Episode 8: How to Have a Tax Free Retirement

HERE ARE JUST A HANDFUL OF THE THINGS THAT WE'LL DISCUSS:

• What are all the different types of taxes that can impact your retirement?
• Importance of tax planning in addition to tax preparation
• The true value of tax diversification
• Is converting some or all of your money to a ROTH right for you?

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Ben Christy:

You’re listening to the ‎Beacon Retirement Strategies podcast, where we believe that peace of mind in retirement requires a plan. And when it comes to creating a retirement game plan, there are a lot of things to consider. This podcast is dedicated to taking a few moments to break down some of the more complex parts of retirement to put them into terms that you and I can understand. This is Ben Christy. And today, I’m excited to be joined in studio by our special guest, Mr. Patrick Min. Welcome, Patrick.

Patrick Min:

Ben, thanks for having me. Thanks for getting me away from doing these tax returns. It’s that time of year, my friend.

Ben Christy:

Well, I appreciate you taking the time to join me. So a little bit about Patrick. Besides being a good friend of mine and the Beacon crew, he’s a CPA and a tech specialist who works really closely with the team here at a Beacon Capital. And then beyond that, Patrick has over 20 years of experience as a CFO for both public and private companies, which means that he knows a thing or two about finances and taxes and how it impacts both corporations and individuals. So today, Patrick and I are covering a topic very near and dear to his heart, and that’s taxes.

Patrick Min:

Ben there’s no better time to talk about taxes than today. Most people aren’t focused on the fact that tax rates are at an all time low and the tax rates for individuals is, we talk about this all the time, they expire December 31st, 2025. So an example I like to give people is, if you’re sitting at the top end of the 24% bracket right now and the clock just changes and we jumped to January 1st, 2026, you could be in the 33% tax bracket. So by sitting on your hands and not making decisions and not doing some planning, 9% more of your money goes to Uncle Sam.

Ben Christy:

Yeah. That’s a great point and one that we make a lot. And I think it bears worth repeating, and we’re probably going to say it several more times. But you have more control over taxes in retirement, let me say that again, more control over taxes in retirement than any other time in your life. And that’s a big deal here. So to get started, Patrick, there’s a quote I saw from Forbes that I think really does a good job of kind of establishing a good foundational understanding of the impact that taxes have on retirement. And here’s the quote verbatim: “Retirement tax mistakes can wreak havoc on your financial independence. Avoiding them can help you ring every last dollar of enjoyment from your retirement nest egg. Ignoring them could result in paying more taxes and potentially running out of money before you run out of life.” That’s big.

Ben Christy:

So unfortunately, Patrick, when it comes to taxes, I think there’s a lot of misconceptions out there. But I think one of the biggest that we hear from clients and people coming in, certainly, to the Beacon office is that taxes and retirement, they feel like when it comes to retirement, they’re going to pay less in taxes.

Patrick Min:

Yeah, Ben. I have this conversation with people quite a bit, that one of the reasons everyone has used this tax-deferred strategy that we’ve all done for 40 or 50 years now, putting monies in 401(k)s or IRAs, is because we believe we’ve been told we’re going to pay less taxes in retirement. It all made sense to us because we sat back and said, well, we don’t understand how things are taxed, but I don’t want to have W-2 income. And again, people don’t understand how IRAs and other things are taxed. The other thing, there’s a study. And I’ve shared this with people, and a lot of those folks have just nodded their heads and said yeah. There was a study that was done several years ago talking to pre-retirees. And they said, how much of your current income, if you’re looking forward to retirement, do you think you’ll need in retirement? And they say probably 70, 80%. but what happens is we all get used to a standard of living, so that number tends to be more, particular in those early years, 120 to 130%.

Ben Christy:

Ooh, wow. That’s a big miss.

Patrick Min:

And you know, Ben. You’ve got parents who have done this. They have more time. They’re spending more time with your kids, with the grandkids. You all are traveling more. They’re taking a more vacations and things. So people aren’t thinking about the fact that their income is not going to go down, typically. And the other thing they’re not thinking about, again, taxes are not necessarily going to go down either if their income doesn’t go down. And in fact, again, I think we both believe that taxes ultimately will go up. They have to just from a math perspective with the debt we have.

Ben Christy:

Well, and then you said it. You hinted on this, but the 401(k)s, the IRAs. As a society, as a culture, as small businesses, as big businesses, we’ve all been encouraged, and we’ve encouraged employers, employees, to put money into these tax-deferred accounts. And people are encouraged to do it because they think they’re getting this great tax break. And to a certain degree, they are on the front side. But when does that come out? That comes out in retirement.

Patrick Min:

Yeah, they have to take those distributions at some point in time, Ben. And a lot of people just don’t recognize that. That time when they had to take it has just changed on the Secure Act to age 72. But at 72, there’s something called required minimum distributions.

Ben Christy:

Yeah, absolutely.

Patrick Min:

It’s funny, I’ll have conversations with people in their late fifties, early sixties, and they’ll say, well, what are RMDs, which is the acronym for that, and we’ll start talking about it. And they’re like, oh, I never knew that. So they think they can just leave their money there, they can take it when they want it. No, sir. Uncle Sam wants his cut of that. And he’s got a prescribed time when he’s going to take that.

Ben Christy:

Well, and you went on the show, the radio show, with us earlier. And I know you were talking about the number of trillions of dollars that are sitting out there in 401(k)s that Uncle Sam is just waiting. And it’s only a matter of time. Particularly with a $23 trillion deficit that we’re looking at, you know Uncle Sam is sitting there waiting. What was that number again that you shared?

Patrick Min:

5.9 trillion. And that’s just 401(k)s, Ben. Doesn’t include IRAs. And a lot of people have IRAs. So if you looked at it, and I’m not an expert on this, but I would say that the majority of people have some up to a lot of their retirement assets sitting in tax-deferred accounts and 401(k)s, IRAs, 403(b)s. And the tax piper is going to come and want to get paid on that.

Ben Christy:

Mm-hmm (affirmative). Absolutely.

Patrick Min:

And what people don’t realize is they’re not only paying on the seed. They got that instant gratification on the seed because they were able to defer taxes and their tax bill for a year was low. What they don’t realize is they’re paying taxes on the harvest.

Ben Christy:

Yeah. Yeah. Which is not a good way to be. It’s kind of backwards. So Patrick, let me shift the conversation slightly. So as we go in and we talk taxes, I think one of the things that often gets overlooked, and it’s kind of a little bit of an education gap even, like you said, with people that don’t quite understand the requirement of distributions and how that applies to them, but I think one of the things that we are almost ignorant to the point of sometimes are the number of different taxes out there and how they really impact us. I think people just assume there’s the set taxes and my income tax. And once I’m done with that, or my state or my federal income tax, I’m good. But yet, there are so many different kinds of taxes that we need to be aware of.

Patrick Min:

There are, Ben. And people many times don’t realize even in the basic income taxes what’s taxed, that the IRA distributions they take or taxed, that the pensions they receive, that money is taxed. It’s all taxed when you receive it. So those are income taxes. You also have taxes on your capital gains when you sell something, a stock, a piece of property. There are taxes on those. That can be longterm or short term. You get a little bit of preferential treatment for longterm currently. That could change. There’s also taxes on dividends. In Tennessee here, we have a Hall tax. That’s the state income tax, if you will, that Tennessee has. It’s not significant, but it is going to go away in the next few years here. But it’s still here in 2020. You’ve got real estate taxes. You’ve got sales taxes.

Patrick Min:

And then there’s these other taxes that a lot of people haven’t focused on. We call them stealth taxes. And those taxes would be things like social security. You could be taxed on your social security. Certain percentages of that could be taxable. And also you could have things like your Medicare Part B. There could be additional taxes there if your income’s too high.

Ben Christy:

Well, and I like what you’re going over here, Patrick. And really what this eludes to is things that are talked about in the tax planning process, which brings up another good point here that I think it’s worth making on this podcast, this episode. It’s talking about the difference between your tax preparation and your tax planning. Tax preparation obviously is something that people are very aware of. They’re very familiar with. They do that with their CPA once a year. Tax planning really opens up a whole new ball game for us.

Patrick Min:

Yeah, Ben. We talk about it all the time. Most CPAs will prepare taxes, but they also do tax planning. And the tax preparation is really a look in the rear view mirror. It’s the scorecards you look at the end of your golf game and say here’s how I did. But it really doesn’t tell you how to improve the next time around. So what tax planning does is it’s more forward looking, and it’s spending more time with somebody trying to understand some of their future goals.

Patrick Min:

For instance, I’ll sit down with a husband and wife and try to help them understand what happens when one of them dies. It’s going to happen. Fact of life, one of them is going to die. And then at some point in time, they go from the married, filing joint income brackets and rates to the single rates. And the standard deduction, if the standard deduction is what they are on, drops to half. Well, their income may not drop that much. So it could be a significant impact. And that’s what a tax plan will do. I talked with somebody this morning about a capital gains on sale of a property, and when they might want to do that would give them the most tax efficient way to do that.

Ben Christy:

Well, and you make a really good point. And I think you look at the uber wealthy, the ultra rich. And we look at them and as your middle of the road income Americans, we look at them and think, wow, they just get tax break after tax break. And I think a lot of people make the mistake of thinking that those breaks don’t apply to them. And part of it has to do with tax planning. And they look at the tax planning, and they immediately equate tax planning to that one time a year I’m preparing my tax returns. And they don’t look at tax planning the way that the ultra rich do, which is tax planning is not a onetime thing. It is something they look at throughout the entire year. And that really is a bit of a game changer, even that shift in your mindset.

Patrick Min:

It is, Ben. And I’ve found that taxes are a little bit psychological. We’ve all had this impression. Either we’ve had a bad experience with we didn’t plan on one year, we owed a lot of money, or our parents did or our friends did, or they hear about a bad letter from the IRS. So that’s what people think about. They think about that one time sort of event that resulted from tax preparation. And they’re not thinking that there may be some bad news out there in taxes, but I can control some of that if I plan for it now.

Ben Christy:

That’s right. Well, and I think that is a great point to drive home because if you’re listening to this podcast and you’re thinking this sounds like something I need to look into, I need to look into tax planning, one of the things, the key categories or subjects that we would encourage you to bring up with your financial advisor has to do with tax diversification because it’s such a overlooked strategy when it comes to taxes in general. But particularly with tax planning, that’s what a lot of tax diversification should be about.

Patrick Min:

Yeah, Ben. When people talk with financial planners or wealth managers about asset diversification, they don’t take that next step and talk about how it’s going to impact their taxes. And there are three primary classes we look at, three primary categories: tax stall ways, which are things like your brokerage accounts, checking and savings accounts, things like that; tax later, which again, I’ve said a majority of the people have some of this, some people have a lot of it, which is the 401(k), the traditional IRAs, 403(b)s, things like that; And then also finally, the tax rarely, the Roth IRA, interest from municipal bonds. Those things don’t tend to show up on tax returns, and having some assets in that class can really help your money go a lot longer and less go to Uncle Sam.

Ben Christy:

Yeah. When we talk about having a tax free retirement, that’s what a lot of certainly the people that we sit down with, we talk with, that’s their desires, to have a tax-free retirement. And you look at that tax rarely. And that’s where I’ll make a little pun here, but when we get down to the brass tax. See what I did there?

Patrick Min:

Yeah, I saw what you did there. I wish I didn’t, but I saw what you did there.

Ben Christy:

That’s really what matters, is trying to look at how much do you have that is in that taxed rarely. And that’s where the conversation turns to Roths. And of course we’re a big advocate, you’re a big advocate, of Roths. So let’s kind of talk a little bit about that because the way I break this down, particularly when we were on the radio and we talk to our listeners,, is it’s really simple. If you believe that taxes are going to go up in the future-

Patrick Min:

And who doesn’t believe that? I want to see the person, Ben.

Ben Christy:

Which with our $23 trillion debt, it’s hard to believe that they’re not going to go up if the Trump tax plan even lasts to 2025. Who knows? But if you believe that they’re going to go up, then it requires you to take steps today. And one of the key components of that is looking at converting some or, in some cases, a lot or all of your traditional IRA, your traditional 401(k) account to a Roth.

Patrick Min:

Yeah. I’m talking to clients about that a lot now, Ben, just planning with Roth or Roth-type instruments. And just for our listeners, a Roth is very similar to traditional IRA, except it’s not tax advantage when you do it. It’s tax advantage when you take money out of it, when you take distributions. The principle and any earnings are tax free, and that’s when you need it. What I have so many times is somebody coming in to me saying, listen, I’ve got all this tax-deferred money, I don’t know what to do. And we start talking about Roth conversions and people don’t tend to understand what that means. And really what you’re doing is taking your traditional IRA money, you’re paying taxes on it, so you go ahead and pay the tax liability, which, by the way, stops the tax clock because the taxes are continuing to accumulate on that harvest as we’ve talked about-

Ben Christy:

Great point.

Patrick Min:

… and then you put that money in a Roth IRA. And at that point, the growth after five years that it’s in there, all the growth is tax-free as well. So it gives you some different buckets of money to pull from, which can reduce your taxable income, which could have all kinds of impacts on the things we talked about, like social security, the Medicare Part B, your capital gains rates. So people aren’t focused on that enough, but I’m working through those strategies with people now. And we would never advocate that if you had $500,000 in IRA that you convert it all in one year. We would come up with a plan for you over multiple years and show you how that can impact your taxes to do that. And again, you’re going to have to pay the taxes on this sometime. The tax liability is there. It’s whether you choose to pay it now when you know the rate or bet on the future when you don’t.

Ben Christy:

Yeah. Very good point. And so just kind of wrapping up, I would highlight three things that Patrick has talked about kind of in closing here that you want to make sure you pay attention to. One, make sure you’re looking into tax planning. Go beyond just the tax prep. Go beyond just getting your returns done for your taxes before April 15th. Go beyond that. Look into tax planning. And specifically, when you’re talking to a CPA, a tax specialist, talk about tax diversification. And as you’re looking at tax diversification, go into a Roth. Have them sit down with you and look at how much money does it make sense for you right now and then as you go forward to convert over to Roth.

Patrick Min:

Ben, I want to interject something here before you close. It’s just a quote that I think is real applicable here. It’s by a guy named Judge Learned Hand. What a great name, Learned Hand.

Ben Christy:

Absolutely.

Patrick Min:

He says, “Anyone may so arrange his affairs that his taxes shall be as low as possible. He is not bound to choose that pattern which will best pay the treasury. There’s not even a patriotic duty to increase one’s taxes.”

Ben Christy:

Well, thank you. That’s a great quote. Thanks for joining again, joining me this day for another episode. And to our listeners, thanks for tuning in and listening to Beacon Retirement Strategies podcast. We know retirement could be complex, and we hope this helps to break down some of those more complex parts of retirement to put them into terms that we can understand. So be sure and look for other episodes and retirement topics, like RMD, social security, annuities risk, and more. Just go to beaconcm.com/podcast, and you can see a lot more of those episodes. As always, we wish you a happy retirement. And remember that peace of mind in retirement requires a plan.

Speaker 3:

Investment advisory services offered through Beacon Capital Management, LLC, an SEC registered investment advisor. Beacon Capital Management, LLC is neither an affiliate or subsidiary of TD Ameritrade Institutional, Fidelity Investments, Beacon Accounting and Tax Service or Knight Legal.

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