by Arif Halaby
The federal and state governments give Americans an opportunity to delay paying income tax on money earned from years of working. These accounts go by the names: IRA, 401k, 403b, Thrift Savings Plan (TSP) or Deferred Compensation (457). Each of these plan names refer to where the regulations are found in the IRS code. So then, what happens at the age of 70 ½? The governments now want their tax money.
This is called a Required Minimum Distribution, or RMD. By being forced to pull out money from your retirement accounts, your taxes and tax bracket can increase. So much so, that as much as 85 percent of your social security income can become subjected to your current income tax bracket. I have seen this reduce retirement by more than $500 per month to a retiree!
Solution: A Roth IRA is exempt from the RMD rules. Consider converting some of your retirement accounts to a Roth IRA each year leading up to retirement. Meet with your tax advisor and financial professional and ask how much you can convert each year without paying huge amounts in taxes. You may be able to use business write-offs, child tax credits, or other credits that allow you to absorb some or all of your tax liability.
When you reach the age of 70 ½ your RMD is only calculated on the non-Roth IRA values. This means when you withdraw money from your Roth, it is NEVER subject to state or federal income tax again, under current law. This includes all the growth since you converted the account. There was an attempt in President Obama’s last budget submitted to Congress (quickly declined) to change this rule. Remember that the political wind may change this benefit out of your favor, so you may want to act sooner, rather than later.
Your goal should be to have a “team approach” towards this issue so that your best interest is the center of focus, which is why we help clients with this process by working with their CPAs and tax preparers. The sooner you begin to plan, the more prepared you will be financially.
Arif Halaby is a Certified Estate Planner in California and President/CEO of Total Financial Solutions, Inc., a financial and insurance services company in Santa Clarita with offices extending to San Fernando, Simi Valley, and Antelope Valley: 661-753-9683