We spend most of our working years worrying about saving enough for retirement and reducing our current income tax burden. In doing so, we often maximize contributions to our qualified/tax-deferred retirement accounts (401(k), IRA, deferred compensation plans, etc.) and build up sizeable nest eggs for our retirement years. But what happens if you’ve maximized those opportunities and as you approach retirement, you realize you saved more money in your tax deferred accounts than you could possibly spend in your lifetime?
Having excess assets in your tax-deferred accounts is a good problem to have, but it can create tax implications during your lifetime, as well as for your beneficiaries at your passing. Depending on your unique situation and goals, there are several options for minimizing the tax burden.
How do I know if I have more than I need in my tax deferred retirement accounts?
A great way to determine if you have more than you need is to work with a financial planner. A financial planner can help you identify and project your various sources of income in retirement, expenses throughout various stages of retirement, and estimate IRS required minimum distributions (RMDs) from tax-deferred accounts.
If your RMDs consistently exceed the annual cash flow deficit that exists between all other sources of retirement income and projected expenses and you are expected to have a large balance left in your tax-deferred accounts at the end of your life, you may have saved more money in your tax deferred retirement accounts than you needed.
What problems can arise from having too much in tax-deferred accounts?
If RMDs exceed your cash flow needs, you may be paying taxes on money you didn’t need to withdraw for your income needs. Excess income from RMDs can push you into a higher income tax bracket. A higher income tax bracket can also have ripple effect on other tax deductions and credits, as well as how much you pay for Medicare Part B and Medicare Part D premiums.
Keep in mind that at the passing of the first spouse, the surviving spouse typically inherits the tax-deferred accounts of the deceased spouse. As a result, RMDs may remain unchanged but after the initial year of death, the surviving spouse’s tax filing status will change to single – possibly resulting in a higher tax bracket for the same level of income.
After your lifetime, current tax laws may require certain non-spousal beneficiaries to withdraw the balances of inherited IRAs within 10 years and pay income taxes accordingly. This can create a significant tax liability for the beneficiaries, depending on the amount inherited and the beneficiaries’ tax bracket at the time, among other factors.
How can I minimize my tax burden?
There are numerous methods to minimize your tax burden on tax-deferred assets. The options below are some of the more common methods; however, choosing and implementing the best solution for you can include utilizing and layering multiple methods. These strategies can get complicated and coordinating with your financial planner, tax advisor and estate planning attorney is a great way to ensure the outcome you desire.
Desired Goal: Pay No Taxes
Desired Goal: Reduce Taxes During My Lifetime
Desired Goal: Reduce Taxes for My Non-Spousal Beneficiaries
As mentioned, having more than you need for retirement is certainly a good problem to have but still requires some planning on your part. If you’ve reached the end of your working years and realize you may have more money saved for retirement than you’ll need in your lifetime, it’s a good idea work with your financial planner to discuss what options may be available for you and your individual goals. Learn how we can help.
The articles in this blog are for informational purposes only and not intended to provide specific advice or recommendations. When making decisions about your financial situation, consult a financial professional for advice. Articles are not regularly updated, and information may become outdated.