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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
One of the core mechanisms of any retirement plan is tax planning because it affects everyone. It's the governor of the thing that's probably your largest bill in retirement. Welcome to the How to Retire On Time podcast. I'm Michael Decker here with David Fransen. This show is all about getting into the nitty gritty, not that oversimplified advice you've heard hundreds of times, and we're answering your questions.
Mike:Text them to (913) 363-1234, and we will feature them on the show. How about that? That's a good time. Dave, what have we got today?
David:Yeah. Featured on today's show. Hey, Mike. When does tax planning really make a noticeable difference in a retirement plan?
Mike:Tax planning affects everyone. And so I would say there's a significant difference that can be felt for all people in retirement.
David:Alright.
Mike:But it's a different conversation for every person. Let me explain. If you have less money, let's say 500,000 or less. Alright. Or you want 80 to 90,000 or less of income, net income.
Mike:Right? So the money you're actually spending in retirement versus you're in the I want a 120,000, 200,000, 500,000 of income in retirement or so on. Or you've got $3.04, $5,000,000 plus. Very different conversations. And here's why.
Mike:Tax planning is a red light green light situation. So do you go fast and aggressive or do you slow down? K? And what I mean by that is if you want less income, if you save less, you might not want to aggressively move your IRA assets to Roth because you could slowly do it in the 10 to 12% tax bracket with the standard deduction and pay very, very little. That also allows you to keep more money in your portfolio, which allows that compounding effect to benefit overall in your retirement.
Mike:Because people people forget, just because you're not taking a lot of income doesn't mean you're being depleted. So if you're doing aggressive conversions, money's going to the government in taxes, which is also depleting the amount of money in your portfolio.
David:Mhmm.
Mike:And that can have a lasting consequence. So if you've saved less, this goes against common wisdom, common consent, or whatever the zeitgeist, if you will. Sure. But I do a lot of plans with a lot of people where I say, don't do any IRA to Roth conversions. It doesn't make sense.
Mike:And let me give you a new example. If you've got a million dollars and the government just comes out and says, hey, everyone. We have, for this year only, we have this new bill. You can convert as much money as you want from IRA to Roth, and you're gonna pay a flat tax of 20%. That's it.
Mike:Sky is the limit. Yeah. Okay? Or you can sign a little waiver and says, you know, we're gonna we're gonna govern you a little bit. You can only do so much, but you can pay 15% for life.
Mike:Which would you do? So if you do the the example of convert everything over, you're gonna take your million dollars, pay 200,000 in taxes, 20%, and you've got 800,000, but you're tax free.
David:Right? That sounds good.
Mike:Grows tax free, pays out tax free, life is good, you are done. Love that. Love being done. In that situation, you paid 200,000 in taxes for life. Mhmm.
Mike:Not a bad deal. If you compare the option to 15% for life, it's the same growth, same inflation, same net income.
David:Okay.
Mike:Okay? You'd pay around, in this example, I think we did it like 60 to 95 years old or something like that. You'd pay around 412,000 in taxes, roughly.
David:So on paper it already sounds bad. Like I'm paying double. Double in taxes. No one wants to do that.
Mike:Yep. So it sounds worse off. Right? Yeah. Here's the catch.
Mike:Alright. The person who paid more in taxes throughout their life because they spread it out and they never quickly depleted the balance in there ends up with over $700,000 more in their portfolio. I think 690, 700,000 is around there. Yeah. More money in their portfolio going to the kids, going to charities, going to wherever they want.
Mike:Yeah. And the reason is 10% growth, let's say, of a million dollars is a better deal than 10% of 800,000. Yeah. That difference adds up over your lifetime. So for people with less money that can navigate a lower tax bracket for life, your effective tax rate is much less, and it's more advantageous for you to slow down and keep the money in your portfolio so there's a compounding effect moving forward.
Mike:Now the opposite of it is someone who saved more money or has too much in their IRA assets. You got to understand that your effective tax rate, that's the total amount you've paid in taxes. Early in the 32% bracket today is still a better deal than the 25% bracket back in 2016. Even though you're in a higher bracket, you've got to pay attention to the dollar thresholds and the lower bracket thresholds. Because our lower bracket thresholds, 1012%, when back then was 15%.
David:Okay.
Mike:So it's hard to do the apples to apples comparison unless you look at the effective tax rate. Total taxable amount, taxes paid, what was that percentage?
David:Right.
Mike:And so someone who has a lot more money, who is planning on more income, might want to get more aggressive going to the top of the 24 bracket or even a little bit into the thirty second percent bracket because if taxes change in the future, it could really hurt you. So this is why tax planning affects everyone, and it prevents you from making an emotional decision of doing too much too soon or too little too slow. Oh. It's a two sided coin.
David:Right.
Mike:Double edged sword. Yeah. What other axioms or sayings you can put in here? Insert them now. Yeah.
Mike:I don't know.
David:But I think those two did it.
Mike:But do you see how it's balanced and everyone's situation's different? Mhmm. And if you're this is one of the key that many people miss. If your required minimum distribution is less than the income you already want, why in the world would you be panicked about taxes? Because you can just take your R and D, call it good, you need more income anyway, and then pepper it in with maybe maybe a little bit more from IRA assets just because you want to deplete them.
Mike:Or maybe you take a little bit from your brokerage account at a zero to 15%, you know, long term capital gains rate. Or maybe you buffer in a little bit of Roth because you have too much in Roth or what. To say too much in Roth. But I mean, guess in theory it could happen. But it's about balance and individual situations as opposed to this blanket statement advice that costs people tens, if not hundreds of thousands of dollars throughout their retirement going the wrong direction.
Mike:And this idea that you can predict the future, no you can't. No you can't. No. It is acceptable to say, I'm concerned that taxes might go up in the future. That's a reasonable expectation and to then create your plan around such.
Mike:It is unacceptable to say, I know taxes are going up in the future.
David:Oh, right.
Mike:I mean, that's like saying, I know Trump was gonna get elected. At one point, he was like a 4% chance of getting elected. Yeah. Like, did you really know? Really?
Mike:Nope. That's why prediction markets are so fun to watch. Yeah. Because like, usually they're right, sometimes they're not. Yeah.
Mike:It's like, what, the March Madness? Yeah. Every now and then there's that surrender surrender Cinderella? Cinderella story. Right?
Mike:You don't know.
David:No. You don't really know.
Mike:But you can make an argument saying the odds point in this direction and I would prepare or I want to prepare for a probable outcome. Totally get that.
David:Yeah. But you don't really know. No. No one really knows, like, oh, that 10 or that 12 seed's gonna make it to the elite eight or final four. You just don't know.
Mike:Yeah. It's so fun though when the 16 seed beats the one seed.
David:Oh, it doesn't happen very often.
Mike:If, like, 90% of brackets are gone. Yeah. So but here's the point. And I'll I'll be very blunt about this.
David:Alright.
Mike:Investments and products and all of that, like, yeah, that's an important part. Yeah. The planning's an important part. Mhmm. But I think one of the core mechanisms of any retirement plan is tax planning because it affects everyone.
Mike:It's the governor of the thing that's probably your largest bill in retirement.
David:Mhmm.
Mike:And understanding when to turn it up and when to slow it down is a critical component of any retirement plan, and everyone's threshold should be different. And to try and do tax planning with someone that can't give tax advice, in my opinion, is kind of like trying to cook a steak without a grill or a stovetop or something. Yeah. I don't know. It's kind of a weird analogy.
Mike:It's like trying to play baseball without a bat.
David:Yeah. Okay.
Mike:Like, I don't know. These are all terrible analogies, but it just I don't see how it could possibly work.
David:And how do we know who can give tax advice? Simple.
Mike:Are you allowed to give tax advice? If they say yes or no, that's your answer.
David:Okay. Alright.
Mike:Because anyone can talk about taxes. I mean, you have to be a CPR or an enrolled agent to represent you in front of the IRS. So from legal advice, that's one thing. And a lot of compliance departments will say, well, can't give legal advice. I get that.
Mike:But to do tax planning and say, oh, well, I can't really do that side of that. I can't give tax advice, so we'll help with your investments. You got to talk to a CPA though about that stuff. I think many times it's been misunderstood of what people can and can't do. Most advisors will say, well, can do IRA to Roth conversion advice.
Mike:That's tax planning. That's a part of it. But, oh, well, we can't really go through your ten forty tax return, you know, the summary of it and and work with you there. That's why not? Why can't you look at that and say, hey, look at line three a right here.
Mike:You've got a lot of or no, three b. You got a lot of ordinary dividends coming in. That's tax inefficient. Why don't we reposition the portfolio so that 50,000 stops getting taxed as ordinary income? We can move it over to three a, which on your ten forty is qualified dividends.
Mike:Those are taxes long term capital gains. That's a tax efficiency. Or we could rebalance the portfolio to have the dividends go in your qualified accounts so that I mean, this is what it should be like.
David:Right.
Mike:But if it's like, oh, I I don't I don't know how to read this in for you. Oh, that's what your CPA does. Like, I'm more on the investment side. That Yeah. I don't see how you can do this job without being able to read and understand how taxes are filed, how to read a ten forty, how to do to simulate a tax return in the future.
Mike:I don't see how it can be done effectively.
David:Right. So I get that.
Mike:Anyway, that's that's my opinion. Did we answer the question?
David:I think so. Let's just review real quick. Yeah. When does tax planning really make a noticeable difference? So certainly in the higher income, way up there.
David:Huge difference. Maybe not as much in the lower if you only have
Mike:Makes a huge difference. But it's it's the it's the balance that you preserve. It's the slowing down of the tax minimization strategies that allow you to keep more of your assets and to help other parts of your plan.
David:Mhmm.
Mike:Your income planning affects your tax planning. Your tax planning affects your income abilities. Your tax and your income planning will dictate then when you should file for Social Security. Yeah. When you file for Social Security, it's gonna affect your tax planning and your Social Security.
Mike:And health care, by the way, is really a tax planning issue and an income planning conversation. Uh-huh. So it all works together.
David:And you've got Irma in the mix as well. Right?
Mike:Yeah. Be mindful of that. Yeah. Not your crazy aunt. Irma is Medicare surcharges if you go over a certain threshold.
Mike:$1 over Yeah. You're paying more your health care expenses. You're seeing your health care.
David:What if you what if you converted too much from IRA to Roth and then suddenly IRMA is you're paying more for Medicare? Yeah. Yeah. You gotta be aware of that.
Mike:Crappy situation. I mean, could look up form s s a dash four four and try and get out of it. Mhmm. But still. Right.
Mike:So it affects everyone, but there are different conversations for different people. And I think that's often misunderstood. Tax planning is for the rich? No, it's not. It is almost just as important if not more important for the efficiencies of someone that has less than a million dollars on how are they going to gracefully take money out while preserving their portfolio and maximizing the efficiencies of the current tax situation.
Mike:Got it. That's all the time we've got for this question. If you enjoyed it, make sure to subscribe, tell a friend, all of that. Go to retireontime.com, by the way, as well to grab the book, the workbook, all these materials, to help you prepare for your retirement. We'll see you in the next show.