Tax-Free Retirement Plans

Investment firms have taken over the management and control of retirement funds. This transition has caused thousands of people’s retirement plans to be switched from safety and guarantees, to risky and unpredictable stock market investments. 

When people direct their money into a 401K or IRA that is managed by a broker or plan administrator without knowing where it is invested or why it’s going there or what they’ll gain from it, they are taking a dumb risk. They are riding the Wall Street roller coaster and are taking unnecessary risk with their retirement funds.

Saving vs. Investing

Saving is putting money somewhere so that when you need it, it will absolutely be there and will be available. It’s money you absolutely do not want to lose. It’s money that you absolutely know for sure will be there when you need it. 

Investing is putting money somewhere, hoping something good will come of it and when you need it, it might be there or you might have lost some of it or even all. This is money you can afford to lose. You are taking a risk with the expectation of making a gain, but you have no guarantee at all. You hope it will make a gain. 

So: Is the money in your retirement plan money you can afford to lose? Which type of plan would you choose to put your retirement money – a savings or investment? If you could choose to put your retirement savings in a plan where the money is secure and has both predictable and guaranteed growth, would you put it there? How about if the plan had all of the following: 

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  • Guaranteed and predictable growth; 
  • Could lock in your principal and the growth, even when the markets crash; 
  • Gives you the control without government restrictions or penalties; 
  • Gives you tax free retirement income; 
  • Lets you use the money in your plan whenever and however you want, without penalty; 
  • Lets you access your money without liquidating your investments; 
  • Allows you to fund it every year with no limits imposed by the government; 
  • Tells you the minimum guaranteed value of your plan on the day you expect to tap into it at any point in time; 
  • No volatility. Your plan does not go backward when the market crashes. 

What kind of peace of mind would this type of retirement plan give you?  

TAXES 

The US currently spends roughly .76 of every tax dollar it brings in on four items: 

Social Security, Medicare, Medicaid and Interest on the National Debt. To properly service this combined debt, assuming those four categories remain the same and do not go up, tax rates to service that debt should increase as follows:

  • the lowest bracket from 10% to 25%; 
  • the middle bracket from 25% to 63%; and, 
  • the highest bracket from 35% to 88%.

We were at similar tax levels during 1960-1963 when the lowest bracket was 20%, the middle was 69% and highest was 91%, so the above levels are not new. We’ve been there before. 

The only way to protect yourself from increasing tax rates is to implement a plan now that will put you in the 0% tax bracket in retirement. This is the only way to protect yourself because if you are in the 0% tax bracket when you retire and tax rates double, two times 0% is still 0%. If you’re in the 20% bracket and tax rates double, you would then be in the 40% bracket. Simple math. No matter what the coming increase might be, when you multiply it by 0, you are still in the 0% bracket. But … you need to plan for this now. 

Tax-Free Plans

First you must understand that money is either taxable, tax-deferred or tax-free. The goal during the years you are working is to accumulate your savings in such a way that all of your income in retirement remains tax-free. 

Your 401K or IRA is a Tax-deferred account. People tend to focus on the ability to get a tax deduction when funding these plans. The real purpose of these plans is not the tax deduction you get when you fund them. Rather, it is to maximize your growth in that plan so that when you retire you have enough there to support yourself for the rest of your life. 

The tax time bomb created by these plans is that the money that comes out during retirement will be fully taxable at whatever the current tax rates will be in the future. Future tax rates are the big unknown. 

Ideally, the strategy is to calculate your anticipated withdrawal amount or RMD from your IRA or 401K so that the distribution will be equal to or less than whatever your deductions and exemptions will be on your tax return. Based on the recent upcoming changes on our tax law, exemptions will be about $24,000 indexed for inflation. 

So, an ideal balance would take into account your anticipated Social Security income, then your anticipated distribution from your tax-deferred IRA or 401K (which will be taxable) in an amount such that the distribution would be totally offset by your allowable deductions/exemptions. The balance of any necessary distributions you need to achieve your desired retirement income level must then come from a tax-free plan. 

If all your eggs are in only the tax-deferred basket, you need to adjust or re-position some of those assets. Planning properly is critical to achieving this balance and it’s not something you do six months before you plan to retire. 

Any contributions currently going into your taxable or tax-deferred plans need to be re-evaluated now according to these guidelines to be able to recognize what amount, if any, needs to be redirected directed to be re-positioned in a tax-free plan. At some point, you will max out what can be accumulated in a taxable plan and what is in a tax-deferred plan, if your goal is to plan to set yourself up in the 0% tax bracket during retirement. 

Understand that this does not mean limiting your retirement income in any way, you can plan this to achieve any level of retirement income you want for yourself. You just need to do the math to achieve the correct balance for your desired income level.  

It’s like everything else in life, those who have good advice will succeed. You also must understand that your broker who is paid a percentage of your assets under management (usually about 2%) will not like this strategy. If you have a $1,000,000 account and your broker is making 1%, he earns $10,000 per year to manage that account. If you re-position $300,000 to a tax-free plan, his income would go to $7,000 per year. 

A Case Study

If you do nothing. Typical husband and wife, age 50 with $500,000 in IRAs, planning to retire at 65. If the growth on their IRAs goes to $1.5 million, they have a problem. You might be thinking, “I’d like to have that problem.” The problem is their taxes. Their RMDs on $1.5 million will exceed their standard deductions, so it will be impossible for them to achieve a 0% bracket. All of their distributions for their retirement will be taxed at whatever rates happen to be in existence when they are retired. They also have to take additional distributions to pay the taxes that are due.  

To add insult to injury, their distributions will most likely cause 85% of their Social Security to be taxable, increasing their tax obligation even more. This will really accelerate the draw down on their retirement accounts. 

So, their strategy NOW might involve stopping the funding of the IRAs and starting to re-direct that money into tax-free plans. Early planning is critical to uncover these problems while you still have some time to correct them. 

 

Information Not Legal Advice. This article has been prepared for general information purposes only. The information in this article is not legal advice. Legal advice is dependent upon the specific circumstances of each situation. Also, the law may vary from state to state, so that some information in this article may not be correct for your jurisdiction. Finally, the information contained in this article is not guaranteed to be up to date. Therefore, the information contained in this article cannot replace the advice of competent legal counsel licensed in your state.  

Disclaimer of Warranty. The material, information and opinions expressed in this article are provided without any warranties, express, implied or statutory. Any and all implied warranties of merchantability or fitness for a particular purpose are hereby disclaimed. 

 

At the Law Offices of Joseph Adelizzi, I have been in practice since 1984, for 35 years.  I am admitted to the California Supreme Court, the Federal District Court for the Southern and Central Districts and am admitted to practice before the U.S. Tax Court in all 50 states.  I have developed an MCLE course for lawyers on retirement planning that I have taught in California and Florida, which has been approved in 23 other states.  I started as a litigator for a law firm that defended insurance companies and became one of their top trial attorneys.  Most estate planning lawyers have never seen the inside of a court room.  I have had the opportunity to prove up a holographic Will and litigate Trust matters for clients because of contests or disputes.  As a result of that experience, I have a different focus when I draft my client’s estate plans if they tell me they expect certain issues may arise.  My philosophy is to protect my clients from the government intrusion into their personal affairs.

Joseph Adelizzi is an attorney with the LAW OFFICES OF JOSEPH ADELIZZI and has been practicing for 35 years. He has developed an MCLE course for lawyers on retirement planning that he has taught in California and Florida, which has been approved in 23 other states. His philosophy is to protect my clients from the government intrusion into their personal affairs.

For more information, call (760) 632-1338 or connect with him on Facebook at “The Law Offices of Joseph Adelizzi.”