Money Makeover: How to Create Tax-Efficient Income in Retirement

Financial adviser John Kilroy of iValue Financial Planning helps a reader create a plan for tax-efficient income in retirement.
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The Question

Roland and Sarah Hodges “have been stewing” about converting their tax-deferred retirement accounts into Roth IRAs. Roland, 66, started collecting his company pension and Social Security when he retired in 2016.

Sarah, who will turn 65 in June, started receiving her company pension and Social Security when she retired in 2018.

At present, the Hodges (whose names have been changed for this article) “don't owe anyone a thing and live very comfortably on our monthly checks.”

Mr. Hodges reports that his wife had an outstanding 401(k) with her company and that makes up a good part of their retirement nest egg, which he reports as not needing to support their desired lifestyle in retirement.

But they are both are concerned about taxes going up in the future and think a Roth IRA conversion is in order. “I have enough cash to roll our IRAs into Roths,” said Mr. Hodges. “I’m just not sure if it's the best move now. Plus, I'd have to use most of our cash to do it.’

Another financial tactic the Hodges are considering is this: Taking a yearly distribution at least from my wife's IRA just to get the amount down before the RMDs start.

The Answer

The Hodges are probably among many retirees or near-retirees in this country who have accumulated pre-tax retirement accounts, company plans, IRAs, and are entering or nearing the stage of life where distributions will have to be made from these accounts, said John Kilroy, a principal with IValue Financial Planning.

They have already begun receiving Social Security and pension benefits and are convinced they have sufficient resources to maintain their lifestyle throughout retirement and don't need anything from these accounts. “However, they have not engaged the services of a financial planner to prepare a retirement cash flow analysis that, hopefully, will support their beliefs,” said Kilroy.

The Hodges are also concerned with how much of this extra money will be lost to federal income tax and possibly state income tax and have increasingly researched the possibility of converting some or all of these pre-tax retirement accounts to Roth IRAs.

“Like many, I suspect, the Hodges are intrigued by the tax-free growth potential of a Roth account but are concerned whether their non-retirement resources would be significantly diminished by the payment of income taxes on a conversion or conversions,” said Kilroy. “They are also focused on the possibility of higher income taxes coming shortly down the road.”

Before executing partial or full Roth conversions, however, the Hodges will need to review, according to Kilroy, a plethora of financial planning considerations, including income taxation (particularly how to manage marginal tax rates and brackets), the philosophy of their estate plan, the construction of their investment portfolio, the importance of proper beneficiary designations, and a cash flow analysis.

“In other words, a comprehensive view of their financial plan,” said Kilroy. And it’s this comprehensive approach that’s needed more than answering isolated questions about whether to do full or partial Roth conversions or take distributions from IRAs now to reduced required minimum distributions later.

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