The Ticking Tax Time Bomb in Your Retirement Account, Ep #12
How much of your retirement will be available to spend? Most Americans aren’t aware of the ticking tax time bomb in their retirement accounts. In this episode of the One for the Money podcast, I share ways you can get the most out of your retirement investments. Listen to learn strategies to overcome the uncertainty of future taxes.
In this episode...
The ticking time bomb [01:04]
Roth conversions [05:48]
The benefits of being tax diversified [09:09]
Reasons not to consider Roth conversions [10:38]
The importance of rebalancing [11:54]
Future taxes and retirement accounts
The vast majority of retirement accounts held by Americans are in the form of traditional IRAs and 401. Contributions to these accounts are pre-tax, meaning that future politicians will determine the amount left to spend in retirement. So, in a sense, these retirement accounts are co-owned with Uncle Sam.
While we can’t predict what taxes will be, I can think of 30 trillion reasons why taxes could be raised. The U.S. Debt Clock online has interesting information highlighting U.S. debt ratios, the largest budget items, and other fascinating census type data. These references to the deficit and taxes aren’t an endorsement or criticism of any political party. The reality is that these factors affect everyone, and we need to prepare as best we can.
Taxes can go in one of three directions: lower, higher, or stay the same. In 2022, taxes are at historic lows, so many don’t believe there’s a risk of lowering taxes. Meanwhile, deficit spending has never been higher. Therefore, you will want to be proactive in your approach to when you pay income taxes.
Becoming tax diversified
We can approach the unknown of future tax rates by becoming as tax diversified as possible. Otherwise, tax rates may determine your lifestyle in retirement because of the amount you’ll have remaining to spend. Americans have two options. They can either hope that taxes will be lower in the future, or they can implement strategies via a plan to become tax diversified.
Roth conversions can be the most powerful way to reduce future taxes when the conditions are right. They work just as they sound by converting portions of not yet taxed accounts to an already taxed account, also known as a Roth. There are no income limitations on these conversions. Remember that income taxes will be paid in the year of conversion, so Roth conversions make the most sense in years where your income is lower. Because of the many factors involved, I recommend you speak with a certified financial planner and a CPA about this before trying it out on your own.
Rebalancing investments
Rebalancing is when adjustments are made to investments to bring them back to specific ratios. This adjustment is made when part of your investments do better than others, causing the ratio of your portfolio to change. Rebalancing would sell a percentage of an investment and reinvest that to achieve the intended ratios.
Many of my clients rebalance investments quarterly. This strategy was beneficial during the so-called COVID correction. The stock market had hit a low in March, just before rebalancing. This dip meant we sold investments and reinvested them into the stock market at much lower prices. While we were fortunate in the timing, it doesn’t lessen the positive impact rebalancing had on the rest of the year.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
Resources & People Mentioned
Ed Slott, CPA - Professor of Practice - The American College of Financial Services | LinkedIn
Increase Individual Income Tax Rates | Congressional Budget Office
The Ticking Tax Time Bomb in Your Retirement Account — Better Planning. Better Life.
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