Beware of the retirement savings ‘time bomb’, warns tax expert

It’s all about taxes.

This is the key concept for retirement savers, specifically because IRAs and 401(k)s are only tax-deferred — not tax-free.

“These funds have not yet been taxed, so a plan is needed to minimize these taxes [so you] You can keep more of your hard-earned retirement money,” Ed Slott, a certified public accountant in New York and an expert on IRAs, told Yahoo Finance. “It’s what you keep that counts.”

This planning has always been the core of Slott’s retirement tax planning strategies. “Always pay taxes at the lowest rates,” Slott told Yahoo Finance. “People don’t realize this critical point and often end up paying much more in taxes in retirement – ​​when they need the money most.”

Slott is the author of the new book “The Retirement Savings Time Bomb Tickles Higher: How to Avoid Unnecessary Fiscal Landmines, Neutralize the Latest Threats to Your Retirement Savings, and Boost Your Financial Freedom.” Here’s what he recently told Yahoo Finance about minimizing taxes in retirement, edited for length and clarity:

See more information: 3 Ways Retirees Can Save on Taxes

Damn. Scary title for your new book, Ed. What Is the Retirement Savings Bomb, Why Is It Making the Noise?

The ticking time bomb is the tax built into all traditional IRA and tax-deferred 401(k) accounts. I’m not talking about Roth IRAs and 401(k)s.

The reason I’m saying it’s ticking louder – I always thought it was ticking – but now it’s really loud is that at some point taxes are going to go up to pay off the huge debt that this country faces. People complain about taxes. But the highest federal tax rate from 1946 to 1963 was 91%. In 1964, it fell to just 77%. I was only 10 years old, but I heard that the whole country danced happily. See where we are today. The maximum rate is 37%.

Provisions of the Tax Cuts and Jobs Act (TCJA) of 2017 that lowered individual tax rates are slated to they expire on December 31, 2025, unless Congress decides to extend them. So you have less than two years to take advantage of current rates before they go up again.

What is the fundamental principle of all good tax planning?

Always pay taxes at the lowest rates. People don’t do this because they don’t want to pay taxes before they have to. So the idea of ​​converting to a Roth IRA bothers them. The way I see it, you need to use those two years to withdraw money from these taxable accounts. Start trimming IRA balances while you can withdraw them at the lowest rates and move them from tax to what I call tax-free territory in a Roth account.

What is the biggest threat to retirement dreams?

Future taxes. I’m worried about tax rates going up for people in retirement.

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Can you explain savings protection versus investment?

I see retirement as a football game. The football game is easily divided into first half and second half. The first half is the accumulation phase. Everyone is familiar with this. This is when you do all your work. You are building, you are saving, you are investing, you are sacrificing to have more.

The problem is that most people, when they get to halftime, think it’s the end of the game. They come in and say, ‘Ed, I’m retired. See how much I saved for retirement. They think the game is over. Meanwhile, the IRS takes action in the third and fourth quarter. They’re not playing anyone, so they win. Investing and saving is the first half, but protecting that money is the second half.

For most people, their biggest asset, other than perhaps their home, is their IRA and 401(k) account, and those are loaded with taxes. So the second half of the game is what counts. Many games are won or lost in the last five seconds of the game on some kick as time runs out. It’s the same thing here.

You can really screw it up in the second half of the game by paying large amounts of taxes, excessive and unnecessary taxes, or losing it due to unnecessary penalties, or not knowing simple rollover rules or early distribution rules.

The stock market is booming and retirement savers are happy. Isn’t that good for retirement savers?

That’s more money you’re going to shell out to Uncle Sam at some point. Remember that much of your IRA or 401(k) is not yours. There’s a mortgage on it, like a mortgage on a house, a debt owed directly to the government. Most people should probably stop contributing to 401(k)s and traditional IRAs and adopt Roth 401(k)s or Roth IRAs.

Clients tell me all the time, ‘in retirement, I’ll be in a lower bracket because I won’t have any income.’ They don’t understand that if they do nothing, the IRA will continue to grow. And at 73, the new minimum age required for distribution, they will be forced to withdraw it.

What is the biggest mistake people make in distribution planning?

Not taking more when rates are lower is being shortsighted. You have to take a long-term view and pay taxes. If you can distribute it at low prices, that’s really the key. But people don’t do that because anyone who wants to pay taxes before you is absolutely necessary. If he doesn’t, however, he will be forced to do so at age 73. You want your plan, not the government’s plan, when your options fall by the wayside.

It’s worth taking distributions sooner than necessary to take advantage of these low rates. Do a Roth conversion or put it in some type of tax-exempt vehicle, like life insurance. The minute you put those funds into tax-exempt vehicles, they grow and grow for you.

What is the best option for most people when they retire, or move to a different job with respect to the employer-provided retirement account?

This is usually an IRA rollover. But there are other options. You can keep it in your 401(k) or roll it over to a new company’s 401(k) plan if you get a new job or take a lump-sum distribution. The IRA rollover offers greater control.

What are your best tips for people taking a required minimum distribution this year?

Invest. There’s no reason to spend it unless you need it for living expenses, and you can take out more than you need and start spreading the tax over more years in those low brackets.

Once in RMD territory, you must take that RMD, and it cannot be converted to a Roth IRA. So take the RMD and then take a little more if you can and convert that portion. The idea is to reduce the IRA’s taxable balance as low as possible. Because if you just build it, you will have these taxes.

Can you talk about the idea of ​​charitable giving and your RMD?

Your RMD is your best asset to donate to charity. enjoy it Qualified Charitable Distribution (QCD). Give the charity your taxable accounts. The charity does not pay taxes.

Some people have favorite causes or charities or want to donate to their alma mater. You must do this with taxable IRAs. And one of the best ways to do this is to transfer directly from your IRA to a charity.

The QCD is available to IRA holders who are age 70½ or older when the distribution is made, according to IRS rules. You can donate up to $105,000 in total to one or more charities directly from a taxable IRA. That would be a reason to roll it over to your IRA and not keep it in your employer’s plan, because you can’t do a QCD from an employer plan like a 401(k).

You’re withdrawing it with zero tax and donating it to charity, something you would have done anyway. It’s a great way to take money out of your IRA and fulfill your charitable intention. Plus, if you do it correctly, over time it can pay off your RMD.

One caveat: I would only do this if you were already donating. I never say donate to charity in exchange for a tax break.

Kerry Hannon is a senior columnist at Yahoo Finance. She is a career and retirement strategist and author of 14 books, including “In control over 50: how to succeed in the new world of work” and “Never too old to get rich.” Follow her on X @kerryhannon.

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