Lifetime Planning: How to Optimize Your IRA and Reduce Taxes

February 12, 2024 – In today's Lifetime Planning episode of the Financial Sense Newshour, Jim Puplava and Crystal Colbert explore the potential advantages Roth IRAs present in retirement and estate planning with tax-free growth and distributions, provided certain conditions are met. The podcast also addresses how retirees can navigate the positive and negative impact of higher RMDs, which can influence their taxable income and consequent tax bracket, especially before anticipated tax increases with the likely expiration of the Tax Cuts and Jobs Act.

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00:00:00: Introduction

00:00:16: Tax implications of increased distributions

00:00:24: Introduction to Crystal Colbert

00:00:30: RMDs based on last year's closing statement

00:01:07: Possible implications including increased Medicare premiums

00:01:42: Higher distribution rates with age

00:02:31: Last two years of Trump tax cuts

00:03:05: Discussion on possible increase in taxes

00:03:49: Importance of having Roth assets

00:06:04: Legacy planning with Roth IRA

00:08:15: Discussion on a powerful tax planning tool: growing dividend streams

00:09:28: Implications of the Trump tax bill on beneficiaries

00:11:49: Role of charity with RMD distribution

00:14:03: Importance of staying in the lower income bracket to avoid high taxes

00:15:09: Planning strategies and avoiding a perpetual tax trap

00:16:35: Plan now to enjoy lower taxes in the future

00:17:04: Conclusion


Jim Puplava:
Welcome, everyone, to another edition of Lifetime Planning. Well, with the stock market at record levels and finishing out last year on a positive note, what does this mean for you if you are retired and required to take minimum distributions? Well, your distributions are going to have to go up and there's tax implications. And that's the subject of today's meeting. Joining me on the program is Crystal Colbert. Crystal, let's talk about when it comes to RMDs. Most people don't realize it's the closing statement of the previous year that your RMDs are going to be based on. So since last year was a good year for the stock market, let's begin with that and the implications.

Crystal Colbert:
Yes. So the S&P closed last year at all-time highs. So that means that's great. Know your portfolios are larger. But with that, if you know a much larger IRA balance and the calculation for your RMD is the last day of the year, it means that your RMD is going to be higher than it was last year or just the highest that it's been. So when it comes to taxes, we want to be cognizant of the fact that if you're going to be taking larger RMDs for the year, maybe you have to reevaluate your estimated taxes for 2024. The other implications could mean that because you have higher income, your medicare premiums will be increased in due time. So it's just something to really keep track of and think about what you're going to do. Put aside extra tax money onto the side and just really be cognizant of these higher RMDs that are coming.

Jim Puplava:
The thing that strikes me, there's two aspects of this. Number one, if your account balance was higher at the end of 2023, once again, your distributions are going to be based on that higher balance. The other thing that is going to come into play is when you take a look at this, you've got tax rates and you've got higher distribution rates. So every year that you get older, you have to take out a larger percentage of your iron. So there's two things that could hit you this year. Number one, you're a year older. That means you're going to have to take more out of your RMD. And number two, you've got a higher balance. Crystal, let's talk about also for those that are taking RMDs, we've got this two year window. This year and next year are the last two years of the Trump tax cuts because they will sunset in 2026. And if we go back to the old tax rates, you're going to be taxed at a higher tax rate, at a lower level of income. So there's a lot of implications here for planning.

Crystal Colbert:
Exactly. So, luckily, right now we're in historically low tax rates for we still have 2024 and 2025. So even with larger RMDs, you still have that benefit of the lower tax rates. But like you said, in 2026, we are going to see an increase. So the 22% tax bracket that you may be accustomed to now, that's going to be 25. And then the 24 that you may be accustomed to is going to be anywhere from 28 to 32. So it's definitely a significant jump. So really trying to take advantage of 2024 and 2025 for Roth conversions is going to be something that you should really start talking with your tax advisor about, and your financial advisor about really taking advantage of the low tax rates, reduce your taxable IRA balances in the future with some Roth conversions, and then ultimately in the future, that will actually lower your RMDs because you have a lower IRA balance. So something definitely to consider in the next two years.

Jim Puplava:
And the other aspect, too, is if you take a look at longevity, people are living longer. What does that mean? It means that every single year you get older, you're going to have to take out more and more. So you might be taking out 6%, 8% of your balance. When you get into your other thing, if you look at the long term returns of the stock market, it's generally gone up. I can remember when we first hit 7000 in the. Remember Ralph Acampora said the Dow would hit 7000. Nobody believed him. And then all of a sudden, it was 11,000. And now look at where we are. We're heading to close to 40,000. So over the long term, the market generally rises, which means higher distributions. Number two, the older you get, the higher your distribution percentages are going to be. So, crystal, let's talk about now. What are the steps or what are things that can be done now for planning opportunities to reduce this tax liability down the road?

Crystal Colbert:
Yeah. So really getting your assets into a Roth IRA by doing these Roth conversions are going to be big for you, especially in future taxes, because with Roth iras, you're not subject to an RMD. So you don't have to worry about future RMDs. The Roth distributions, they don't count towards your ordinary income. They also won't make your Social Security benefits taxable. Any income that you're taking from your Roth is not going to count towards your Social Security taxable benefits. It also won't increase your Medicare IRMA levels. So it's really huge to have Roth assets available to you because of how many benefits they truly have in the future. And then the other aspect to it, too, is if you do have assets in a Roth, if you're really looking for legacy planning when it comes to a Roth IRA, if your assets are in a Roth IRA, your beneficiaries who do inherit it, they are not subject to taxes if they take distributions from a Roth. So even though there's no longer that stretch IRA available, any distribution that they take is tax free. So really, if they were to have it in a traditional IRA, they do have to take it out within ten years. And depending on how large your IRA balances are, that could put them in a significantly higher tax bracket if they're having to take out ordinary income distributions every single year. So, definitely something to make note of.

Jim Puplava:
And the other thing, too, for those of you that want to reduce your income tax rates, most of us are familiar with tax free bonds. These are bonds issued by states where you don't pay state taxes on the income and you don't pay federal taxes. But there's another aspect to a Roth when it comes to tax free, you keep it in there for five years. When you start taking it out, it's tax free income. Now, the best that you could probably get in tax free bonds today is somewhere between three and 4% competitive with treasuries. But here's another aspect. There are a lot of dividend paying stocks out there. Take an example at and T or Verizon, where you're getting six and a half. There's stocks that are paying 8%. So you put these dividend paying stocks inside your Roth, and the dividends are six and a half, 7% or even 8%. What does that mean to you? You are getting 8% tax free on the distribution. And if you take a look at, let's say, the average person could be, let's say, 24% tax bracket, maybe a 6% state or seven. So let's just take, let's say, a 30% to 35% combined tax bracket. So if I take, let me just do this calculation here. So let's say I could get six and a half percent on a stock like Verizon or at and t, and I am getting, I'm in a 30% bracket. That six and a half percent is equivalent to earning 9.3% pretax. We have one of the stocks that we use. I can't mention this stock, but it's over 9%. So pay 9% and you take somebody in a 30% tax bracket, crystal, that's equivalent to earning 13% pretax. I don't know anywhere that I could get a seven, eight, or 9% tax free bracket. And here's the best part about it. It's not just that you're getting six and a half, eight, or even 9% today. These are dividend aristocrats that have a history of raising their dividends. So maybe you're getting six and a half now, but let's say they raised the dividend three or 4%. So next year you're getting six and three quarters. The year after that, you're getting 7%. So imagine owning the equivalent of a tax free bond that increases its tax free income every single year. There is nothing, and I'm telling you, folks, there is nothing more powerful than a growing dividend stream put inside a Roth IRA. It's one of the most powerful tax planning and compounding tools that you can get.

Crystal Colbert:
Exactly. And especially to your point, with income consistently rising and those distributions not affecting your ordinary income or your taxable Social Security benefits or your Medicare premiums, it's huge. You can't see that anywhere.

Jim Puplava:
And once again, I want to point out, it's not just going to be tax free to you, because with the Trump tax bill that came into play in 2017, they changed how you have to take income as a beneficiary back prior to 2017. Let's say you pass away and you have, I don't know, let's just say a million dollars left in your IRA. You have one beneficiary. It's your son or daughter. Back in those days before. Prior to 2017, they would have to take out the income out of that inheritance over their life expectancy. So let's say your son or daughter was age 40. They might have 30 years to take more than 30 years to take out that income. That changed after 2017. Now your beneficiaries have ten years to take out that income. So let's take two cases. You have a million dollars in a Roth, so that's tax free, and you have a million dollars in a regular IRA. Now, you pass away the million dollars in your IRA, your beneficiary has ten years to take that income out. So hopefully they would take it out one 10th each year. So you don't have a big lump sum in any one year because you have penalties if you don't deplete it in ten years. That's $100,000 a year they have to take out. Imagine what that is going to do to your kids tax brackets. If you have to take out $100,000 now, you still have to deplete the Roth IRA. The big difference is not only was it tax free for you, it's going to be tax free for your beneficiaries as well. So that tax free status goes to the next generation as well.

Crystal Colbert:
Exactly. So let's just say there's individuals that don't want to do raw conversions, but they are charitably inclined. Jim, what would you recommend somebody look into if that were the case?

Jim Puplava:
Well, this year you can take a distribution, an RMD, and you can give up to $105,000 to a charity. So the distribution goes directly to charity. So, number one, you met your RMD distribution, but since it goes directly to a charity, it is non taxable to you. So, as you mentioned, crystal, if you are charitably inclined, this is another opportunity for you to reduce your taxes. We're doing that with a number of clients this year. And so there's a couple of other opportunities. If you just don't want to pay the taxes and you have more than enough income, you don't need it. And once again, you are charitably inclined to do so.

Crystal Colbert:
Yeah, and what's awesome about these distributions is you don't have to be itemizing to be able to do it. The only stipulation to it is you do have to be 70 and a half years old to start it. But even if you're not taking RMDs, if you wanted to reduce your IRA balance, it's still not reportable income to you in that year that you do the qualified charitable distribution. So, like you said, you can go up to 105,000 for 2024, thanks to the Secure act, and just start to reduce your balance slowly. So if you are charitably inclined and you do make those charitable contributions, consider it taking it from your IRA instead of just writing that check.

Jim Puplava:
The other thing I'd point out, most people are going to be in the 22% to 24% tax bracket. But here's the problem. We have, like a 12% tax bracket, then it jumps to 22. There's a big jump from that lower bracket to the 22% bracket. The next big jump comes after the 24% bracket. It goes from 24% to 32%. So that's an eight percentage point increase in how much the government is going to take of your income. So this is one reason you want to keep yourself down in that 22 24% bracket. There's a number of reasons for that. You keep yourself in a lower income tax bracket. And don't forget Medicare. Medicare. The more income you make, there are six Medicare brackets. You could be paying four and five times as much in terms of Medicare, depending on like, what if you had a big capital gain? Maybe you were in the magnificent seven or an index fund and you had huge capital gains. Now you have to report them. So you really want to do planning. So you don't jump from that 24% bracket to the 32% bracket because you're going to get killed in taxes.

Crystal Colbert:
Exactly. So there's some great planning strategies when it comes to qualified charitable distributions and incorporating that into your tax planning. So definitely, if you are charitably inclined, take a look at that, because like Jim said, it counts towards your RMD. So if you wanted to lower overall your AGI because your RMD is so much larger this year, that's one way to do it because it is not taxable to you as ordinary income.

Jim Puplava:
So here's something that we're going to tell you. Plan now or you're going to pay more taxes later. So if you're turning 73 this year, you're going to have to start taking an RMD. So if you are that person, you are turning 73 this year. You need to start planning now and you want to work with an advisor so you can take advantage of the different opportunities you have, whether it's a roth conversion or maybe lowering other aspects of your income. So you keep yourself in a lower income tax bracket, folks. You do not want to jump from a 24% bracket to a 32% bracket. And you don't want to be caught in what is called a perpetual tax trap. Remember, in 2026, the income tax rates are going to be going up, number one. And number two, you're going to get hit at higher tax rates, at lower levels of income. For example, the 25% tax bracket for a married couple will be roughly about 154,000 in 2026. Right now, you don't hit the 32% bracket until you have almost 384,000. So the point I'm making, if you don't start planning now, you are going to be facing higher tax rates the rest of your retirement. So don't procrastinate. Set up a plan now to minimize that and start enjoying lower taxes or tax free income. So if you were in that situation this year, give us a call at financial sense wealth advisors. It's 888 486-3939 that's 888 486-3939 remember, plan now or pay more later. I'll behalf of crystal and myself, we'd like to thank you for joining us here on lifetime planning. We hope you have a good rest of the week.

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