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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.
Welcome to how to retire on time, a show that answers your retirement questions. Say goodbye to that oversimplified advice you've heard hundreds of times. This show's all about the nitty gritty. Now that said, remember, it's just a show, not financial advice. It's educational.
Mike:So do your research. As always, text your questions to (913) 363-1234. Again, (913) 363-1234. Let's dive in. David, what do we got?
David:Hey, Mike. Can you explain what tax planning is? Everyone talks about it, but then recommends IRA to Roth conversions.
Mike:First off, let's just dispel the IRA to Roth conversion bit.
David:Okay.
Mike:It's not essential for everyone to do. Some people have a sufficient amount of assets elsewhere that the IRA is maybe a third, maybe a half of their overall portfolio. And if they just focused on generating their income through their IRA, that their RMD is a part of their already expected income anyway. So do you really wanna do IRA to Roth conversions? And if so, what's the benefit later on?
Mike:See, people want the 0% tax bracket. Yeah. Well, that's nice, but how much does it cost to get there? Are you willing to pay, I don't know, 20 some percent in taxes, in federal taxes at the federal tax rate so that you can maintain a 0% tax bracket, or would you rather than just take income for life at the 10 to 12% tax bracket while you're utilizing the standard deduction, the senior deduction, and the one big beautiful bill deduction? So assuming that tax planning's IRA to Roth conversions, yes, is an oversimplification, and yes, it's not right for everyone.
Mike:Everyone's different. Your plan's different. Your projections are different. Your strategies should be different. But that's just the tip of the iceberg when it comes to tax planning for what it's worth.
David:Okay.
Mike:And did I hit that hard enough? That there's more to life than IRA to Roth conversions?
David:Why, why is everybody talking about it? Is just because we have it ingrained in our mind like, oh, Roth is tax free growth. I'm gonna do whatever I can to get there.
Mike:Yeah. You know, I was talking with the CPA the other day, and he made a really good point. He says, your IRA to Roth conversion opinion changed this year. I said, yes. It did.
Mike:Because the tax brackets, the percentages were supposed to increase at the end of the year, and the tax dollar thresholds were supposed to decrease at the end of the year. In other words, your taxes were gonna increase in two different ways. So it made sense to maximize higher tax brackets now because overall, your tax bill is expected to increase. Okay. And then the one big beautiful bill comes into play.
Mike:Uh-huh. Oh. Alright. Trump comes in, and whether you like them or not, I don't care. Whether you think this is good for the economy or not, I don't care.
Mike:Well, here's what happened. Your taxes were maintained. Oh. They're not going up, so maybe that increases the deficit. Maybe supply chain economics solves the issue.
Mike:No one really knows what will happen, but your taxes got locked in at a lower rate. Allegedly made permanent, but tax code's really written in pencil. So there you go. But, yeah, your opinion on will taxes be greater in the future, that's an opinion. No one knows the future.
Mike:Yeah. So you are making educated assumptions on what you think will happen and then proceeding as such, because you can't actually plan for the future. You can plan around the different variables for the future. Talk about meta or existential right there. Yeah.
Mike:And people say, oh, well, the The US debt's really, really high, so taxes have to go up. Just remember that solving the the deficit, which by the way, deficit's different than the debt. The deficit is spending too much every year, which adds to the debt. The debt's its own thing. Yeah.
Mike:They can solve debt in other ways. There's more than one way to solve these issues. Mhmm. It's not just increasing taxes.
David:Yeah. That would just be one out of all the strategies, that's one option.
Mike:Yeah. Growing the economy is another option. Yeah. And maybe AI contributes to the growth of the economy. Maybe it doesn't.
Mike:I'm trying to be neutral about all these things instead of being trying to be prophetic. I'm not a prophet. Okay. So tax planning. What in the world is tax planning?
Mike:What is it? Let's really tax planning, in my opinion, is understanding the tax code and the various loopholes that may or may not be available to you to help you lower your overall tax bill. Yeah. So when Warren Buffett says, I pay less in taxes than my assistant Yeah. What he's really saying is he makes like a what?
Mike:A 100 k salary is what he makes. Mhmm. So maybe his assistant makes more than that, but he's operating mostly off of long term capital gains. What's that? The first 96,000 or so is taxed at the 0% tax rate as long as there's no ordinary income.
Mike:That's a tricky part. Yeah. Because it means you don't take any ordinary income. IRA to Roth conversions shows up as ordinary income.
David:Okay.
Mike:IRA distributions shows up as ordinary income. Social Security pensions, they show up as ordinary income. Your dividends, if it's not structured correctly, shows up as ordinary income. K. So there's all these things that could get in the way that maybe you can, maybe you can't utilize the 0% tax bracket, but maybe you utilize the 15% tax bracket for long term capital gains.
Mike:Understanding what you can give and what you can take as you manipulate how you're going to generate income in retirement, that's tax planning. It's understanding the difference between two a, which affects your modified adjusted gross income that's showing up there, and your two b. Maybe you've got some interest that's being taxed because you're holding too much in cash. And if you're holding too much in cash, does the interest put you over a threshold that then triggers IRMAA or not?
David:Two main two beer lines on the ten forty.
Mike:On the ten forty. Yeah. And does that put you a dollar over on the IRMAA? Because that could cost you an extra $102,100 dollars a month just because you held too much in cash with everything else that was going on. Tax planning also needs to be coordinated with your investment adviser and your CPA or enrolled agent or tax professional.
Mike:Because if you've got someone over here trading your brokerage account, and they have great growth, but they create too many capital gain issues, that affects your modified adjusted gross income and other parts of your ten forty, which then push you into other situations that may not be favorable. So tax planning isn't just saying, hey, CPA. Here's what happened. Well, here's where you pay your taxes. Good luck next year.
Mike:Yeah. That's not tax planning, and tax planning is not saying, alright. Well, we're gonna do some IRA to Roth conversions. Here's the tax bracket. Let's just make this work.
Mike:Forget about all the other unintended consequences. It's not about maximizing your ordinary income brackets. You need to acknowledge the other parts of your ten forty. What's going on on line seven? Or so I'll just kind of go through, you know, schedule d.
Mike:You got schedule c. Do you have a side business? Do you have a business? What's going on there? Are are there short term capital gains or the long term capital gains?
Mike:What's the cash flow look like, and is that going in the right direction? Too many times I've had people say, hey. Let's do some tax. I say, great. The first thing we're gonna talk about is line three a and three b.
Mike:Because you're trying to get a lot of dividends in here. You're reinvesting dividends. This number is gonna get bigger every single year, which is gonna get in the way of other things. Do you wanna start spending this income? Well, but I need to do my IRA to Roth conversions.
Mike:That's true. So what if we sold some of these positions? Yeah. This year, we might have a difficult tax bill, but we can move it over other positions that then don't create ordinary dividends. Maybe we buy specific stocks, and now it's a qualified dividend because we're holding it for the correct duration of time, and now we're getting taxed at long term capital gains instead of the dividends, and we're matching roughly what the the actual dividend target payout would be.
Mike:These are things that are not talked about at all because how many people pull up their ten forty, and then they pull up their statements and then compare the two? It doesn't happen.
David:Yeah. Statements like from financial statements or IRA statements.
Mike:Yeah. If someone has a brokerage account, I'm looking at their ten forty and their their statements next to each other. And then saying, okay. So here's your positions here. That's probably what's contributing here.
Mike:Let's take a six or 7% expected dividend on here. Okay. That's kind of how much we're getting right here. Got it. And then we're adjusting along the way.
Mike:Right? So that's a conversation that's not really happening. Are you a business owner? Do you want an encore career? Maybe you're an executive or just a really smart person.
Mike:You've got all these skills, and you're going, you know, I I'd like to keep working, but not as much. Maybe I want to be a consultant or something on the side. Great. Now we're looking at line 12. Line 12 is where you got your deductions, you got your write offs, and so on.
Mike:Gotta be careful because there are certain things you can write off. There are certain things you can't write off. But do you see how tax planning is one part understanding your investments? Mhmm. One part understanding your cash flow, and cash flow is not income.
Mike:Cash flow is the movement of cash in and out of your investments and accounts.
David:Okay.
Mike:So you can have tax inefficient cash flow that's trying to grow your portfolio, but you're creating tax issues along the way.
David:And so what what's an example of some cash flow? Is that like a a position paying a dividend and then the cash?
Mike:Yeah. Your tax on your dividend is being reinvested or spent. Is that efficient? Or if you've got rental income. Okay.
Mike:You've got rental income coming in. Do you have is it efficient? Are you writing too much off? Are you getting a reasonable cash flow or income from that point? It's understanding the flow of money through your accounts and the tax consequences that are being triggered in every bit of movement.
Mike:Mhmm. And if I can go a step further, are you getting a good amount of return from your money? So some people are dividend investors, which is wonderful. That's one of the 10 strategies that work when it comes to retirement income, but they're getting like 2% from their dividend because they haven't really done the research on appropriate dividend stock or investments. Lot out there.
Mike:So it's a highly nuanced conversation that doesn't start and stop with IRA to Roth conversions.
David:Yo, it sounds like tax planning is, if I can put it in a nutshell, you're trying to be proactive and not like reacting every year. Yeah. You're being proactive with if I do this, then this sets me up in a certain way.
Mike:Right now, we're doing our year end tax planning for our clients for next year's income. So we're anticipating by holding these positions, you're probably gonna get around this much in your dividends. This much will probably be taxed as ordinary income, this won't be probably qualified dividend. But what if we shift this around? What if we take this much and do an IRA Roth conversion?
Mike:We're gonna be within this bracket, but your standard deductions over here. We are proactively assuming next year, and the things that we can do can save, it's not guaranteed for everyone, but thousands of dollars.
David:Okay.
Mike:There's one guy was we were looking at who's got a side business, and it's just an LLC. I said, I won't say his name, so we'll say David, because you're right here, and I can say your name. David, your LLC, it's just passed through taxation. This doesn't make sense. Let's have you file as an s corp.
Mike:We're gonna have your income this much being now taxes income. Mhmm. So you're gonna pay FICA tax on this and so on, and then the rest is gonna be profit. And because you want your kids to help out, we're also going to have them as employees a part of here. Here's how we're gonna structure that.
Mike:So that lowers your overall income, and you're getting your assets to the kids. That saved him, I think it was like 7 to $10,000. Just in that one little adjustment right there. Yeah. That's net of all of the other burdens of the bookkeeping and things like that he'd had to sign up for because he has to manage things slightly differently in that situation.
Mike:He's more than happy to do that, and that was also fun. This isn't tax planning. This is more legacy planning, but we then were able to structure so his kids were able to be employees of his side business. Now they're able to contribute to a Roth, and they're actually helping him out. It's a legitimate, like, employee situation.
Mike:Right? So now they're gonna be funding their Roths at the ripe age of 16 and 17 years old. And if they just put it in high growth vehicles just by funding the 16, 17, and 18 year old Roth contributions, probably half his retirement has already been paid for before he even starts college. Wow. Yeah.
Mike:So there is so much that can be done when you stop looking at, hey. Let's just pick out your stocks and grow your money, and you you take a step back and you look at the whole picture.
David:Right.
Mike:And a lot of that is tax planning. These are things that are not commonly talked about because a lot of people will have in their disclosures, we can't offer you tax advice. We can't talk about taxes. We can help you with IRA or Roth conversions, but that's kind of the limit of our scope. It's hard, in my opinion, to give investment advice without acknowledging the tax consequences.
Mike:Yeah. How about that?
David:I'll let that sink in. It seems like it should be a no brainer. Right? Well, of course, taxes and your wealth planning and management and retirement
Mike:Yeah.
David:Should go together, should be considered together, but often it's not, you're saying.
Mike:Well, imagine trying to bake a cake with half the recipe. Ugh. And the rest of it, you just gotta guess. Have you ever tried to like, let's say all you have all the wet ingredients. Uh-huh.
Mike:K? But you're not really sure exactly how much flour, so you kind of keep adding it till you think it's the right texture. Right. And you're not really sure about the baking soda or the baking powder, so you're just kinda guessing it. And then you put it in there, and it's like a brick.
David:Yeah. So you've guessed, and it didn't work out.
Mike:I did try once to bake a cake without a recipe. Uh-huh. It did not go well. Yeah. Baking is very scientific.
David:It really is. There's a
Mike:reason why there's a recipe, but that's something you need to consider with taxes. Yeah. There's a reason for certain you don't wanna jump over dimes to pick up pennies. Here's another one I'll just throw out there as we kind of, I guess, end this segment. No one wants to pay taxes.
Mike:I get that. But what's worse? Avoiding a potential tax bill and making adjustments to your portfolio positioned for the next environment for the financial markets, or just writing it out and seeing what happens. Because avoiding taxes could actually hurt you more than help you. Right?
Mike:Avoiding taxes can cause you to get just nailed in a potential market crash. Avoiding taxes means you've given up your ability to make investment decisions or adjustments in your portfolio. So if you have no control, you have already determined the next twenty to thirty years of your life, and you have no willingness to adapt along the way, that's a risky thing to do. That's like saying, alright. We're gonna drive straight for the next 70 miles on this road.
Mike:You've got your car locked in. You're not gonna change anything. You think it's gonna go straight, but you can't see it because there's ups and downs along the way. But what if you need to turn? It's kind of a weird analogy, but does it make sense?
Mike:Yeah. Sometimes it makes sense to just have a higher tax bill. Maybe once every three years, you make a significant adjustment to your portfolio. You pay the tax bills, and, yeah, you're getting hit by Irma, but you're not getting hit by Irma the other two years. You've gotta have some sort of system, some sort of schedule that allows you to adjust along the way.
Mike:You've gotta make adjustments along the way. You don't wanna buy and hold and close your eyes and hope it works out. Just remember, Cisco, the darling company of the nineties Mhmm. Crashed over 80% and took twenty four years just to recover. Woah.
Mike:But they didn't pay taxes, those who didn't sell. Hopefully, that illustrates my point. You don't wanna just get on the roller coaster, not put your your safety belt on, and to hope it works out. You'll wanna be prepared for the good, the bad, and the ugly. It's like when clients have charitable intent, I say, great.
Mike:Donate in January January and December of that same year, and then the following year, don't. It's really hard to exceed the standard deduction. But if you do all of your donations, all of your charitable gifting, you pile it up into the same year, but you just do it in January and in December of the same year, then you're able to probably write off part of it and actually benefit from it. So these are things to consider, but tax planning is much more than IRA to Roth conversions. Though IRA to Roth conversions may be an appropriate part of your overall plan, and maybe you even started earlier before fifty nine and a half, if you understand what I mean there, and there's a lot of nuance.
Mike:It's looking outside of just that strategy and looking at the other strategies, even to the extent of things like qualified opportunity zones, oil and gas partnerships. I know some people that have even used life insurance as a mechanism to utilize some tax efficiencies. Everyone's different, so be mindful of that. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast.
Mike:Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date, go to ww.yourwealthanalysis.com today to learn more and get started.