$1 Million Retirement Account
For many, accumulating $1 million in savings is seen as the ultimate goal for a secure retirement. It's a figure that has traditionally symbolized financial readiness, promising peace of mind in the golden years. However, as economic conditions shift and personal retirement goals evolve, it's time to reconsider whether this milestone is truly one-size-fits-all. If your retirement plan account has reached $1 million, it's time to speak with an advisor about tax planning.
Meet John and Lisa, both government employees planning to retire at their earliest retirement age. Both are what we like to call super savers; for years they have been maxing out their thrift savings plan (TSP) contributions and their IRA contributions. In addition, they invested in non-retirement accounts every year. John and Lisa reached out to Red Clover to see if they could retire early.
Roth vs. Pretax Retirement Plan Contributions
At this point in John and Lisa’s career, their salaries are nearing the career peak. They are in a higher tax bracket than they were a few years ago and because of that had defaulted to making pretax contributions to the TSP.
We analyzed the income taxes they are paying while working vs projected income taxes in retirement. Based on that analysis, we determined that pretax contributions were only reducing the annual tax bill by a small amount. Changing to Roth TSP contributions increases current income taxes modestly but significantly reduces lifetime income taxes.
Retirement Income Plan
Beginning to withdraw 4-6% of the balance in your pretax retirement savings, as soon as you retire, can help to reduce your required minimum distributions in the future. This strategy will not only fund your spending needs in retirement but will also reduce their lifetime tax burden.
Roth Conversions
For those that want to leave a tax friendly estate to their heirs or are married, beginning to convert some of the pretax retirement savings to Roth can significantly reduce your lifetime tax burden.
Since John and Lisa are married, inheritance of the retirement plan in the event of one spouse’s death must be considered. Doubling the amount of pretax retirement savings and moving to a higher tax bracket because of the death of the spouse, will significantly increase income taxes for the surviving spouse. We analyzed how much more income they could realize and stay in the same tax bracket. We convert this amount each year so that the future growth of the assets converted will be income tax free.
Charitable Giving
Giving back to the community is a priority for Lisa and John. They make significant charitable gifts each year. Unfortunately, cash gifts to charity, do not give as much of a tax break as they had in the past.
Lisa and John have some individual stocks that are carrying large capital gains. We recommended that they gift shares of these stocks to a donor advised fund instead of making cash gifts to the charity. The charity will still receive their gift, Lisa and John will take the same income tax deduction and as an added benefit, avoiding realized capital gains from the sale of their stocks.
Once Lisa and John turn 70, we plan to make the charitable gifts from their pretax retirement accounts. This will provide a larger tax deduction than making gifts from income or non-retirement savings. Once their required minimum distributions (RMD) start at age 75, the charitable gifts will count towards their RMD.
The Benefits of Tax Planning
These combined strategies have the potential to save over $2,000,000 in lifetime taxes for Lisa and John. More importantly it will enable them to retire in their early 50’s and start living the life they have always wanted to live.
If you're interested in developing a retirement plan tailored to your unique situation, consider scheduling a consultation with a Red Clover. We can help you craft a strategy that ensures security and satisfaction in your retirement years.