When it comes to paying taxes, less is less. So says Ed Slott of Ed Slott and Co., who delivered the keynote at TheStreet's Retirement, Taxes, and Income Strategies symposium held recently in New York.
"The less you pay the more you keep -- but to keep more and pay less, you have to have a plan, which almost nobody does," said Slott.
But if you don't have a plan -- like most people -- you'll get a plan, said Slott. "I call it the government plan," he said. "That's not a good plan because that's the default plan. That's what everybody gets."
And when it comes to retirement, Slott said, taxes are the single biggest factor that separates you from your retirement dreams. "We spent our lives, 20, 30, 40 years building, working, saving, investing, sacrificing, so you have something now," said Slott.
Slott likened saving for and living in retirement to a football game. The first half is the period is the period in which you save for retirement and the second half is the period in which you withdraw money from all your retirement accounts.
"People work, save and invest -- that's what I call the first half of the game, and finally they get to retirement and they say, 'Look at me, I have retirement money. I've saved. I've done it,'" he said. "They pat themselves on the back, walk into the locker room, they're done."
Meanwhile, Slott said, the IRS comes out in the second half. "They're playing the third and fourth quarter. They're playing nobody, so they win," he said. "The point is now we have to move into the second half of the game when the money comes out."
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But if you only have money in tax-deferred accounts such as IRAs and 401(k)s, the distributions in the second half will be taxed as ordinary income. According to Slott, there a big between tax-deferred (IRAs and 401(k)s) and tax-free (Roths) and the big big difference comes down to one little word. "And that word is yet, Y-E-T," he said.
"Tax-deferred means you won't pay taxes on that money yet, but you will," he said. "At some future time in retirement, and probably at a higher rate. Tax-free means you'll never pay taxes on that money."
And that means there's an always, definite rule. "Tax-free is always better, you get it?" he asked. "That means you keep 100% of your money. You will always have more money if it's tax free in retirement."
According to Slott, one reason to save using a Roth or convert traditional IRAs into Roth accounts is this: "Tax-free money always grows the fastest, because it's never eroded by taxes, current or future," he said. "You want to move your money... from accounts that are forever taxed to accounts that are never taxed. You don't want to be worried about taxes in retirement."
Besides being tax-free, Roth accounts have another benefit. Unlike a traditional IRA, there are no required minimum distributions for the original account owner. "Probably the biggest single benefit, no required minimum distributions during your lifetime," he said. "That's a huge benefit. In other words, that money can keep growing, compounding, snowballing tax-free. You keep 100% of your money. That's way better than tax-deferred, because if this account was tax-deferred, it might still be growing, but it would be growing for you and Uncle Sam. You'd rather have it growing without sharing, all for you."
Slott also noted that distributions, though required, are tax-free to owners of inherited Roth accounts. "Remember, the Roth benefit tax-free carries over to all beneficiaries, children, grandchildren," he said. "That's the power of the Roth IRA, the snowballing, compounding tax-free over time. In fact, for children and grandchildren going out over 15, 20, 30 years, it's all tax-free."
To be sure, you do have to contribute to a Roth using after-tax money. And every case is different. But it it's likely worth it. Said Slott: "The Roth IRA brings the question: Should I pay a tax now? And I think, every case is different, but it pays to pay some money now. It's like paying off a mortgage and knowing your retirement account is free and clear. The last thing you want to worry about in retirement is future higher taxes eating into your standard of living, your spendable money or worrying about it. Now, if you have Roth IRAs and tax-free sources of income in retirement, you never have to worry about tax increases. In fact, every time there's a tax increase your money's worth more. It pays to buy it now while the rates are low."
Slott noted that Roth IRA conversions are now permanent under the Tax Cuts and Jobs Act of 216. "So you really have to get good advice and do a thorough evaluation because once you convert, it's permanent," he said. "There's no going back like we used to have before 2018."
Slott also said conversions could put you in a higher tax bracket. But again it would be wise to to talk to an adviser about income tax bracket management. "Go over this with your adviser and look at how much you could convert keeping in those low 22%, 24% bracket," he said. "You'll be amazed how much you could push through. Maybe a series of smaller annual conversions over the year may be the way to go to push money into tax-free territory. Forever taxed to never taxed. Yes, you will pay tax on that money now, but never again."
Slott addressed the question of whether we can trust the government to keep its word that Roths will always be tax-free. "My answer is yes on that, believe it or not," he said noting the history of tax laws. "The government has been continuously lifting the barriers on Roth," he said.
Another benefit of owning Roth accounts is this: "If you can keep income low, say by pulling from tax-free sources like Roth IRAs or life insurance... you'll avoid the big income taxes but you will avoid what high income causes," he said. "The higher your income, the higher your tax on Social Security, the higher your Medicare surcharges, the lower your medical deductions, you lose anything good on the tax code, all the benefits, credits and deductions start phasing away as your income goes up, so having lower income in retirement by pulling from tax-free sources gives you more spendable money. You could take money and never have to worry about taxes."
Pathological Savers Should buy Life Insurance
Slott also addressed what he called "pathological savers," those retirees who won't spend their money in retirement. The folks who don't want to spend their money because they want to leave money to their children should buy life insurance.
"Let's just peel off 5% or 10% of that million dollars and buy a life insurance policy," he said. "After you die, the kids you're so worried about, they'll have millions more than you ever had, and it will all be tax-free... What does that mean for the remaining 90% to 95% of your money? You can spend it, you can enjoy it, you can have a life. It gives you the freedom to have a life."
Generally, life insurance proceeds you receive as a beneficiary due to the death of the insured person aren't includable in gross income and you don't have to report them, according to the IRS. Slott also advocated for the purchase of hybrid life/long-term care insurance policies, which is another way to avoid fear of spending in retirement.
Buy Guaranteed Income
Guaranteed income -- perhaps from an annuity -- should be another goal in retirement as well, Slott said. "As you get older, here's another always rule," he said. "Income is always more important than savings, because savings can run out. Look how long people live now, savings can run out."
"You hear all kinds of bad things, good things," he said. "Yes, the stock market returns over time, but sometimes you run out of time. As people get older and they move, I see it in my clients and in myself, closer to retirement you want more safety and more guarantees. I'm not saying for everything, it's good to have some exposure in the market, but I would say for every retiree, for a minimum, for your basic living expenses, those have to be guaranteed. You can't play fast and loose with that."
To be sure, annuities have fees. But you have to look at both sides. "Of course, they have fees," said Slott. "That's what pays for the guarantee. There's no guarantee in the stock market. The fee is you could lose your money. I know the market goes up and down and up and down, but if you need money later in life, like people who wanted to retire in 2008 when the market tanked, they didn't have the years left to get to catch the wave, to get the rebound. They were actually stuck withdrawing from the market, in the declining market. There's a sequence-of-returns risk... It's a fancy name for 'you're out of money'. You can't make that money back. Maybe there's something to be said for these annuities."
In fact, he said getting a guaranteed income check in the mail is the epitome of financial security.
"Knowing you will never run out of money in retirement, at least for your basic living expenses," said Slott. "If you've got that covered, then yes, you can have other money in the market and take that risk and maybe get the upside there, but in retirement you've got to have guarantees... You can't rely on luck, the hope that it'll last. This gives you a guarantee, that's what you really pay for, so it's something you might want to look into."
Slott also urged investors to work with a planner who was competent with retirement planning. "Most advisers are trained to help you make money, that's great, but when it comes to retirement planning, it's what you keep that counts after taxes," he said. 'You can make all this money in the market. The market goes up and down and up. When it goes down, you lose money, when it comes back you get it back. If you lose money to taxes, you're never getting that money back. That's a one-way street. That's why you need an adviser to guide you through the second half of the game, so you don't blow it in the last five seconds."
Slott also urged those attending the symposium to create a plan and act on it. "One of the most popular excuses is, 'If I do planning,' or they would say, 'If I do a will, I will die.' Well, that's true, but the corollary to that if you don't do planning, you will also die with a big fat mess and your family will hate you. Nobody wants that."
And don't wait for special occasion. "Tax rates are low," he said. "This is the time to strike. This is probably the best time in history to move from 'forever taxed to never taxed' and have a tax-free retirement, but you have to take action."
More resources: Ed Slott created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group, which were developed specifically to help financial professionals earn recognition as leaders in the IRA marketplace. He is the author of Ed Slott's Retirement Decisions Guide: 2018 Edition and Fund Your Future: A Tax-Smart Savings Plan in Your 20s and 30s. He publishes Ed Slott's IRA Advisor, a monthly IRA newsletter.
It's never too late - or too early - to plan and invest for the retirement you deserve. Get more information and a free trial subscription to TheStreet's Retirement Daily to learn more about saving for and living in retirement. Got questions about money, retirement and/or investments? Email Robert.Powell@TheStreet.com.