The Tax-Efficient Way To Simplify Your Retirement

-> Create Your Custom Strategy To Retire Early

Here's a promise: you're about to unlock the secrets to maximizing your retirement savings across multiple accounts, all while maintaining tax efficiency. Ever wonder how to manage investments spread across Vanguard, Fidelity, and Schwab? Look no further. Join us as we delve into the complexities of coordinating these diverse accounts, discussing the potential pitfalls and the importance of tax-savvy decision-making. We’ll also tackle a listener's question on the intriguing risk can analogy, as well as the choice between qualifying for subsidies and opting for Roth conversions. 

Imagine if you had a "superhero account" to streamline your retirement planning. Well, it’s not as far-fetched as it sounds. In the next part of this episode, we’ll explore the concept of an "in-service distribution" and how to leverage it for your benefit. And yes, we’ll also introduce you to the concept of this superhero account - a brokerage account that can be your knight in shining armor. Let's take a case study of Rachel, who is planning her retirement in two to four years, and discuss her path to achieving optimal tax efficiency. Gear up as we demystify the realm of retirement tax planning through this engaging discussion.

Create Your Custom Early Retirement Strategy Here

Ari Taublieb, CFP ®, MBA is the Vice President of Root Financial Partners and a Fiduciary Financial Planner specializing in helping clients navigate the nuances of an early retirement.

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PS: Before anyone decides to move forward with our services, I want to ensure we're the best fit to help you reach your goals and I personally have the first conversation with you.

Transcript

Speaker 0: 0:00

I'm going to guess that you don't just have one account. Most people that are reaching out have a 401k, maybe a Roth IRA, sometimes a Brokerage account. It totally depends, and what we're going to get through today is how to be tax-efficient when you're trying to coordinate all of these different accounts when moving into retirement. So that is what we're going to talk about today and I am very excited. I am going to go through a quick review of the week, and this is going to come from someone who sent me this email. They wish to be remained anonymous, so I will keep it that way. They told me I didn't know what to do about my health insurance and thought about maximizing my subsidy until I heard your podcast on Roth conversions. Thank you for teaching me about the risk can.

Speaker 0: 0:41

Now, if you don't know the risk can analogy and I do a lot of these analogies, which I try to keep not silly, but sometimes intentionally silly so that you guys all remember them. But we all have risk, and when you walk outside, there's a risk that you get hit by a car Not a fun risk to think about, but it's the truth. You have the same thing with your tax plan, and so what that means is you could say when your income is really low that you want to intentionally keep your income low. So what this listener is saying is they thought about when they retired and their income was going to be very low, to intentionally keep it low because then you can qualify for subsidies and for healthcare purposes. That was their plan. Now, when they talk about the risk can, what they're doing is they're just kicking that can Think about like a soda can. They're just kicking that risk can down the road because later, because they saved and invested well, they're going to have significant RMDs. And so they asked themselves okay, with this risk can, idea, should I take that risk and keep kicking it down the road, or should I almost eat the bullet and eat a little bit of cauliflower? If you guys know my analogy by now, where I'm going to ask you to pay a little bit in taxes or eat a little bit of cauliflower to avoid having to eat a ton in the future. And so some people just can't get their head around it. They just want to absolutely not pay any more than they need to for healthcare purposes, and there's nothing wrong with keeping your income low to qualify for subsidies. In fact, sometimes I recommend it, but it depends on if you're going to have these big RMDs later and you want to be able to control your income so you don't pay any more than you need to in taxes over your whole life, not just in a two, three or four, even five year period. So what he's talking about is that risk can analogy? I'm sure this listener realized that because he had a healthy 401k or pre-tax balance, that he was going to get hit later with a big tax bill. And so he said I'm going to eat a little bit of cauliflower or I'm going to go ahead and kind of bite the bullet, if you will, on the risk and not get the subsidy for healthcare purposes and instead do Roth conversion. So that's what he's alluding to there.

Speaker 0: 2:41

What I'm going to now go into is today's episode. Today's episode once again, it's that how can we be smart, the tax efficient way to simplify your retirement. So I'm going to give you some insight, because this comes from a listener question, and the listener who reached out to me goes by the name of Rachel, and Rachel said that I could go ahead and use her name. So thank you for that, rachel. Now Rachel is 58 years old and she's hoping her tire in the next two to four years. Now she's not 100% confident that she can do so, and she had mentioned that she has her investments in a bunch of different institutions, so I'm not going to explain every single one here, but some of those are going to be familiar to all of you Vanguard, fidelity, schwab and so this is pretty normal during someone's career where they're going to have multiple locations of where their assets are, because maybe you had one job and at that job it was at Fidelity, meaning the 401K is only offered through Fidelity. Then another job 401K only offered through Vanguard, and so that's just very common. That's going to happen. Now some of you are going to take that step during your career and when you leave that job, you're going to roll over that 401K into your new 401K or, instead of that, you're going to roll it into an IRA where you can invest it however you see fit, instead of just having limited options. That's not bad.

Speaker 0: 3:56

You also and this particular listener, rachel, she has different accounts beyond just the 401K, and I think a lot of you do as well. In fact, I know you do, because when you reach out, you tell me so you've got Roth IRAs and brokerage accounts and I'm always going to, in case you're ever confused, refer to a brokerage account as the superhero, because if you want to retire early and a lot of you know this by now you need some way to bridge that gap. And I'm not just talking about the gap between the time when you retire and Social Security begins. I'm talking about the gap if you retire at 57, and you want to retire at 60, and you're going. Okay, do I just have to get until that 59 and a half and to tap into your retirement accounts? Oftentimes yes, if we want to be smart with tax strategy, but ideally longer than that.

Speaker 0: 4:39

Ideally, you have that superhero account. That's your brokerage account, and they come up with a bunch of different names for it to make it as confusing as humanly possible. But it's taxable account, joint account, brokerage account. They all mean the same exact thing. In that superhero account, that brokerage account, there's absolutely no limitation, meaning don't even think about your income. You can always contribute to it. The difference is you don't get a tax benefit upfront Now as the assets grow. You pay capital gains taxes on them if you hold it for over a year and if you hold it for under a year, it's going to be taxed as if it's just ordinary income, as if you just made more money.

Speaker 0: 5:15

So when we're going through the process today, I want you to think through your exact situation and go hey, where are all my different assets? Do I have some 401Ks looming around? I haven't moved over in some time, am I still working? And pro-tip for you guys If you are above the age of 59 and a half, I would say 99% of the time there is an option to do what's called an in-service distribution or in-service withdrawal. If you are over the age of 59 and a half, you can ask your employer if it's eligible for your plan and it will allow you to move your money, even though you're still working there, into an IRA. So hypothetical you're 60 years old and you're still working. You want to work three more years. What you can do is an in-service distribution move, call it, a million bucks from your 401K into an IRA and go invest however you see fit and prepare that income for retirement In a 401K. It's more difficult to do so because there's just limited options of what you can invest in. So pro-tip on that in-service distribution, sometimes called an in-service withdrawal so worth asking your employer about.

Speaker 0: 6:19

Now let's get back to Rachel's question. Rachel's trying to retire in two to four years. She's got a bunch of different accounts and all she basically said was Ari, help me simplify. Is there anything I'm missing? So that's what we're gonna go through Now. The best way to understand it is understanding what are the tax implications of all these different accounts. And when you move things, is there anything you should be aware of so that before you move something, there's not a big tax surprise? No one wants a big tax surprise.

Speaker 0: 6:43

So there are a bunch of different types of taxes that the main ones to be aware of, especially with retirement accounts if you wanna retire early, are regarding ordinary income taxes, capital gains taxes in any early withdrawal penalties Now I'm not gonna tell you the penalties to scare you and you're gonna be efficient, so it's not even gonna have to impact you but capital gains taxes, those are taxes paid on any profits from the sale of your investments, but it's only within those brokerage accounts, that superhero account so I don't want you to worry about it with your IRAs and Roth IRAs. It's not applicable there. The amount that you're gonna pay in those capital gains taxes is dependent on how well you've done so. Super basic example let's assume you buy Apple stock for call it $5,000, and it grows to $10,000 and you hold it for over a year. If you hold it for over a year, you're gonna get that long-term capital gains tax treatment, which for most of you is gonna be 15%. It can go up to as high as 20% and there's a net investment income tax of 3.8%. So at the very highest it could be 23.8% in capital gains taxes that you could pay.

Speaker 0: 7:47

Now another thing we need to be aware of is that early withdrawal penalty, which most people that are coming to me are trying to avoid, and that's where the superhero account comes into play. But it's just good to be aware of it. In that early withdrawal penalty, those are taxes that are imposed on any withdrawals from retirement accounts like an IRA or Roth IRA. If you are under the age of 59 and a half, in the amount of that penalty it's 10% of what you're withdrawing. So we just wanna make sure that whenever we're looking at where's income gonna come from if we retire early, that we have a plan to address that, because I do not want you to and I have a real client example for you.

Speaker 0: 8:23

I won't do a whole story because I do separate episodes of those, but I have a real client example of someone who came to me and they had about five and a half million bucks but it was all in a 401k and they were 53 years old and they wanted to spend a very healthy amount every month and they were what's called qualified rich cash poor. So I made up the term because most of you know what house rich cash poor is, where you have a significant net worth but maybe it's in a home. The difference is that's not too helpful if you're not gonna sell the home, so it's just not worth much. If you wanna stay in that home, you might have a high net worth, but you're actually cash poor. Same thing with that example right there. So someone's coming to me, they're 53, they've got five and a half million bucks. Seems like they're in a great spot, but if it's all locked up and they can't tap into it, ignoring rule of 55 and all these other options I talk about on the show that they're in a tough spot where they're gonna have to go out and pay that penalty. If they wanted to withdraw and retire, call it the next day. So fortunately we found out another method and that's another story.

Speaker 0: 9:22

But the premise is you don't wanna be qualified rich, cash poor, where you just keep maxing out your 401k because it's what you've done for 30 years. You wanna start to get intentional and go when am I gonna need this income? Do I wanna start to maybe intentionally taper back on the maxing out of a 401k and add to that brokerage account to help bridge the gap Once again, the superhero account? So let's start going through a few things here. So if you have money in a 401k or an IRA and you are gonna pull it out to that 10% early distribution penalty, you're also paying taxes on it. So there's kind of the double that's coming to hit you there.

Speaker 0: 9:58

Here's the thing to be aware of. You don't have to worry about it if you're transferring assets. So if you have a 401k and you wanna move it into an IRA and you are under 59 and a half, you don't want no taxes, no penalties. You're simply just transferring, you're just moving the assets. So there's actually no penalty that occurs. Some people think there is a penalty, but that's only if you don't fill out the paperwork correctly. So don't worry about that, and if you're doing it on your own and you don't have a planner, it's very simple. I've seen nightmares where people do fill it out incorrectly, but it's very rare, so don't beat yourself up or worry about that.

Speaker 0: 10:33

Now let's assume that you're at Vanguard and Vanguard has some very specific let's even say proprietary funds and you go to move maybe an IRA at Vanguard to an IRA at Fidelity, because you're just trying to put everything into one spot, vanguard might have those proprietary products that won't allow you to move them. So, before you even consider transferring, what you wanna understand is are there any proprietary products that cannot be moved? It's very rare, but I've seen it in instances. So that's the first thing to be aware of. The other thing is if you're having any issues meaning when you go and are thinking through, am I gonna have issues, should I say when I'm moving my 401K into an IRA?

Speaker 0: 11:15

What often will happen is a check will be issued and when that check is issued, you wanna make sure it's made payable to the institution that it's going to for the benefit of you. So here's what it should look like, for example, if I'm retiring and I wanna move my 401K into an IRA and I have a million bucks, I want them to write the check made payable to Schwab for the benefit of REtowelbleab. I don't want it to be made payable to me because then it's taxable. So just that little change of Schwab for the benefit of REtowelbleab is essentially going to be reported on your tax return that it is a rollover and therefore not taxable. So something to be aware of if you're moving anything from a 401k to an IRA and all my current clients know that we have Hannah, as well as Carly, as well as a few other members of our team here who help with all of that.

Speaker 0: 12:06

So if you're listening to this going, oh my gosh, did we just do that correctly? The answer is yes, because we took care of it for you. Now, almost all 401k providers still will issue a physical check. In my opinion, it's ridiculous that that's even still the reality of what we're talking about, but they don't want to make it easy for you, and it's because you're taking money from them. You're taking money and you're moving it elsewhere. So we just want to make sure before you do any 401k moves, because it's scary to move a million dollars and have a check just be floating around out there. You want to make sure that you are crystal clear on the instructions and the timing of when that needs to occur. So we always and this is to your point, rachel want to simplify and consolidate. When you just have a brokerage account, two Roth IRAs and a multiple 401ks and maybe an inherited IRA, now all of a sudden, you've got six, seven, eight, nine, 10 accounts, it's hard to know financially if you're doing all the right things because you just have so many different things in different places, and so don't beat yourself up.

Speaker 0: 13:01

Once you actually are consolidated and my recommendation is to pick one custodian, like a Vanguard, like a Charles Schwab I use Altruist for my personal assets as well as for a lot of my clients. The reason I like Altruist is they don't make their own products, meaning all they are focused on is being the best custodian ever, not trying to make a new Vanguard product like an ETF or a mutual fund which, by the way, aren't bad products, but we just want to be really wise and intentional about how we do that. So Altruist I really like because they allow you to be able to invest however you see fit, like a Vanguard, fidelity, but they only partner with advisors. So if you go to Altruist. They're not accessible to a lot of you, so I don't want you disappointed when you go there, but for a lot of people that reach out to me, they're one of the primary custodians that I like to recommend. Now, in addition to that, I want you to think about the following.

Speaker 0: 13:52

If you have an IRA or a Roth IRA, it's fairly simple. If you want to make any changes in there and you're worrying, are there going to be any tax implications? The answer is no. There are no tax impact, no changes when you move from anything in a Roth IRA to an IRA. So if you have a Roth IRA and let's assume you go and you have 500,000 a Roth IRA, you could sell 500,000 just in that account. Assume it's all in Apple stock. You could sell all of that and buy Microsoft an hour later or a minute later or a second later. There's no tax implications that will occur. It's not the same way with a brokerage account. So if you have a brokerage account, more than likely you have a lot of really healthy gains there because you've probably had it for some time. Maybe there's 300,000 bucks, maybe there's $2 million.

Speaker 0: 14:37

What you don't want to do is just go sell everything overnight, but what you can do is transfer it. So let's assume you have $2 million. You want to put everything in fidelity. That's where you're coordinating all of your assets. What you want to do is move once again your old 401Ks into fidelity and, whether that's an IRA or a Roth IRA, you want to do the respective amounts. So let's assume you have a 401K with a million dollars and 750,000 of it is pre-tax and 250,000 of it is Roth. So you want to make sure the 250,000 Roth goes to the Roth IRA and the 750,000 pre-tax goes to the IRA. So you want to make sure they go to the right accounts. Simple enough.

Speaker 0: 15:15

What you want to do is take it a step further. If you have a brokerage account that you started many years ago at Vanguard, you're trying to put everything in fidelity, but you're wondering are there going to be tax implications? The answer is no. What you can do is move everything that's at Vanguard maybe there's $500,000 there. You can move $500,000 at Vanguard that's in a taxable account directly to fidelity and there will be no tax implications. All you did, excuse me, was transfer assets. You didn't sell any assets. What you also want to do is take it a step further, and this is what I'm talking about. You're likely going to have to pay taxes at some point. As those assets continue to grow. $500,000 becomes a million, the tax bill might be much larger because if you buy Apple stock at $10,000 and it grows to $100,000, that's a $90,000 gain. More often than not, people will say let me try to avoid paying any taxes.

Speaker 0: 16:07

Now, this is going back to that risk-can analogy at the beginning. I want you to know that we all have risk. You already do know that, so I don't need to say it. But I want you to be wise about it. I want you to get to your desired outcome in the most tax-efficient way. The way to do so is to be really intentional.

Speaker 0: 16:23

Let's assume you buy Apple stock for $10,000, that grows to $100,000. That's a $90,000 gain. What if you also hypothetical bought any stock let's just say Coca-Cola for $10,000, and it went down to $5,000? What you can do is you can sell that Coca-Cola stock $10,000 went down to $5,000. That's a $5,000 loss and you can offset that to the gains, as opposed to taking that Apple stock you bought for $10,000 and it went to $100,000 and selling all of it. You might say let me just sell $5,000 worth Apple stock. You bought for $10,000 grew to $100,000. You're only going to sell $5,000. Why? Because you can offset that to the Coca-Cola loss. And now you took the $5,000 of gains, offset it to the $5,000 of losses and now you have zero tax impact and you can reposition that $10,000.

Speaker 0: 17:15

It's really powerful because if you want to retire early, you likely don't want those assets fluctuating wildly. The brokerage account or the superhero. That's the best account for your retirement, for your early retirement, because it's going to keep your income low. What if Apple stock does really really well? Well then you're going to be happy. But if it doesn't do well and it goes down and you need those funds to create income for you before you can tap into your retirement accounts, you're going to be in a tough spot. The way that you can get around that is going into your brokerage account and determining what you should sell and what you should buy to see how you can make sure you don't pay any in taxes. That's just an example.

Speaker 0: 17:50

Here's the other thing You're going to have to pay taxes at some point and you can keep kicking that risk, hand down the road, or you can say you know what. I'm going to have to pay taxes at some point. I'd rather pay that now as opposed to in the future when it keeps growing, growing, growing. The little bit of a silly analogy. I'll tell everyone. I'll say hey, what's the most amount of money you could lose in that brokerage account? They go. I don't know, I go well, technically. If you bought Apple stock for $10,000, it could go down to zero. Is that right? They'll go. Yeah, that's right, I'll go. Well, what's the worst case scenario tax wise? And they go well.

Speaker 0: 18:23

I think I heard on your podcast obviously no one would say it like that that the most is 23.8% and I'll just give it to you that that is the answer here. Because of the max capital gains of 20% plus the net investment income, that's 3.8%. So what this is saying is in the worst possible scenario, apple stock let's assume you sold it you'd be paying 23.8% taxes versus worst possible scenario, apple stock goes down to zero. So we just don't want the tax tail to ever whale the life dog which I see too often. So summarizing key points here what are the benefits of consolidating your retirement accounts is easier to manage everything. So pick one custodian and almost say can I have everything there? It's diversified in the way it's invested, but it's simple in where the assets are.

Speaker 0: 19:09

Some of the risks, if ever, when you do consolidate, is that there are tax implications that you just aren't aware of. If there's any proprietary funds or you're moving something and an advisor says, do you want me to sell it for you, and you accidentally say yes, that's where tax implications could become an issue. So, before moving anything, I would say go through a process with either an advisor if you determine it makes sense to work with one or, if not, understand the tax implications of any potential moves. When you do consolidate, how can you find an advisor who can help with consolidating? That you know. Of course, this is what we love to do. We want to help people just like you retire with confidence, and I have people right now that are working with me in their 70s and it's because they retired early, but they didn't do it with confidence, meaning they did it on paper, but they realized they wanted to spend more than they projected. So they went back to work and they tell everyone, they tell me to tell everyone. All right, make sure your clients only retire once. You just don't want to have to do it again. So just making sure you have the right fit in terms of an advisor to help out with that.

Speaker 0: 20:09

What are all those different types of accounts? Some of you might have a SEP IRA. That SEP IRA can go into a traditional IRA. Some of you might be going I've got deferred comp. How does that factor into this completely different strategy? Some of you might go oh my gosh, I'm going to do part-time income. That's different from what I'm talking about today. I'm just talking about the tax efficient consolidation and, overall, simplifying your retirement. That is my goal. My goal is that you're able to move everything IRAs, roth IRAs, brokerage account to your optimal mix, and for some of you that might be 80% equities, for some of you it might be 60% equities. But moving in the right direction and having that superhero account be the more conservative of all of the others, because that's when you're going to want to need income first. That superhero account, that's what you're going to want to tap into because it keeps your income low to do all of the cool tax planning stuff.

Speaker 0: 20:59

I talk about Roth conversions and pairing it maybe with a donor advised fund and tax gain harvesting all that stuff I love talking about in terms of choosing the right investments. I'm often asked what are the right investments? And I'm going to give you the kind of dopey analogy here. Okay, but a lot of you are coming to me, going, I want the lowest possible fees, and I will ask you and I want to this to say, to be mean, but I'll say, hey, why don't you just go to the dollar store and buy all your food there? And they'll say, well, it's not the best value. And I'll go. Exactly.

Speaker 0: 21:28

The goal is not to just have the lowest fees. At the same time, don't go to Whole Foods just to buy paper plates. Whole Foods can have great options, but the premises I'm not bagging on Whole Foods here the premises I want to make sure that you're not paying too much in fees, and that's kind of the analogy of going to Whole Foods is buying paper plates. It's can we go to maybe Trader Joe's or Vaughn's or Albert Sins and some of these places? For what are the best investments that you need just for your specific goals, where you're not overpaying but you're also not underpaying. Meaning, not the dollar store, but not paper plates at Whole Foods. Okay, so it's not a perfect analogy, but hopefully the theory resonates, which is what I call BB bang for your buck.

Speaker 0: 22:09

I don't want you just to have the lowest possible fees, that would be very simple. I want you to make sure you're getting the best value for the fee, so that's what it really comes down to now. That's what I want to really go through in today's call, and so, rachel, I'm hoping this was helpful for you. We are going okay. Where should all my assets go? If Fidelity is where you want to consolidate, great, how can we start to move everything those old 401ks and IRAs and brokerage accounts and HSA? Can we put everything in one custodian, because it's just easier to manage so you know how well you're doing, or else it gets really hard to track everything. Now, some of you are going. I would love to do this, but I'm still working so that current 401k cannot be moved to Fidelity, and if that's, you don't worry, that's okay.

Speaker 0: 22:51

What I want you to do, though, is take a look at all of your investment options and, of course, this is what we do for our clients and say based off of your options available, how should you be invested compared to your options available elsewhere? So client comes to me they have a million dollars and a 401k. They have two million dollars in IRAs and Roth IRAs and their 401k options weren't the best. So what we did is we made a very simple plan for their 401k and how the fund should be invested there, because it didn't offer great diversification, and then their IRAs and Roth IRAs we invested in a totally customized manner that would look like it makes no sense at all. If you didn't know, they had a 401k elsewhere. So we put a ton of exposure in the Roth IRA and IRAs based on what was lacking in availability at the 401k. If that makes sense, so I hope that does.

Speaker 0: 23:40

That's what I want to go through in today's episode is can we be efficient when you want to simplify your life for tax purposes and a lot of this is not rocket science, but I think it's going to simplify your brain which is if I go make transfers, other taxes no, there's no taxes. When you make a transfer, when you move your 401k into an IRA, there's no taxes that are occurring. As long as you're having the check made payable correctly and deposit it within 60 days, as long as you're doing all the right things, you don't have to worry about it. Now, that's a large reason. People are coming to us for the peace of mind, to make sure they're doing the right things, not leaving anything else behind. So today was less investment heavy, but more on simplifying your life.

Speaker 0: 24:16

So hope that this was helpful and if so, please do, as always, leave a five star review on iTunes. It's what helps more people find the show. You can email me directly in the description of the episode If this was helpful and if you want more content just like this. I love hearing from all of you. It's really what makes my job fun and why I'm going to continue to always do this. So thank you all. Please do leave a review If it was helpful, either on YouTube or on iTunes, as it helps, once again, more people have confidence towards their early retirement. Love you, guys.

Speaker 0: 24:44

Thank you for listening to another episode of the early retirement show. If you have a question that you want answered in a future episode, you can always go to my website, earlyretirementpodcastcom. That's earlyretirementpodcastcom, and you can go ahead and submit a question that I'll look to answer in a future episode. Thank you all for listening. Please do rate it, review it and share it with someone who you think would benefit from this information. If there's anyone out there that you know, I certainly appreciate it and I will see you all each week. Hey guys, it's me again. Please be smart about this. Nothing in this podcast should be construed as financial, tax or legal advice. Consult with your tax preparer or financial advisor before taking any action. This podcast is for informational purposes only.