Transcription:

Episode 4 – IRA Planning Mistakes with MFS Investment Management

00:13:42

Announcers: The money experience where experts in finance and life experience professionals, chat amongst friends, get comfortable and listen in while we uncomplicate all things money, how to save it, how to invest it, and even how to spend it. Here are your hosts.

Kevin: Welcome everyone to the Money Experience podcast. I’m your host, Kevin McGarry, managing partner of Valley Finance Group. I want to thank everyone for listening in. I’m really excited today we have guests that have been on before Miles Manheimer, and Doug Orton of MFS. Welcome gentlemen.

Miles: How you doing Kevin? How’s things going today?

Kevin: Things are going well.

Miles: I have Doug with me today too. He’s our vice president business development consultant with MFS. He’s been around since 2007 with MFS. He does a lot of planning mistake topics out there today. So, I brought Doug out with this today to go over a little bit of what’s going on in the market from IRA planning mistakes. So, I’ll put Doug right out there and let him get going so we can have some questions.

Kevin: Great, Miles. Thank you Doug, thanks for joining us again.

Doug: Thanks. Glad to be here.

Kevin: And what’s exciting about Doug, everyone is he’s our IRA resource and MFS is a great company that we partner with that helps us with our IRA planning. I think one of the questions coming up lately or concerns with a lot of our clients here is potential tax law changes. Planning for your IRA, your IRA distributions in retirement when you don’t know what the tax laws will be, how do you prepare for that?

Doug: Yeah, I think that’s a great question and I get a lot of concern from investors about what’s going to happen on the tax front. And what I like to stress is predicting what Congress is going to do is really, really difficult, but we can successfully plan for our uncertainty. And one of the tools we use in the financial planning world is diversification. Your listeners are probably familiar with investment diversification, where you buy different types of investments because you don’t know what’s going to do best or worst. They might be unfamiliar with the concept of tax diversification, which is one of the tools we can use when we’re faced with uncertainty.

Kevin: So, when you’re doing tax diversification, like can you explain that in a little bit more detail for us?

Doug: Sure. What a lot of us have is what we would call a tax concentrated portfolio. Let’s say I have a traditional 401K and maybe I’ve got some traditional IRAs and then I’m planning to draw social security at some point those are all taxed as ordinary income, which is one of the higher tax rates that we can be impacted by. And what we mean by tax concentrated is that’s only one option. If I add in maybe a little bit of Roth assets through a Roth IRA or Roth 401K, and maybe even add a taxable account to the mix, I can go from one tax treatment to two tax treatments to potentially three or four different tax treatments. That way my financial advisor, my tax advisor, can work together to figure out what mix should I recognize each year in retirement.

Kevin: Many of our clients, they retire and their biggest assets they retire with is their 401K and they rolled into an IRA and then they want to buy a boat or they want to pay for their child’s wedding and they don’t understand the concept of the impact of that distribution to their tax bill. And a lot of times they’re given a nice gift to the IRS. Is there anything they could do or that you saw or maybe even recommend prior to making that distribution?

Miles: Absolutely. So, I can’t make any tax recommendations but there’s a couple of strategies that I think people should talk over with either their financial or their tax advisor. If you’re in that situation and it’s about to happen, you might want to consider splitting that up between multiple tax years. Let’s say I want to buy an RV, if I take out some of the money in December, I take out some of the money in January, at least I get a two year split. And that would minimize what we call bracket creep, which is if I recognize too much taxable income in a single tax year, I might be in a higher tax bracket than usual. That’s not optimal. The second strategy I might think about is well in advance of any of that occurring, are there things I can do to give myself options? And one of those is using either the Roth IRA or the Roth 401K because in retirement, as long as I follow a few basic rules, those withdrawals from a Roth are tax free. And so I might think about that as a tax emergency fund so that I get to that I’m at the RV show, I need to buy this RV today. If I take it as a Roth withdrawal, I don’t have to worry about the tax liability from it. Not saying that’s optimal. You obviously want to talk to your financial advisor about whether you can afford those large purchases, but the tax conversation is one that people sometimes overlook.

Kevin: Miles, you drive around an RV, right?

Miles: Well, yes. I was thinking a question for Doug actually, because most people don’t realize on their 401Ks that they actually can put it in a Roth. So Doug, explain sort of the logistics or how hard or what the plan availability is, if you don’t mind, just because most people don’t even realize that that’s an option in most 401K plans.

Doug: Yeah, absolutely. That’s a good point because on the IRA side, I can’t make contributions to a Roth IRA if I make too much money, but if my 401K offers Roth, there is no income limit on that. Everybody can take advantage of that. And that’s actually going to change a little bit in 2024. There was a tax act last year called Secure 2.0 and one of the things it implemented was if you’re over 50, you get to make what are called catch up contributions into a 401K. It’s just an extra amount you can put in. Starting next year if you’re considered a highly compensated employee, those catch up contributions will have to be made as Roth. So, if you’re not making Roth contributions now but you’re considered a highly compensated employee under current tax law, that’s anybody who makes over 145,000 a year, you want to talk to your financial advisor about what the implications are going to be of switching to Roth because you won’t have the choice, it’ll just happen starting next year for that particular employee.

Miles: And so Doug, from a bracket creep standpoint, that’s really helps to alleviate that bracket creep by getting involved when the Roth early on. Would that be correct to say that?

Doug: Yeah, so what’ll happen is when you switch to the Roth while you’re employed, that’ll increase your taxes a little bit now, but it’ll decrease your taxes in retirement because the Roth income will come out tax free. The traditional is the exact opposite. It’ll decrease your taxes while you’re working, but increase your taxes in retirement. And it’s one of the things that leads me to what I would suggest is you want to have the discussion with your financial advisor about which one’s better for your individual circumstances because for most of us, sometimes the traditional beat will be appropriate, sometimes the Roth will be appropriate and that might switch multiple times during your career. So, it’s a conversation you want to have with your financial advisor relatively frequently.

Kevin: So in that note, is there any other planning strategies that you recommend? Just plan for the future and what the unknowns of future tax rates?

Miles: Yeah. One of the things is that sometimes we talk about different types of accounts as either tax advantaged or tax disadvantaged. And the more realistic way to think about it is every type of account has both a tax advantage and a tax disadvantage. And the one that sometimes overlooked is the plain old taxable account. The disadvantage of that account is that you recognize taxable income generally every year. You might have capital gains that are recognized, you might have dividends that you might have to pay taxes on, you might have bond interest that’s taxable. That’s the disadvantage. The advantage is that each of those types of income, you get the tax advantage at the time. So, if people are unfamiliar with long-term capital gains and qualified dividends, those are taxed at a lower rate than ordinary income. So, recognizing those in a taxable account, that’s the advantage where if that happened inside your 401K, it gets eventually turned into ordinary income. So, that’s a tool that you might want to talk to your financial advisor about because there’s also no limits on the taxable account. You can put as much money in the taxable account as you want. So, if you’ve already maximized your 401K and your IRA and you’re looking for that next account, that’s an option that’s available to everybody.

Kevin: Awesome. Well, I want to say thank you, but before I do that we wrap this up just takeaways and Doug Miles, correct me if I’m wrong here, is when you’re planning for distributions in the future off your retirement accounts your IRAs, you want to have tax diversification. And everyone’s situation is different in that, and that is sitting down with a financial advisor, a value financial group or whoever you may work with. Also any large distributions and even your monthly income, it needs to be planned a plan distribution strategy to make sure that we’re not giving any gifts to the IRS. And if you’re maxed out on your 401Ks and your IRAs and Roth, you make too much income for a Roth, the taxable account could be a nice strategy. Is there anything else you would add there?

Doug: No, I think you summarized that beautifully. The more options you have from a tax perspective, the better off you’ll be. And then getting advice before you take any sort of withdrawals is a great option because sometimes once you’ve taken that money out, there’s nothing that your tax advisor or financial advisor can do. But if you get advice before you take it, you just have more options and more opportunity to have a more tax efficient retirement income.

Kevin: And for us here, Doug, what we like to do for that is like we create that bucket. If you’re planning your daughter’s wedding or you want to buy that vacation home, or you want that truck, let’s figure out a strategy to fill that bucket up so you can achieve your goals and your dreams there when with the planning. So again, I want to thank you, Doug. You’ve been a great IRA resource for us as well as Miles, you’ve been a great partner over the last 25 years. Thank you for listening and if you have any questions or need any help with planning, our information will be on the show notes. Give us a call, give us an email, and have a great day.

Announcer: Thank you for listening to the Money experience where we’re helping you create experiences and memories to last a lifetime. To reach out to Kevin or to learn more about how Kevin can help you start saving, please visit valleyfinancial.com. To listen to previous episodes of the Money experience, go to valley financial.com/podcasts/the money experience.

This material is intended to be educational in nature and not as a recommendation for any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended for any form of substitute or individualized investment advice. This discussion is general in nature and therefore not intended to recommend or endorse any asset class, security or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment clients, as well as all other readers are encouraged to consult with their own professional advisors, including investment advisors and tax advisors.