By Mike Gertsema, CEO & Wealth Advisor
Most people work their entire lives saving money in their 401(k) plans or other employer retirement plans with the goal of having enough to retire comfortably.
The goal is to replace their net take-home pay with Social Security, pensions and the income and growth off of their retirement investments.
If they can live comfortably throughout retirement off the income and growth from investments, they want to leave something to their loved ones as their legacy. Sounds logical and obtainable for most people, so what is there to rethink?
In the past three years, we’ve seen some major law changes: the Tax Cuts and Jobs Act of 2017, the SECURE Act signed in 2019, and most recently, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed in 2020.
All this new legislation is impacting your retirement and your financial plan.
Your retirement plan should be a living document that changes as you or as the laws change. It’s not meant to be a once in a lifetime event.
Your plan should have the ability to illustrate the changes for your benefit and adjust your retirement income strategy.
The Tax Cuts and Jobs Act of 2017
The Tax Cuts and Jobs Act of 2017 changed the tax brackets and the standard deduction from 2018 to 2025 among other items. Most people may not have realized much of a change other than they lost the ability to itemize on their income taxes and may have received a federal income tax refund, but that’s probably about it.
However, what we are finding is most people are in a lower income tax bracket and are paying a lower effective income tax rate.
In other words, you may have the opportunity to take more money out of your IRA on an annual basis and pay a lower federal income tax on the distributions compared to the amount of income taxes you paid before the Tax Cuts and Jobs Act of 2017.
The Act is set to expire in 2025, leaving us with the question: what do you expect income taxes to do: go higher, lower, or stay the same?
The SECURE Act
Many people were not affected because they already live off the distributions from their IRA.
But it didn’t change the fact that you may be forced to increase the amount you have to take in distributions later in life and that the higher distributions may push you into a higher income tax bracket.
In other words, if you choose not to research the Tax Cuts and Jobs Act of 2017 and not look forward to the projected RMD in future years, you may find yourself paying more income taxes on your distributions from your IRA at some point.
Not to mention the tax impact on your spouse if you die unexpectedly. The Act also changed the rules on how your non-spousal beneficiaries take your IRA.
They still have the lump sum option and the option of spreading the distributions over 5 years, but they lose the lifetime benefit known as the “stretch IRA.” The lifetime option was changed to a maximum of 10 years, which shortens the time and possibly increases the amount paid in income taxes.
The CARES Act
The CARES Act, signed in 2020, also made changes.
If you are 72 or older and have an RMD, you can skip the distribution in 2020. This didn’t affect a lot of people since they were living off the distributions of their IRAs anyway, but for some, it puts off the inevitable issue of paying income taxes later and possibly at a higher income rate.
At Gertsema Wealth Advisors, we believe our clients and the public deserve the right to know how the major law changes will affect them, their retirement income strategy, and their estate planning.
The misconception is their tax preparer is supposed to be telling them, however in most cases, your tax preparer has no information regarding your total financial picture, they simply have what you’ve provided them, which is your income (W2 & 1099s), so they can determine your tax liabilities.
If you are working with a good financial advisor, you should have a financial plan that includes tax planning that’s reviewed annually, because it’s as important as your investments and their performance.
The major law changes combined with your retirement plan and estate plan has the potential to significantly improve your plans and your legacy.
Don’t Worry, You Still Have Options
If you go to the Tax Cuts and Jobs Act of 2017 and discover that you can take more out of your IRA at a lower income tax rate, a great option is available:
- Convert the distribution from the IRA to a Roth IRA through 2025.
- Pay the income taxes now at a lower rate and let it grow tax deferred for tax free distributions to use in the future or to give to your beneficiaries as a legacy.
You’ve heard of asset allocation and diversification, right? What about asset location?
We’re giving people the opportunity to have access to an after-tax account which is an Individual or Joint Account, an IRA Account which is taxable, and/or a Roth IRA account which is tax-free.
If we find income taxes go higher in future years and it is taking more of your distributions for retirement, we can reduce the tax burden with asset location – taking distributions from each type of investment and reduce the overall income tax liability.
Another great feature with the Roth IRA is there’s no required minimum distribution during the account owner’s lifetime, which allows you the flexibility to grow the account and leave a tax-free benefit to your beneficiaries.
Plus, your beneficiaries have the same distribution options on the Roth IRA as the IRA: lump sum, 5 years, and 10 years.
Can you imagine your beneficiaries having an investment that can continue to grow with a tax-free distribution? What a legacy!
So Where Do You Go from Here?
If your financial advisor is not bringing this to your attention, explaining the income tax changes, and going over your income tax returns annually, you may have the wrong advisor. You can read more here.
If you’re interviewing advisors, we have a list of questions you should ask.
By utilizing our technology, we can illustrate the law changes, different strategies for distributions, Roth IRA conversions, and different amounts on a digital screen right before your eyes.
We generally project life expectancy of age 90 and illustrate how changes made today may affect your current cash flow, taxes, and estate.
We personalize all of our plans and projections with our client’s current financial information and clearly and simply break down:
- How the law changes affect their lives
- Their income tax returns and retirement cash flow,
- And, the pros and cons of their financial situations – which helps them make good decisions for today, tomorrow, and their future.
It’s very exciting to watch clients’ facial expressions when we illustrate the opportunities that they have today by providing them personalized information and the digital experience that has a direct impact on their lives.
This is all part of our regular portfolio review process for our clients and it should be yours as well.
We have a mission in life and we want everyone to understand the financial opportunities that are available to all us, not just a chosen few.
We make the complicated simple and we strive to empower you to make life’s decisions on your terms.
If you’d like to contact us, feel free to contact us here.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Converting from a traditional IRA to a Roth IRA is a taxable event.