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Three Tax-Savvy Strategies for Funding Your Retirement

Michael Mechler CFP® CBEC®
July 25, 2022

You’ve worked long and hard to accumulate a comfortable retirement fund. But that’s only half the story. As you move from saving to spending, taxes can have a significant impact on your retirement cash flow. And required minimum distributions (RMDs) can have a significant impact on those taxes.

 

Three Tax Savvy Strategies for Funding Your Retirement

 

People often move to a lower tax bracket when they retire, because their taxable income typically decreases without a regular paycheck. However, large RMDs — which are based in part on retirement account balances — may push them back into a higher tax bracket. And that can mean more of your distribution goes to taxes and less goes into your pocket.

A strategic withdrawal plan can help you manage the tax implications of RMDs and other withdrawals, which can help ensure you have the cash flow you need to support the retirement lifestyle you want. Many people find qualified distributions, Roth conversions and qualified charitable distributions to be useful strategies for achieving these goals.

 

Qualified distributions

Qualified distributions are withdrawals made from a qualified retirement account (like a 401(k) or an IRA) before you begin taking required minimum distributions. Qualified distributions are considered taxable income, so this strategy makes the most sense when you’re in a lower income tax bracket. The strategy isn’t as effective if you withdraw so much money that it pushes you into a higher bracket.

Qualified distributions also draw down your account balance, which may help reduce future RMD amounts, which in turn may help keep you in the lower tax bracket.

 

Roth conversions

Converting traditional 401(k) or IRA accounts to Roth accounts can be another tactic for managing the tax implications of retirement cash flow. Roth IRAs have no minimum distribution requirements, so you can withdraw as much or as little as you need (after age 59-1/2) — generally without paying tax on the distributions. (Note: Roth 401(k)s do have RMDs.) Depending on whether you leave any money in the traditional accounts, a Roth conversion may also help reduce or eliminate future RMDs that could impact your tax bracket.

If you don’t need the funds in the new Roth account, you can let them grow tax-free. Many people earmark them as a legacy for their heirs, who can generally inherit the money income-tax-free.

There are two caveats to Roth conversions. First, you pay taxes on the funds you convert, so this tactic again may make more sense when you’re in a lower income tax bracket. In addition, you may not be able to access the converted funds for five years after opening the account without facing a 10% penalty, unless you already satisfied the five-year holding period with an existing Roth IRA.

 

Qualified charitable distributions

A qualified charitable distribution is a distribution made from a qualified retirement account directly to an eligible charity. This form of donation typically is not subject to tax and may reduce taxable income. In comparison, if someone withdrew money from a retirement account and then donated part of that distribution to charity, the total withdrawal would be taxed as income.

If you’re taking RMDs, the amount of your qualified charitable distribution may also be considered part of the distribution requirement. People must be at least 70-1/2 years of age to take advantage of this strategy, and qualified charitable distributions are capped at $100,000 per person per year.

 

Look at the big picture

These are just three tactics that could be part of a retirement cash flow strategy. Life insurance retirement plans, or LIRPs, may provide another option for tax-preferred retirement income.

Planning for retirement cash flow might also include a cash reserve strategy, which focuses on having funds available to cover expenses for three to six months. These funds might be useful to help weather an economic downturn, potentially allowing someone to avoid tapping other assets until markets readjust.

There is no one ideal strategy for every person. And an approach that makes sense one year may need to be revised the following year, as market conditions, tax rates and other factors change. Your Hancock Whitney team, along with your tax adviser, can help you see the big picture, assess your situation and determine an optimal annual withdrawal strategy that helps you manage taxes and live the retirement life you want.

 

Talk to an Advisor

 

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