It’s that time of year again. The administrator of your tax-deferred account (IRA or 401K) will call advising you on your required minimum distribution (RMD). Often, the account holder’s response is, “Darn, here’s the government making me pay taxes on this money.” Therefore, their goal is to take only the minimum distribution and pay the least taxes. This logical response ignores the reality of IRAs and 401k’s.
An IRA or 401K is merely a tax deference vehicle. The taxes will be paid. By someone. Someday. If you have a $400,000 IRA and you’re in the 22% tax bracket, your IRA isn’t worth $400,000 but 78% of that — $312,000. Can you increase the value of that $312,000? Yes! If the person who draws down the IRA is in a lower tax bracket, say the 10% bracket, the account is not worth $312,000 but $360,000! That’s $48,0000 like magic. If that is your situation, deferring distributions as much as possible may be smart.
What if your beneficiaries will be in a higher tax bracket? In that case, withdrawing the funds from the IRA and paying a 22% tax rate may actually increase the net amount to your family. For example, if a married couple is in the 22% income bracket, but their income is at the lower end of the bracket, say $100,000, they can draw out $68,000 more without increasing their tax rate. That $68,000 distribution will then net approximately $53,000. That amount can be gifted to beneficiaries or reinvested in assets that will gain a step-up in basis. If the beneficiaries are in the 32% tax bracket, the net increase in wealth to the family is $6,000. Repeat that for multiple years, and that strategy increases the value to the entire family.
Since IRAs and 401Ks cannot be transferred into irrevocable trusts for asset protection planning, converting your assets from tax-deferred accounts can also give you greater flexibility for other types of planning, such as Medicaid planning.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, specific tax, legal or accounting advice. We can only give specific advice upon consulting directly with you and reviewing your exact situation.
