By Phillis Sax Pilvinis
Once upon a time it was probably true that in your working years you were in a higher tax bracket than you would be in retirement. However, as pensions have phased out, pre-tax 401(k)s have become more prevalent, and life expectancy has increased, this no longer holds true in many cases.
I want to scream it from the rooftops – taxes, taxes, taxes! If you do not have a tax plan, you do not have a retirement plan and this often-ignored facet of holistic planning can have major ramifications.
First, let me be clear – tax preparation is not tax planning. Your accountant prepares your taxes based on what has already happened, not on what will be. Tax planning is a proactive approach to anticipating what taxes you could pay in the future and using the tools available to you right now to mitigate the impact of this on your retirement.
If you are like most people, you do not consider your silent partner when looking at the value of your retirement accounts. For example, if you have pre-tax accounts totaling $1 million you don’t really have that much and the value is unknown because the terms of your partnership can change at the drop of a hat.
A typical scenario is someone who has saved a lot in a 401(k) or IRA, who thinks they are in good stead for retirement. They have paid off their house and have no other debt, but in fact they probably owe more to the government than they ever did their mortgage lender.
In the normal course of doing holistic planning, it is eye-opening when I show people their future tax liability. Often times many people find themselves in a higher tax bracket in their 70s and 80s, than they were in their 60s simply due to their Required Minimum Distributions (RMDs) which they may or may not need.
RMDs, which begin at age 72, can create a domino effect for your whole retirement by generating extra income. This then moves people into a higher tax bracket which often means they have more of their Social Security taxed, and can potentially trigger additional costs for Medicare Part B.
With that said, there is still a great opportunity right now to act while we are in a low tax rate environment. As the tax bill was written, taxes will definitely revert to 2017 rates on January 1 2026. Further, with the deficit at record high and more stimulus on the way this is probably just the tip of the iceberg.
So, what can you do? There are different strategies such as Roth rollouts, which allow you to move your money from forever taxed to never taxed. My mentor Ed Slott taught me it is always, always, always best to pay taxes at the lowest rate possible, and right now it is likely they are as low as they will go for the foreseeable future.
For example, for those of you who have done the heavy lifting and saved a significant amount in pre-tax retirement accounts, there’s a gift for you in the tax code right now – it’s called the 24% bracket. Right now, a married couple can have up to $326,000 of taxable income and stay at a marginal rate of 24% and during my 61 years this is the lowest I’ve seen this go, and I’m a tax nerd. That same level of income in 2026, at the 2017 rates, would blast through the 25% and 28% rates, landing you well into the 33% bracket.
Time and time again, when comparing tax strategies to the conventional wisdom of deferring withdrawals until age 72, we have been able to show our clients a significant amount of tax savings. By strategically withdrawing pre-tax funds to max out the 24% bracket through 2025 and move them to tax free vehicles, most have seen the opportunity to significantly lower their lifetime tax bill and RMDs, as well as reducing the tax liability they leave for their heirs.
However, before we proceed with this, we always do the analysis which includes a side by side comparison of the numbers if they stick with conventional wisdom, deferring withdrawals until age 72, compared to doing strategic tax planning. We of course further verify this with a tax professional to review the accuracy of the numbers.
Every situation is unique, so it is imperative that you work with a strategist to review the actual numbers before blindly acting. Verified numbers do not lie, so let the data speak for itself. Depending on your needs, two prevalent strategies for moving money from pre-tax to tax-free are Roth conversions and properly structured life insurance.
Again, I caution you not to go into this alone because one small mistake can cause a big problem and the IRS is not very forgiving. Not all advisors are created equal, so make sure you are working with someone who is an expert in implementing these strategies. Unfortunately, in my 30+ years in the industry, I have seen both Roth conversions and life insurance structured improperly which can do more harm than good.
As Judge Learned Hand said, “In America, there are two tax systems: one for the informed and one for the uninformed. Both are legal.” So, get informed. Do not be taken by surprise and let unplanned taxes impact your retirement lifestyle and unravel your dreams. Now is the time to act.
About the author: Phillis Sax Pilvinis
Phillis Sax Pilvinis is the founder of PSP & Associates Retirement Wealth Strategists - a Phoenix-area wealth management and retirement income planning firm. She has decades of experience and expertise in helping families achieve their financial goals, and get successfully to and through retirement. She is a charter member of Ed Slott’s prestigious Elite IRA Advisor Group, author of Creating Calm Amidst the Storm and can be heard weekly on Sundays at 8:00 PM on 92.3 KTAR when she hosts her popular radio show Retire Financially Fit with Phillis.