's what I really mean by that. Tax diversification is having savings and investments in different account types based on how those accounts are taxed, not just different investments. So when we think of diversification, we often think about large versus small and growth versus value and US versus international and how our money, our investments are actually diversified.
Jacob Duke:But what I want you to focus on here is what's called tax diversification, and this boils down to where the different buckets of money are saved. So you've got pre tax, which is traditional IRA and traditional four zero one ks or any sort of employer plan that's tax deferred. These are gonna be taxed later. So you didn't get taxed on the front end, you deferred those taxes into the future, and these account types are subject to RMDs like I mentioned. Now the second account type is after tax, or maybe you would call it tax free.
Jacob Duke:And this is your Roth IRAs, your Roth 401Ks, money that you've paid tax on already, the growth is tax deferred and could end up being tax free, but then the withdrawals can be tax free as well, because any contributions you make to a Roth account type are always gonna be tax free regardless of your age. The earnings within that Roth account, those are subject to different rules in terms of can you get that money out without penalty before certain ages and before certain time periods are met. Think about the five year rule and the age 59.5, and I'm talking about that, but in general, these are tax free accounts. You pay tax on the front end and you can withdraw tax free in the future. And the third account type, in my opinion, is perhaps one of the most important for retirees, especially early retirees, and it's gonna be the taxable brokerage account.
Jacob Duke:This is where you do not receive any sort of benefit when you put money in, you're putting after tax money into the account, but then you are also paying taxes along the way through dividends, interest or capital gains generated, you're paying taxes every year because you're gonna get a ten ninety nine on the account type. So what you've got though, is you've got three different buckets, got pre tax, after tax being Roth, and you've got this taxable that's kind of in between. The benefits of the taxable is that there's no age restrictions, you can use the money at any time or age that you want. There's no time limits or wait periods that you have to fulfill, and there's no contribution limits, meaning you can put as much money into those taxable brokerage accounts as possible. So whenever you got these three account types adequately funded, you are gonna have what's called tax diversification, because now you've got optionality around where you pull money from and when you pull that money out.
Jacob Duke:Ultimately impacting what your tax bill is gonna look like. So for example, the taxable brokerage account, I've talked about this in other episodes, but it could help you benefit from something called tax gain harvesting, where you intentionally sell some long term capital gains of investments within the account, ultimately to help you pay no taxes on those gains because of your other income sources being small enough. So I'm not gonna dig into that again, there's other episodes I've done on it, you can check those out. But in general, where you got these three different buckets, you can control your income, which controls your tax bill, and ultimately helps you lower those premiums before 65 on your health insurance and avoid Irma potentially down the road. And not to mention, if you do have this taxable account growing, you can use it in a more tax efficient manner while you are in early retirement, or it's a great way to transfer wealth completely tax free to the next generation because that brokerage account, it's gonna receive what's called a step up in basis in the future as well.
Jacob Duke:So it's a great legacy planning tool, just like the Roth IRA is a great legacy planning tool, no taxes on Roths if you inherit those in the future. Those pre tax IRAs and four zero one k's though, they will be taxed, and so they're kind of the worst thing you could leave to your heirs down the road. Now you're like, Jacob, this all sounds great. I hear what you're saying, but how do I actually get there? How do I build this tax diversification since I see the risk that comes with a tax deferred IRA or four zero one ks?
Jacob Duke:Well, two things come into mind. If you're not yet retired and you're still working, you might want to think about slowing down on your tax deferred four zero one ks and IRA contributions. So maybe shifting to the Roth side and the brokerage side could be a big advantage for you. Now you've got manage this with, hey, what is my tax bill going to be? How much more tax am I going to pay every year?
Jacob Duke:Because I'm probably working and making good money. Am I willing to increase my tax bill right now in order to build more flexibility in the years to come? That's a question you've got to ask. You've to evaluate, hey, what is it worth to me to do that? Because some folks, it might say, hey, I'm actually going to not slow down on my tax deferred right now, but when I do get to retirement, I'm going give up two or three years of those lower premiums to get as much money out of the tax deferred side, whether it be convert to Roth or make distributions for a brokerage account, but I'm going to wait until retirement to do that because my tax rate today is 32% and in retirement it'll be, you know, 10 or 12 or 22%, that's a big difference.
Jacob Duke:So for some folks, it might not be the right thing to slow down, but you at least need to evaluate it. For others, though, who are in that ten, twelve, 22, 24% bracket, it is very much a conversation or a thought that you need to have to evaluate, hey, should I slow down on all of my tax deferred contributions and start funding Roth or brokerage account instead to build more flexibility now in these last few years for the first few years of retirement. Now, if you're after retirement, or maybe if you're thinking once you do get to post retirement, thinking about Roth conversions in those early years, what we call maybe your gap years between when you retire until your social security kicks in or until your RMDs would start, doing Roth conversion during that period of time is going be the most tax advantageous time to do those conversions, because you'll be hypothetically in the lowest tax brackets possible. So planning on and doing Roth conversions after you retire and before other income sources in the future, such as a pension or social security or RMDs would ever start, is a great way to lower your lifetime tax bill.
Jacob Duke:Now, there could be a price to pay here, right? You could say, hey, I'm going to pay more taxes now, when I don't otherwise don't have to, and I might pay higher premiums on my health insurance pre 65 or even pay IRMA surcharges for a little bit in order to do the conversions for the greater good of not having to pay IRMA forever throughout my lifetime and my spouse's lifetime, or also not leave a major tax bill for my heirs down the road. See, you might have to give up a little bit right now in the early stages of retirement in terms of tax optimization and paying more than you otherwise have to pay in order to save a ton of taxes over your lifetime. That's where a true analysis and plan comes into place, and that's what we do with our clients, because we think that taxes, they are a huge part of everyone's retirement success. In fact, taxes will likely be your largest expense throughout the rest of your life once you are retired, and so we want to minimize those as much as legally possible by just thoughtful planning and restructuring of when you take money and where you take money from throughout retirement.
Jacob Duke:So if you're someone who's like Jacob, this all makes sense, but I need help with that. You can go to our website, apply to work with us, we're happy to talk with you, see if we're the right fit to help you with your retirement planning needs. But in general, the whole point of talking about all this is because we want you to have freedom, freedom of your income, freedom to do Roth conversions, freedom to minimize your health insurance premiums both now and in the future, build a better legacy for your heirs down the road, right? And oftentimes what you see in this as you start going through this and executing a plan is the emotional benefit, right? You have more confidence to spend freely and enjoy your money.
Jacob Duke:You have less anxiety around what if tax rates double throughout the rest of my lifetime and now I'm, you know, got all these different tax deferred accounts getting taxed at really high rates. And so whenever we start to take this full circle and really understand the plan is comprehensive and holistic, I want you to be reminded of what our goal is as planners here at River Tree. Our goal isn't for you to just die with the biggest account balance because that could be a detriment to you and your heirs tax bill down the road. It's actually for you to live right now today as best you can with the most flexibility. And yes, there's a money component to that.
Jacob Duke:That's why we're talking about the risks of tax deferred money. That's all you have and how to fix it. But the whole point of even going down that is not to simply just save on taxes, it's to save on taxes so that you can go enjoy more life and do it with more freedom. So if this resonates with you, but maybe you've been listening to the show for some time, I'd love to hear your thoughts, right? You could leave a review there on Apple Podcasts or Spotify, but also just share it with a friend or family member who you think could benefit from these conversations.
Jacob Duke:So thanks so much for tuning into this week's episode of Retirement Answers. Again, my name is Jacob Duke. I'll see you again next week. Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal or tax advice. Retirement Answers is for educational purposes only.
Jacob Duke:Thanks for tuning into this week's episode. I look forward to talking with you again next week.