Beware the retirement savings ‘time bomb,’ tax expert warns
It’s all about the taxes.
That’s the key concept for retirement savers specifically because IRAs and 401(k)s are only tax-deferred — not tax-free.
“These funds have not yet been taxed, so you need a plan to minimize these taxes [so you] can keep more of your hard-earned retirement money,” Ed Slott, a certified public accountant in New York and an expert on IRAs, told Yahoo Finance. “It’s what you keep that counts.”
This planning has always been the core of Slott’s retirement tax planning strategies. “Always pay taxes at the lowest rates,” Slott told Yahoo Finance. “People miss this critical point and often end up paying much more in taxes in retirement — when you’ll need the money the most.”
Slott is the author of the new book “The Retirement Savings Time Bomb Ticks Louder: How to Avoid Unnecessary Tax Landmines, Defuse the Latest Threats to Your Retirement Savings, and Ignite Your Financial Freedom.” Here’s what he recently told Yahoo Finance about minimizing taxes in retirement, edited for length and clarity:
Read more: 3 ways retirees can save on taxes
Yikes. Scary title to your new book, Ed. What is the retirement savings bomb, why is it ticking louder?
The time bomb is the tax embedded in every traditional IRA and 401(k) account that is tax-deferred. I’m not talking about Roth IRAs and 401(k)s.
The reason I’m saying it’s ticking louder — I always felt it was ticking — but now it’s really loud is, at some point, taxes are going up to pay the big debt this country is facing. People complain about taxes. But the top federal tax rate from 1946 through 1963 was 91%. In 1964, it went down to only 77%. I was only 10 years old then, but I heard the whole country did a happy dance. Look where we are today. The top rate is 37%.
Provisions in the 2017 Tax Cuts and Jobs Act (TCJA) that lowered individual tax rates are scheduled to expire on Dec. 31, 2025, unless Congress acts to extend them. So you have less than two years left where you can take advantage of today’s rates before they might go back up.
What’s the foundational principle of all good tax planning?
Always pay taxes at the lowest rates. People don’t do it because they don’t want to pay tax before they have to. So the idea of converting to a Roth IRA bothers them. The way I see it, you need to use these two years to get money out of those taxable accounts. Start trimming those IRA balances while you can get them out at the lowest rates and move them away from the tax man into what I call tax-free territory in a Roth account.
What is the single greatest threat to retirement dreams?
Future taxes. I am worried about tax rates rising for people in their retirement.
Can you explain savings protection versus investing?
I look at retirement like a football game. The football game is easily divided into the first half and the second half. The first half is the accumulation phase. Everybody’s familiar with that. That’s when you do all your work. You’re building, you’re saving, you’re investing, you’re sacrificing to have more.
The problem is, most people, when they get to halftime, think that’s the end of the game. They’ll come in and say, ‘Ed, I’m retired. Look how much I saved for retirement.’ They think the game’s over. Meanwhile, the IRS comes out to play in the third and fourth quarter. They’re playing nobody, so they win. Investing and saving is the first half, but protecting that money is the second half.
For most people, their largest single asset, other than maybe their home, is their IRA and 401(k) account, and those are loaded with taxes. So the second half of the game is what counts. Many games are won or lost in the last five seconds of the game on some kick as time runs out. It’s the same thing here.
You could really blow it in the second half of the game through paying large amounts of taxes, excessive and unnecessary taxes, or lose it to unnecessary penalties, or not knowing simple rollover rules or early distribution rules.
The stock market is booming, and retirement savers are happy. Isn’t that a good thing for retirement savers?
That’s more money you’re going to fork over at some point to Uncle Sam. Remember, a lot of your IRA or 401 (k) is not yours. There’s a mortgage on it, like a mortgage on a home, a debt owed right back to the government. Most people should probably stop contributing to traditional 401(k)s and IRAs and go Roth 401(k)s or Roth IRAs.
Clients tell me all the time, ‘in retirement, I’ll be in a lower bracket because I won’t have income.’ They miss the point that if they do nothing, the IRA continues to grow. And at age 73, the new required minimum distribution age, they’re going to be forced to take it out.
What is the biggest mistake people make with distribution planning?
Not taking out more when rates are lower, being shortsighted. You have to take the long view over the long haul and pay taxes. If you can get it out at low rates, that really is the secret. But people don’t do it because who wants to pay taxes before you absolutely have to. If you don’t, though, you’re going to be forced to at age 73. You want your plan, not the government plan, when your options fall by the wayside.
It pays to take distributions before you have to in order to take advantage of these low rates. Do a Roth conversion, or put it into some kind of tax-free vehicle like life insurance. The minute you get those funds into tax-free vehicles, they grow and compound for you.
What’s the best option for most people when they retire, or they move to a different job when it comes to their employer-provided retirement account?
It’s generally the IRA rollover. But there are other options. You can keep it in your 401(k), or roll it to a new company’s 401(k) plan if you get a new job, or take a lump sum distribution. The IRA rollover gives you the most control.
What are your best tips for people who will take a required minimum distribution this year?
Invest it. No reason you have to spend it unless you need it for living expenses, and you can take out more than you have to and start spreading the tax over more years of these low brackets.
Once you’re in RMD territory, you must take that RMD, and that can’t be converted to a Roth IRA. So take the RMD and then take a little more, if you can, and convert that portion. The idea is to get that taxable IRA balance down as low as possible. Because if it just builds, you are going to have these taxes.
Can you talk about the idea of charitable giving and your RMD?
Your RMD is your best asset to give to charity. Take advantage of the Qualified Charitable Distribution (QCD). Give the charity your taxable accounts. The charity doesn’t pay tax.
Some people have favorite causes or charities or want to give to their alma mater. You should do it with taxable IRAs. And one of the best ways to do that is a direct transfer from your IRA to a charity.
The QCD is available to IRA holders who are age 70 1⁄2 or over when the distribution is made, per the IRS rules. You can donate up to $105,000 total to one or more charities directly from a taxable IRA. That would be a reason to roll over to your IRA and not keep it in your employer’s plan because you can’t do a QCD from an employer plan like a 401(k).
You are getting it out at zero tax and giving it to a charity, something you would’ve done anyway. It’s a great way to get money out of your IRA and fulfill your charitable intent. Plus, if you do it correctly, with the timing of it, it can offset your RMD.
One caveat: I would only do it if you’re already giving. I never say give to charity for a tax break.
Kerry Hannon is a Senior Columnist at Yahoo Finance. She is a career and retirement strategist, and the author of 14 books, including “In Control at 50+: How to Succeed in The New World of Work” and “Never Too Old To Get Rich.” Follow her on X @kerryhannon.
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