Myth or Fact: My income tax rate will be lower in retirement.

While difficult to predict with certainty, more and more factors are siding toward MYTH. Why?

Tax Rates

We are experiencing the lowest tax rates in the US due to the Tax Cuts & Jobs Act, which will expire after 2025. 

Tax Brackets

Inflation “inflated” the tax brackets. The result? Potentially lower taxes.

Traditional IRA Balance

Investors have a considerable amount of their net worth tied up in Traditional IRAs, which is essentially a compound debt to the IRS. Traditional IRAs trigger sizable tax bills when distributed.

Tax Rate Arbitrage

The foundation of solid tax planning revolves around profiting off the spread between tax rates now vs. later. In other words, pay tax when rates are low (e.g., NOW).  Here are some strategies to consider:

Take a Withdrawal

Take withdrawals from your Traditional IRA between 59 ½ and 75 (the new RMD age).

If you don’t need these funds, execute Roth IRA conversions. Pay ordinary income tax on the conversion (don’t withhold from the conversion) and allow the funds to grow in a tax-free environment.

Change Your Contribution Type

Replace your tax-deferred IRA & 401(k) contributions with Roth IRA & Roth 401(k) contributions.  Although you lose the upfront tax benefit, you gain tax-free growth forever.

More Ways to Roth

Are you a high-income earner? Do a Backdoor Roth! You’re eligible if your Modified Adjusted Gross Income exceeds $153K/$228K single/married in 2023.  Watch out for the pro-rata rule!

SECURE Act 2.0 (passed in December 2022) contains provisions that may allow the following:

  • Roth components for SEP and SIMPLE IRAs. We haven’t seen this in action yet; stay tuned.
  • Employer matching contributions may be eligible for the Roth 401(k) bucket; again, stay tuned.

How will future tax rates impact your standard of living? 

Funneling funds into a Roth using the abovementioned strategies permits tax-free growth and serves as a hedge against uncertainty. This “uncertainty” not only applies to your life but also to your beneficiaries, who may inherit the funds! Who knows what the tax rate table has in store for them 😉.

Our Thoughts on Age

Does this strategy depend on whether you are 35 or 65? Maybe. However, that also depends on how you visualize your retirement. Consider these items:

Physical Health

How long you’re going to live and what you need to spend on healthcare before you pass are fundamental financial considerations.

Tax Rate of Your Beneficiaries

Some are of the mindset they want to leave nothing; others feel differently.

Spending Smile

Do you view yourself as wanting to be a “big spender” in the early years of your retirement while tapering off, only to potentially ramp up for health care at the end? This is called the “retirement spending smile.”

Final Thoughts

Roth contributions allow you to pay tax on the seed (initial contribution) instead of the tree (balance later in life).

Connect with us to discuss which strategy is best for you.

Please consult with your financial advisor and/or tax professional to determine the suitability of these strategies. All views, expressions, and opinions in this communication are subject to change. This communication is not an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services.