Almost every client we talk with emphasizes one primary, overriding goal: having enough money in retirement. Most do not know how much money they need to save, or the planning process to get there. To provide the answers, we work collaboratively with clients to develop an overarching spend-down strategy designed to minimize taxes in their retirement and legacy plans.
By dividing their financial life into four timeframes, we can focus on the present but explain to clients the plan’s future benefits. Those timeframes are accumulation, blackout, spend-down and legacy. The overarching constant of these four stages is taxes. Our goal is not to help clients structure their affairs simply to pay the least amount of taxes each year. Rather, it is to create a framework that helps a family lose the least amount to taxes over a lifetime. Let’s look at these timeframes and, for each, provide examples of what strategies can be most beneficial.
Accumulation: This period begins with the first day of a career and ends when earning years cease. Some of the most common accumulation strategies are these:
- Begin saving as early, and as much, as possible.
- Take advantage of any employer match offered in a 401(k) plan.
- Choose between Roth and traditional retirement accounts based on both current and future expected income tax brackets.
- Build a globally diversified portfolio using an evidence-based approach.
- Choose an allocation between stocks and bonds that matches your need, willingness and ability to take risk.
- Choose the right location, that is, type of account, for holding stocks and bonds. Specifically, match ordinary-income-producing assets (bonds) with ordinary-income-tax accounts (401(k)s and IRAs). Match dividend- and capital gain-producing assets (stocks) with accounts that take advantage of preferential tax rates on those dividends and capital gains, and that allow a tax-free step-up in basis at death (joint or individual brokerage accounts).
- Manage the financial hardship of a premature death by securing adequate and appropriate life insurance.
- Plan for disability or premature death with powers of attorney and a will.
- During the final earning years, when your marginal tax bracket generally is highest, fund a donor advised fund with appreciated stock worth several years of charitable contributions.
It may seem like the majority of the time and effort required to construct a comprehensive financial plan goes into formulating and executing these strategies, perhaps because they tend to get the most front-end attention or because the accumulation period is one of the longest. However, the way clients maintain and distribute the nest egg they’ve spent decades building can be just as important as the way they accumulate it, and can have a lasting impact on a family’s wealth.
Blackout: This period begins at the end of employment and ends at age 70½. It can be several years or nonexistent. Strategies useful during this time can be counterintuitive, because recommendations to pay more income taxes than necessary now can seem difficult. However, it is important to take the long-term view and avoid the common objective of always paying the least amount in taxes in the current year, focusing rather on taxes that can be saved in the future by taking advantage of potentially lower tax brackets during this timeframe.
Estimate what the marginal tax bracket after age 70½ will be if no planning is done, and consider converting a traditional IRA to a Roth IRA, thus shifting income into a lower tax bracket. Determine the optimal Social Security claiming strategy while efficiently transitioning from an employment paycheck to a paycheck from savings. Review the purpose and/or need for life insurance, and, finally, analyze supplemental Medicare policies and choose one best suited for your individual circumstances.
Spend-down: This period begins in the year you turn age 70½ and continues for the rest of your life. This is the age when the government mandates that investors begin taking required minimum distributions from their retirement accounts. The goal in this period is to use the funds you’ve accumulated to maintain your lifestyle.
Strategies during these years usually focus on after-tax, risk-adjusted returns. Review your choice of allocation between stocks and bonds to ensure it continues to match your need, willingness and ability to take risk. Start each year with an understanding of where funds will come from to support your income needs and lifestyle. Project adjusted gross income to control the impact on future Medicare premiums. In addition, consider donating to charity directly from an IRA and use the standard deduction to minimize taxable income. Sell equities with a high cost basis when necessary to fund your lifestyle, and take advantage of market downturns to harvest losses to lower taxes. Perhaps name a charity as your IRA’s beneficiary. It’s also vital to review estate-planning documents periodically and change them to adapt to your changing circumstances.
Legacy: Ultimately, this period occurs after your death, but the choices to make during your lifetime involve how much you will give to heirs, charity or the government at your death. Most of the strategies to limit the amount that goes to the government in taxes are put into place years before the end of life. Examples include equalizing the ownership of equities between spouses to take advantage of the step-up in basis on the first spouse’s death (this allows a surviving spouse to reduce equity risk, if desired, without income tax), revising beneficiary designations after the death of a spouse, selecting the best assets to give to charity, choosing the best assets to give to heirs, and preparing heirs for the transfer of wealth through lifetime gifts and/or family meetings.
Developing a spend-down plan is personal and unique to each individual, couple or family. An advisor in this arena must be comfortable and proficient in the worlds of investments, income tax, estate tax, insurance and charitable planning, to name but a few. The savings and peace of mind realized with a well-constructed and regularly reviewed plan are difficult to measure in dollars and cents. Clearly, those without a plan can suffer hardships they may not overcome. Why would anyone allow the latter to occur when proper planning, if it’s begun soon enough, can help avoid this outcome entirely?
William Morgan is a colleague and fellow wealth advisor in the BAM Alliance.
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The opinions expressed by featured authors are their own and may not accurately reflect those of The BAM ALLIANCE®. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
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