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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.
Tax binding is extremely complicated, but those who pay attention typically come out very well. Welcome to the Retire On Time podcast. I'm Mac Decker with David Franson here with Ketrick Wealth. As always, text your questions to (913) 363-1234, and we will feature them on the show. Remember, this is just a show, not financial advice.
Mike:Do your research, and if it makes sense, you can call a professional to help you along the way. Alright, David. What's going on today?
David:Hey, Mike. How do you solve for tax efficient retirement income? Oh, it's a okay. So there's a lot here.
Mike:Yeah. Tax efficient income. Usually, people are gonna gravitate towards the idea of Roth income. Right? So Roth will grow tax free and pay out tax free.
David:That's why it's very efficient. Right?
Mike:It's the easiest answer, but it's the wrong answer most of the time. Ah. And you have to think about where's your money right now and where do you want it to go. And there's two places you want it to go. That's three places you're gonna want it to go.
Mike:Okay. One is as income. That's usually what the most popular question that you get in retirement planning is, how do I generate income? So Yep. Your money needs to generate income.
Mike:The second one is your money may need to may wanna make it to a Roth.
Mike:Because you might say, well, I know what taxes are now. I don't know what taxes are in the future. If I can move money into a Roth at a tax rate that I know, you know, the devil the the devil you know is better than the devil you don't. Oh. So you can get it to the Roth now, and then if taxes are worse later on, you're not affected by
David:it. Doesn't matter.
Mike:It's kinda like just defining things right now.
Mike:And that that in some sense makes makes sense. Yeah. Okay. And then you have your legacy. So you don't need it right now as income.
Mike:You don't really intend to be concerned about it for for tax reasons, so you just wanna grow it and then pass it on to your beneficiaries. Now let's solve for that one first.
Mike:For tax efficient income, if you quickly get everything to a Roth, then your kids are gonna get so many of your kids are gonna get everything in a Roth, they have to take it out within ten years for tax purposes. So they're not being taxed on it. It's just they have a a limit based on current tax law. Well, you could just leave it in your IRA and then not pay the taxes. There's RMDs to account for.
Mike:Then so ask me about that if I forget about it in a second. But that's if if you keep it in your IRA, that's a higher dollar amount than the net of tax difference. So when you think about dollar for dollar, you can grow it. You can grow more money faster because of compounding interest. So if your kids are not high income earners Mhmm.
Mike:Depending on your account size, it may actually be better for legacy purposes to just grow the money, take out the income you need. Maybe that's your RMD. Maybe that satisfies it, and you let it just grow, grow, grow, grow, and then your kids are paying the taxes at their tax bracket or their tax situation compared to yours. Now for some people, your tax rate is greater than what your kids are likely gonna be. For other people, and this is your tax rate in retirement.
Mike:For other people, your tax rate in retirement might be less than your kids now or in the near future or distant future if you live a long fruitful life. Mhmm. So do you see how it that complicates the legacy side. And then you might say, well, Mike, I don't need any of it. So I still need to do some Roth conversions?
Mike:Not necessarily. Because the RMD might force you to take a distribution, but you don't have to spend it. You just have to pull it out of your IRA. Oh. So if you grow the balance, the the the dollar amount in your IRA, and you take an RMD out, you pay the income tax fine, you have you deal with it, but then you just put it into, like, the S and P 500 or some growth funds.
Mike:You know, Vanguard's got a good growth fund. Their their Dimensional Funds has a great growth fund. There's lot of great growth funds out there, and you let it sit, well, then your kids are gonna get that in a step up with a step up in basis. Mhmm. Right?
Mike:So the capital gains that you'd have to pay if you sold it, you they don't have to deal with that. And so if you think about growing the highest dollar amount, then the legacy plan, you might really not wanna be aggressive with IRAD ROTH conversions. It just depends on where it's going Okay. And their tax situation. And so that's it that's counter or that's that contradicts common ideas.
Mike:Yeah. Well, I need to do this. Well, why? Where is it going? How is it going to get there?
Mike:So that's the legacy side. Now let's talk about income. K? K. So many people will say, I need to do IRA to Roth conversions because I'm concerned about income tax in the future.
Mike:Well, that's a true statement. It makes sense why people would wanna be concerned about taxes in the future, especially when you consider our deficit.
David:The country's deficit, federal deficit? Yeah. Okay.
Mike:Yeah. It it doesn't go down.
David:It never seems to go down, does it?
Mike:It it they're just gonna put it away or something. Yeah. Alright. It it well, it did. And Republicans hate when I point out that the the the budget was balanced with Bill Clinton.
Mike:Oh, yeah. And then they all say, well, but Newt Greenwich was not that's right. Yeah. We had a Democratic president. There was Newt who was a Republican, so you had Democrats and Republicans talking together and sorting things out.
Mike:They worked together. They actually worked together. So, you know, if that ever could happen again, then maybe we'd balance the deficit and we'd start paying down our debt or something amazing. Yeah. But that's probably not gonna happen anytime soon.
Mike:Doesn't seem like it. No. But we can hope. It's it's okay though. Yeah.
Mike:But where was I going with that? Oh, so but you so you have this idea of, okay, I wanna just be done with this. You know how that that satisfying feeling of checking something off the box? I do. Yeah.
Mike:It feels great. Right? It does. Balance is difficult because balance requires you to kind of thread the needle and be okay with some sort of risks and do an indelicate dance for the rest of your life. Well, for the rest of your life, according to tradition, there's usually a standard deduction.
Mike:Okay. Yeah. So if you were able to find balance in your plan, and let's say most of your assets are in IRA or a four zero one k pretax Mhmm. And your you did some IRA to Roth conversions, but you got to a place where you're in the 10 to 12% tax bracket, they typically don't tax the risk or they don't typically tax the poor or adjust the poor rate often.
David:Oh, right.
Mike:Right. It's usually ten, twelve, used to be 15%. It's kind of in that range. So if your income is in the ten, twelve, or 15% range, I know it's not 15% today, I'm just citing other versions, that's an appropriate tax range. So if you're taking your income out of it and you can maintain that, you're gonna have more dollars in your account to grow, and you're paying less in taxes along the way.
Mike:Okay. So why would you do quick conversions in today's rate at that 22 or 24% tax rate
David:Oh, right.
Mike:When you could sustain a lower tax bracket? So you you convert enough to then maintain the lower rate. Are you with me so far?
David:Yeah. So in retirement, you're converting enough assets along the way from IRA to Roth just to stay in those brackets.
Mike:You convert enough that your the income that you want Oh, yeah. The RMDs are not greater than the lower tax brackets.
David:I see.
Mike:So then you could sustain that the RMD everyone's scared about Yeah. Is within a tax efficient threshold that leaves more money to stay in your account as opposed to being paid out in taxes for some tax benefit. Mhmm. So that it it sounds odd when you explain, well, keep money in there and pay more taxes over time, but it actually is better for you because you've got more dollars that are being left in there. You have more dollars to grow, compounding interest is more favorable for you.
Mike:Uh-huh. And now then you can consider standard deduction, for example. The standard deduction would allow you to then let's say, these are not real tax bracket rates.
Mike:But just for easing easing you know, let's say you're gonna take $50,000, and let's say the standard deduction is not 32. Let's say it's 25,000. Let's say it goes down.
Mike:So 50,000, 25, you get because of the standard deduction in some future arbitrary rate that I just made up.
Mike:And then 25,000 is now split between a 10 or 12% bracket. That's very tax efficient income. You get 50,000, only 25,000 is taxed, and it's only taxed at a fraction of the cost. That's a good long term strategy. So you don't wanna go to zero.
Mike:You wanna understand the balance of this. Are you with me so far?
David:Mhmm. Yeah. K. We're getting efficient here.
Mike:Now let's let's bridge in. Maybe you've got some brokerage funds.
David:Oh, yes. This is after tax money that is subject to capital gains. Right? Yep. Okay.
Mike:Yeah. So if you sell it, you pay capital gains, whether it's long term capital gains or short term capital gains. Alright. Now let's say that you've bought and held certain positions for a long term period of time, and now you're able to work with these long term capital gain laws.
Mike:So the first 96,000 or so, it changes each year. I can't remember what it is exactly this year to the dollar, but it's about a 100,000 for a married couple.
David:Okay.
Mike:K? All of the gains are taxed there. So let's say the 50,000, 25 thousand's taxed, 25,000 was on the standard deduction, there's still 50,000 of gains. Mhmm. That would be taxed at 0%.
Mike:That's I mean, imagine you have a $100,000 income and only 25,000 of it is taxed at around, let's say, 12%. Yeah. You're not paying much tax. Your effective tax rate is super low. Yeah.
Mike:So to convert enough to maintain lower thresholds for your income purposes is huge. Mhmm. But it requires balance. It requires strategy. Right.
Mike:Now to make sure I'm answering the question, because I kinda went down a rabbit hole, can you remind me what the question was?
David:Yeah. Let's let's double check this. How do you solve for a a tax efficient retirement income?
Mike:Okay. So, again, it's understanding where it's going. We talked about the legacy. We talked about then your, no, your your income side of things. Mhmm.
Mike:What was the third one I brought up?
David:Let's see. We were talking about income. Yeah. Need I wanna make sure I
Mike:get it. Tape. Yeah. No. We don't have that ability, but so it's it's oh, it's growth.
David:Yeah. Oh, legacy growth?
Mike:Or oh, no. The portfolio.
David:Like,
Mike:how you want the portfolio to be. Mhmm. So if you want more flexibility, you want more I think it is. Someone's gonna listen to podcast and say, oh, no. It was this one.
Mike:They got it wrong. Whatever. Just
David:call us out in the comments.
Mike:It's fine. Yeah. But if you consider the growth part of your portfolio, more dollars in there means more dollars that it can grow. It's just it's a big deal.
David:And so have you seen have you heard stories out there of of maybe people or clients you've talked to where the advice they've been given is just, oh, we need to do as much Roth conversions as possible. Just doing Roths for Roth's sake because it
Mike:Well, it's it's fun to say I'm in the 0% tax bracket. I pay no taxes Oh, right. In my life anymore. I'm done. Yeah.
Mike:And does that mean You're paying a premium to be able to say that. It's not financially in your best interest. Here's just a, you know, a simple example. Let's say I have to remember the the so let's say the IRS simplifies the tax code. Mhmm.
Mike:K? This is hypothetical just to prove a point. Yeah. And they said you can convert your million dollars in your IRA from IRA to Roth, and you pay 20% flat. That's it.
Mike:You're done. Mhmm. No cap. As much as you want. Twenty percent one time done.
Mike:So your your million dollars goes to 800,000. You with me so far? Yep. K. And then you take your income out, 4% rule or some arbitrary income like that.
Mike:Let's assume a 6% growth in the portfolio or something around there. Okay?
Mike:So if you take that scenario versus, no, I don't wanna do the 20%, but I'll do 15% for life. And the government says, great. Here's the contract. You've now committed to this. Yeah.
Mike:And you just take out your 4% or so. If you if you have all things being equal Yeah. K, same net income coming out. So the the one that's all in Roth is basically take taking a smaller distribution than the one who's taking it from the 15% because they have to pay the taxes to have the same net income.
Mike:The person who paid the Roth paid 200,000 in taxes. The person who did 15% for life paid like 400 and some thousand dollars in taxes.
Mike:So double.
David:So that sounds like a bad deal off the bat. Like, oh, they paid doubles in taxes.
Mike:But when you consider the the 20%, you know, reduction of the plan or the of the portfolio that now is 800,000 and how a million dollar portfolio versus a $800,000 portfolio, now they're growing at the same rate, the same compounding rate
Mike:The person who paid more in taxes did 15% for life, ended up with significantly more I think it's like $6,700,000 more in their portfolio. Dollars to go to Legacy or dollars to pay for end of life health care, dollars for charitable purposes, dollars for whatever it might be. Mhmm. And the reason is they had kept more dollars in their accounts, and more dollars grows faster based on the law of compounding interest. Mhmm.
Mike:So it's not as cut and dry when you look at tax efficiencies.
Mike:I think I know the third one.
Mike:I I'm gonna quote it wrong, but it's seasonality of your tax planning.
David:Okay. So What does that mean?
Mike:If you're 60 to 65 years old, you're gonna wanna treat your taxes differently than if you're 65 to 67 years old or 67 to 75 and 75 on. Why?
David:Different seasons of your life. Mhmm. Okay.
Mike:You want to, in my opinion, if you can manipulate your tax income to be within the federal poverty line or very close to it. So above $25,000 of taxable income because you you need to show something Uh-huh. In there, but then everything else is basically manipulated through a low effective tax rate. You gotta consider your modified adjusted gross income and your adjusted gross income in this. But you wanna get your taxes as low as possible so you qualify for cheaper health care.
Mike:Oh, yes. Then from 60 to to 65 years old, you're off Affordable Care Act. Now you're on Medicare. You can have a higher income situation, but you're looking at modified adjusted gross income because you've got the one big beautiful deductions. You've got the senior deduction, and the standard deduction.
Mike:Mhmm. Three different layers of of deductions for the 65. Okay. And then so you're now maybe being a little bit more aggressive with that because maybe you haven't filed for Social Security because you're trying to drain down your IRA assets to bring harmony into the balance that you're seeking Mhmm. For tax efficiency.
Mike:So you're bit more aggressive there. Maybe you file at 67 years old and lay off some of the aggressiveness of the conversions. Maybe you don't. Maybe you delay till 70. That depends on your specific situation.
Mike:But the Mhmm. The point here is you've got different windows of opportunities or different seasons for your tax planning to make sure that you're moving money not as income, but where it needs to go for your long term lifestyle and legacy goals so that you can achieve more efficiencies with your cash flow, with your portfolio management, with your tax planning. Right. Tax planning is extremely complicated. It is a it's very delicate.
Mike:It is a nuanced pursuit. Mhmm. But those who pay attention typically come out very well. Yeah. That doesn't that sound easy?
David:Yeah. Sounds so easy.
Mike:No big deal. No big deal, though.
David:All these different income rates and
Mike:tax brackets. But They're constantly changing.
David:Yeah. Right. And it is possible. It's possible for anybody. Right?
Mike:Yeah. If you know the right questions to ask and and how to how to plan. I mean, so we have our our planning software. So what was that? Freeretirementplanner.com Yeah.
Mike:That you can go to and play around with it. All these are on retireontime.com, but that's the Okay. Freeretirementplanner.com goes straight to the planning software that we publicly make available. Yeah. Then you've got free tax planner.
Mike:I think that's what we called it.com. Okay. Again, retireontime.com, the tax planner. You can play with your tax rates. Well, what if, and this is the beauty of it, when people play with the tax calculator Mhmm.
Mike:It's not a legitimate tax return. It's a basic simulation of what could be. Ugh. K? We wanna get you close to it.
Mike:There are too many too many variables Mhmm. When it comes to filing the tax return. We don't wanna overpromise anything. But it's it gets you close enough to understand. Alright.
Mike:And you could say, well, what if I took 50,000 out this year from my IRA, and I realized 20,000 in gains, but I really got this much in income? What would that look like? What if I took all of my income from IRA this year, or what if I took most of my income from the IRA and then I turned on Social Security? What would that look like? When you play and run different what if scenarios, just playing with the calculator, play equals learning.
Mike:Yeah. I mean, look back at how you learned when you were five, six, seven years old. You were playing with stuff.
Mike:You know, if I throw this rock through a window, will the window break? Yes. Right. I throw it against the side of a house, will mom come out screaming at me? Yeah.
Mike:That's those are dumb examples, but that's basically how kids play is if I do this, what's the result?
David:Right.
Mike:Except for a tax calculator, you're not actually filing your taxes. You're not breaking windows. You're just Yeah. Saying, okay, if this, then that. If this, then that.
Mike:You raise your awareness which can help you make a better decision moving forward.
David:Love it.
Mike:That's the idea. Yeah. So if you enjoyed this video, make sure to subscribe, tell your friends, and go to retireontime.com for resources, calculators, books, workbooks, and much more. That's retireontime.com. We'll see you in the next show.