Finally approaching your retirement years is an exciting time. After decades of contributing to a meaningful career, planning the details of your ideal retirement is likely the next step for you to ensure a seamless transition to retirement. Our physician wealth management advisors can help!
The way that your financial and investment accounts are structured can contribute a great deal to the amount of after-tax dollars that you keep post-retirement. There is a lot of strategy and planning that can go into the asset classes of investments that are held in each account, and even the type of accounts you save in, as well as the priority of which account to max out first before going elsewhere.
For example, holding your most aggressive holdings in tax-advantaged accounts such as an IRA or a 401(k) can be worthwhile. Since those holdings tend to grow the most, it can be beneficial to hold them in a tax-advantaged vehicle. As a second example, it can be a good idea to avoid holding Real Estate Investment Trusts, or REITs, in a taxable or trust account because of the dividends received. These can be held elsewhere for better tax efficiency.
Your Golden Years
You may think that you are the most excited person about your retirement, but in reality, it may be your financial planner.
Yes, you’re approaching retirement, and you’ve done a lot of hard work to get here, and you’ve got lots of great experiences to look forward to — not to mention the vacationing you’re bound to do! But the retirement time frame is an opportunity for your financial planner to save you hundreds of thousands of dollars as you make the transition through retirement, 401(k) rollovers, social security, and required minimum retirement distributions. We’re not saying your financial planner is a complete nerd, but this is an exciting time for strategizing and planning to maximize your wealth.
The Tax Barometer
For years you have been earning wages and paying taxes. Taxes, right? It’s quite possibly your biggest expense. It is this way for a lot of America. As we like to call it, you’ve been working, your tax barometer is way up there, and it’s running on all cylinders. Now with retirement, it’s going to drop — for the time being. But, with RMDs on the horizon, it’s likely going to jump back up. So you see, we’ve got a limited window of opportunity, and you have to take advantage of it. Let’s get into the details.
Let’s jump into an example to illustrate the concept: Jane Doe has worked as a physician for several decades. She is now age 60, and she is retired as of September 1st, 2022. She has planned well and saved regularly. In this case, Jane has $400,000 in after-tax dollars in a brokerage account, and she has $850,000 in her Rollover IRA that came from her 401(k) and $100,000 in a Roth IRA.
Due to Jane’s personal situation, she is comfortable waiting to take social security until age 67, at full retirement age with social security. When she reaches age 72, she will be required each year to distribute a certain percentage of her Traditional/Rollover IRA to herself, and this is taxed as ordinary income. The IRS does this to get “their dollars” out of the account sooner.
Because Jane Doe has saved $400,000 in after-tax dollars, in the next 6 years, she will rely solely on that account to pay for her living expenses. She can use the Roth 100% tax-free, but in our example, she is saving that for later. This $400,000 essentially equates to a budget of $65,000 annually for her to live on until social security payments are turned on. For Jane, ages 60-67 are her “Golden Opportunity Years.”
The $400,000 of after-tax dollars is only taxed at capital gains tax rates; it is not taxed as ordinary income. Therefore, once 2022 is over, we expect Jane Doe’s tax barometer to plummet back down, even to a 0% tax bracket. Working with her financial planner, Jane Doe could do a Roth Conversion annually until age 67 (and maybe even until 72, depending on her ordinary income) to convert her 401(k) savings into after-tax dollars. Yes, she will have to pay ordinary income taxes on every dollar she converts. But Jane is now in an extremely low tax bracket compared to her working years, and where she will be at age 67 and 72. Now is the perfect time to execute this strategy.
Yes, this sounds amazing (because it is), but Jane is very likely to pay tax on her conversion. There are certain IRS thresholds that designate how much income is taxed at certain tax rates. With larger 401(k) balances, the higher the amount that should be rolled over each year, which eventually results in a larger tax bill. Careful planning, analysis, and projections by a financial planner can be immensely useful in maximizing the wealth that you get to keep as you move forward into retirement.
Jane Doe was an example, and for many people, this scenario is different due to the individual nature of personal finance. Some may have poor health and will elect to take social security sooner. Some may want to work well past age 60 or even 65. Everyone is different, and this strategy may not work in your personal situation. That being said, it could be a very viable tool for you.
The Overlooked Principles
What is easily overlooked in examples like these is that Jane Doe had spent years carefully saving and taking advantage of opportunities available to her, such as a 401(k). Sadly, not nearly enough Americans are saving enough or at all for their retirement. Having been a consistent saver and having savings across several different account types enabled Jane to have the flexibility to execute these opportunities instead of only having saved in a 401(k). For retirement planning, the best time to start is yesterday. The second best time is today.
IMAFS Offers Wealth Management for Doctors
Here at IMAFS, we work with many physicians to strategize and plan out their steps along the path to understanding, building, and managing their wealth. We have a team dedicated to wealth management for doctors who help our clients navigate and execute financial strategies like this one. It is our pleasure to customize holistic financial plans to ensure the financial well-being and prosperity of each of our clients.