Before passing the SECURE law, I published proposals for withdrawal strategies for the rich. A lot has happened in the eighteen months of that position, and strategies for all future retirees have changed. The pandemic has worsened the economy, we have both a new president and a new Congress, and life expectancy has changed. God latest post deals with reduction strategies until 2021 for low-income retirees, but high-value retirees should also reconsider their approaches.
What has changed?
The rich are likely to have enough money for a comfortable retirement. That’s not the point here. The question is how to maximize the efficiency of retirement to meet other financial planning goals, such as leaving more to charities or increasing the legacy left to heirs. To increase efficiency, a potential retiree should pay attention to market conditions and a change in tax law.
The economy apparently shifted as a result of the pandemic and the government response that followed. The common concern of many financial analysts is that we are in an environment where the economy is struggling while the stock market is booming. This poses a threat from a range of return risks, especially for high-value individuals who invest a significant portion of their wealth in the stock market. One need only look back at the Great Recession to see situations in which individuals who have just retired have suffered as much as a 40 percent loss in their retirement capital due to falling stock prices. Because retirees accumulate their retirement capital rather than accumulating an investment portfolio, an early blow to the value of that capital can have lasting consequences.
The accompanying economic issue is the emergence of inflation for the first time in many years. The onslaught of inflation soon after retirement threatens to permanently lose the purchasing power of retirees – and since that purchasing power is not easy to regain, inflation poses a deep financial risk.
Double threats following the risk of a return and a jump in inflation mean both make up pension portfolio and red decumulations of that portfolio are crucial to achieving planning goals. This means that the “adjust and forget” strategy is likely to disappoint high-value retirees.
When, not if, taxes change
Although the common mantra for retirement planning is working with the tax situation that exists today – which is not possible changes that could happen in the future – these are not common times. Both federal and state taxes are likely to change, and the net outcome will be a tax increase for high-income individuals and net worth. These increases, however, are unlikely to be simply a comprehensive increase in marginal tax rates. The changes are likely to be more nuanced and will provide an opportunity to dampen some of the effects of these increases by carefully arranging the manner and timing of retirement income.
As for the federal income tax, the delay in the entry into force of any tax increase could be a driving consideration. Many income tax benefits from the Tax Reduction and Jobs Tax Act expire in early 2026. The composition of the current Congress and administration would suggest that these tax breaks would at least be allowed. It is also possible that taxes will change before sunset, but the changes are unlikely to have retroactive effect earlier this year. With the prospect of a future income tax increase, the present value of income tax payments today may be superior to the usual savings-deferred savings strategy. The advantage of the way you pay now over the payment later can be presented in a number of ways.
It is not at all wise that the current maximum marginal tax rate of 37 percent is lower than the proposed Obama-era tax return of 39 at percent. In the area of retirement planning, this is becoming a very realistic consideration because there have been more, not less, opportunities to delay income lately. But should you delay when tax rates rise?
With the SECURE Act, minimum allocations (RMDs) have been pushed back from 70 ½ to 72nd. Last November, the IRS increased the RMD table of life expectancy for most retirees, so the distribution needed each year will be less than what would be needed at the moment. This means the ability to further defer taxes on the IRA and 401 (k) into the future. However, income tax on these tax-deferred accounts cannot be avoided forever. Thus, a case may be established for the payment of low taxes on the IRA and on balance sheets of 401 (k), instead of enjoying tax deferral and paying tax at a higher rate in the future.
The tax advantage of paying taxes can now also be shown in the form of avoiding future changes in tax thresholds. Examples include income limits for Part B Medicare premiums and non-indexed net investment income (NII), or the accrued set of qualified deduction of operating income for transient business owners in 2026. In other words, it’s not just the rising marginal tax rate, but other taxes that will in the future to be a bigger bite. An example of a payroll tax where this may occur is the proposed additional FICA tax that would apply to wage earners with an income in excess of $ 400,000. All this together for the future retiree, the recognition of gains, losses and taxes becomes crucial.
An additional complication of the tax combination is the fate of real estate and gift taxes. The property and gift tax rate of 40 percent is still higher than even the proposed upper income tax rate, but currently these transfer taxes apply to only a small subset of high-value demographic data. However, the level of property tax exemption will automatically fall from the current sky-high of $ 11.7 million to about half less than in early 2026. Furthermore, there is a democratic effort to improve that date and further reduce the exemption. to $ 3.5 million, with a concomitant increase in the applicable tax rate. This means that far higher net taxpayers will have to consider whether it makes sense to trade by paying more income taxes to avoid paying high taxes on gifts and property.
We are dealing with a staggering pile of tax reasons for well-cured retirees. There can never be a right approach, because no one knows where the economy and taxes are taking us. Perhaps the best strategy for high-value taxpayers is to get good advice from multiple sources. Some strategies will focus on the product (for example, investments and annuities) and thus on the area of financial advisor; some will be considered on the basis of income tax; and some will be real estate tax planning techniques and gifts that come from real estate lawyers. The prospective retiree should bring together a planning team and develop a coordinated and dynamic approach to adapting to a changing situation. Start with a tax-smart approach for today and agree on how to monitor and change the plan as tax and economic changes evolve.
What are the possible approaches to consider for now? Below are five examples of countless planning options to consider.
1. As mentioned above, save tax by paying taxes. It may be better to pay income tax now at 37 percent than to lower the thresholds and increase rates in the future. In particular, take the distribution of the IRA as an early source of withdrawal of funds to finance pension income needs.
2. Reduce total taxes by converting the IRA into a Roth IRA. Roth’s systematic conversion technique helps distribute income taxes over several years. This approach is currently even stronger as tax rates are likely to increase. Further, because the IRA approach no longer applies to most users of inherited IRAs, the Roths are a way to avoid this trap after tax.
3. Postpone your social security application until you are 70 years old. While there are concerns about the level of funding for this popular benefit, it is one of the few life benefits adjusted for inflation today. Even high-income retirees need sources of income that retain purchasing power.
4. Consider giving gifts, not wills. During this current period in which property tax exemptions are large, many wealthy taxpayers have slowed donations to achieve an increase in the tax base at the time of death. Now that property taxes are likely to apply to those same wealthy individuals, it might be wiser to transfer some wealth right now to avoid high property taxes. This will vary significantly between individuals and careful tax modeling will be required.
5. Take a new look at income that brings irrevocable transfers, either to heirs or to charity. For example, a confidential annuity (GRAT) is an ideal means of securing a certain pension income, while at the same time transferring gratitude from the estate. GRATs are a particularly powerful weapon, while interest rates remain low, and Congress has not yet reduced their use. If the end user of the property is, instead, a charity, the taxpayer should consider a charitable arrears (CRAT) or gift annuity. In both cases, the donor receives current income, income tax relief and removal of property from the property.
The opposite Day happened on January 25, and the Day of the April Fools’ Day has just passed, but there is still a lot of opportunity to move in a different direction than usual. In particular, high-value individuals should avoid general knowledge, avoid basic rules, and approach their pensions with a different plan. The economy is in decline and taxes are likely to change. These new approaches in 2021 can only provide the net advantage sought by high-value individuals.