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An Income Strategy for Retirees in their 60’s

Tuesday, January 16th, 2018

An issue facing nearly all retires in America is structuring their retirement income. Common sources include Social Security benefits, IRA distributions, and withdrawals from taxable accounts. Each of these sources have numerous options and limitations which means the right coordination will provide higher and longer lasting income.

Consider a retired couple in their 60’s with large IRA values. Under current law, required minimum distributions must begin after turning age 70.5. The first distribution is 3.65% of the IRA and continues to rise from there. For retires with large IRAs, this might mean withdrawing more than needed and being taxed on those distributions at ordinary income rates which could cause higher tax brackets and more tax liability.

One potential strategy to combat this is to delay Social Security until age 70, supplement current income needs with cash and taxable investment accounts, and initiate partial Roth conversions before RMDs begin. Typically, early retirement years before RMDs are years with relatively low taxable income due to the loss of wages. Since Roth conversions are taxable in the year they occur, this provides an opportunity to convert pre-tax money to a tax-free account at a lower tax rate. Delaying Social Security will eliminate its taxation during conversion years, so the only taxable income would be the conversion amount and any investment account withdrawals. Withdrawals from an investment account ease the tax burden because only gains are taxed at the much lower capital gains rate. If a Social Security recipient lives beyond their early 80’s, delaying payments until age 70 maximizes their lifetime anyway, so this tactic further increases lifetime income.

In a hypothetical scenario, a husband and wife retire when they turn 65. During the taxable years when they are 66-70, the husband converts $75,000 per year from his IRA to a Roth. Upon reaching age 70, Social Security will begin, required IRA distributions are severely reduced, and the couple has access to the tax-free income from the Roth.

This strategy also benefits the next generation. When an IRA is inherited by the owner’s children, they are forced to begin taking distributions from the account as well (if the owner had begun RMDs). These distributions are taxed as ordinary income at the children’s rate which can lead to them paying more taxes. However, when a child inherits a Roth IRA, they are still forced to take distributions, but those distributions are tax-free.

For couples with long life expectancies and who have RMDs that will boost them to the next tax bracket, this strategy can extend the life of their nest egg, reduce lifetime taxes, and increase the amount passed on to heirs. However, this approach incorporates many moving parts and everyone’s situation is different, so due diligence should be taken to be sure it is appropriate. Spousal ages, Social Security benefit amounts, income needs, IRA balances, other sources of income, current and future tax brackets, life expectancies, and other individual factors must be considered to determine if this tactic should be done and the manner in which it is carried out.

For more information on how this strategy can work for you, contact Wilsey Asset Management at 858-546-4306.

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