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Why You Need (and deserve) a Written Tax Plan Thumbnail

Why You Need (and deserve) a Written Tax Plan

Taxes will likely be your biggest expense in retirement. You need a written strategy to keep them minimized.

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Full Transcript below:

Speaker 1 (00:07):

Welcome back to 30 Minute Money, the podcast that delivers action-oriented smart money ideas and bite-sized pieces. Joining me in studio, Steve Wershing from Focused Wealth Advisors,

Speaker 2 (00:17):

You're getting that intro down pretty well now. You did it pretty

Speaker 1 (00:20):

Smooth. I almost don't have to read the little card that's right in front of me.

Speaker 2 (00:24):

Almost, almost, almost. Well, you make it sound good, so

Speaker 1 (00:27):

Thank you. So do you have a written tax

Speaker 2 (00:31):

Plan? Yes, I do. And

Speaker 1 (00:33):

You're going to tell us why you should.

Speaker 2 (00:35):

Everybody needs one. Why Everyone needs one. That's right. So let's just set it up. So taxes will be your biggest expense in retirement, not your house, not vacations, not even healthcare. Taxes will be your biggest expense in retirement. And so when you make changes, when you take advantage of some opportunities, they can yield pretty big dividends. I was talking with a client a couple of weeks ago and they had just moved to me from another person in the company and I was talking about these strategies and I said, well, there's a realistic possibility you're going to pay a couple hundred thousand dollars in taxes, and so if we can make some moves, that'll save that, save you some of that money. And she said, no way am I going to, I don't have that big a portfolio. No way am I going to owe that much in tax.


And I said, okay, well let's do a couple of quick calculations. So you've got a portfolio this size. And so we put that in and I said, and let's say you're going to be drawing out about this much per year and let's just say that you're drawing out only as much as it makes. So you're only going to be drawing out this much per year. Yep, that's fine. Great. And you're going to be retired for, I dunno, let's say 30 years. Okay, well, assuming no increase for inflation, no increase for interest rates, it looks like your tax obligation will be $252,000. And she was like, get out.


Exactly. So it's going to be your biggest expense. And the biggest mistake that people make is shortsightedness. The biggest mistake that people make is saving money, trying to save a little bit of money on this year's taxes without taking a look at what that means for the long-term. And that's where we see the biggest opportunities. And so that's why a lot of what we do is focused on, you know what, you might pay a little bit more in taxes this year, but it enables us to avoid taxes on that ever again. And if you do that over a long time, that affect compounds so you can save more and more, pay less and less and less and less in tax over time. This is the mistake that I see CPAs make because CPAs are all about reporting. I say this with a broad stroke. I apologize to any CPAs who actually do long-term tax planning out there, but what I see from my clients is that most CPAs are focused on the 10 40 for last year, and they're focused on what opportunities there might be on that return or on the next return for saving some money in tax, but they don't think about what happens way down the road.


So I'll tell you a real life story from one of my biggest clients. I started working with her, she was a good saver. Her husband was a good saver. He passed away, left his IRAs to her, so they became part of her IRA. So she had lots of money. That's great. She's in a pretty good position. But I projected it out. And when she was going to turn 73 and had to start taking required minimum distributions if we did nothing else because she's getting a state state pension, she's getting social security and she's taking a little bit out of her portfolio, but she doesn't really need all that much to supplement it, to keep her standard of living. If we just kept all of those things going for the length of time it was going to be until she had required minimum distributions, her first year required minimum distribution would be $157,700 enough to push her up to tax brackets.


And so we've been working on this aggressive program of doing Roth conversions and that kind of stuff. And we always coordinate with the client's, other advisors. And so I called the CPA and I said, what I'd like to do is convert, I think it was at that point 30 or $40,000 from her traditional IRA to her Roth IRA. And he said, that's going to bump up her tax bill. And he said, yeah, I understand that. And he said, well, why would you do that? And I said, well, I'm really worried about required minimum distributions. And he said, Steve, she's not going to have required minimum distributions for 12 years. And I said, that's right. We only have 12 years to solve this problem. And there was silence on the other end of the phone. That's amazing. That's amazing. And then he said, you think farther ahead than I think any financial advisor I've spoken to.


But that's important. But that's why you need, and that's what that effect, that if you don't do much, if you don't take money out of your retirement plans until you absolutely have to, we call that the time bomb because all of a sudden required minimum distributions are going to come hit you in the face like a baseball bat. And we don't want that to happen. But to do that, to head off a lot of those taxes down the road, it requires a long-term plan. And so I believe that everybody deserves, everybody who's working with an advisor deserves to have a written retirement income plan and a written tax plan, a tax plan that projects out those potential taxes all the way through retirement. Because unless you do that, you can't see what kind of a problem you're trying to solve. And so I think that everybody needs to have one of those. Everybody deserves to have one of those.

Speaker 1 (05:58):

Absolutely. That's an amazing story about 12 years in the future. But I mean, really how many people think that far,

Speaker 2 (06:08):


Speaker 1 (06:09):

A couple years

Speaker 2 (06:10):

Tops, and you don't want to do too much at once. It's a little bit like taking vitamins or doing exercise, right? It works best if you do a little bit at a time for a long period of time. So we don't want to do a humongous Roth conversion this time and push you into the 35% bracket. That would kind of defeat the whole purpose of the thing. Yeah, exactly. But that's why we talk about maximizing your bracket is you want to go up to the top of a bracket, and sometimes that's a little bit of an opportunity. Sometimes it's a little bigger opportunity, but doing it year after year after year, the cumulative effect is that you can move a lot of money from the deferred bucket over to the tax-free bucket. Now, one big concern that people have is are these projections really accurate?


I mean, really seriously, these things are projected 10, 20, 30 years into the future, how accurate could they be? And the answer is they are not going to be accurate. They're probably not going to be close to being accurate. But we're not looking at the numbers, we're looking at the magnitude. We're looking at is this a big thing that's going to hit you later or is it a small thing? If it's a small thing, even if the numbers are wrong, we're not going to worry too much about it. But if it's a big thing, we know that the numbers aren't going to be exactly right. But if it's a big thing, it just means that we need to do more today. And so it's the magnitude that is the problem. Without looking at that, without looking at what the magnitude is, forget about what the numbers themselves are without looking at the magnitude, we have no idea how big a problem we're trying to solve. So if you project it all out, then you've got some idea of what you're up against.


Now, some of these things that we do will not have an effect for many years. And so when we look at doing a Roth conversion, we don't just take a look at what the effect is on this year's taxes or next year's taxes. What we can actually do is build side-by-side scenarios to say, if we don't do a Roth conversion, this is what that lifetime of projected taxes will look like. If we do this Roth conversion, even just this one conversion this year, we can project that out too and say, what's the effect of this one conversion over lifetime? Because if you take out, if you do a Roth conversion now, it lowers the amount you have in your IRA. And so when you get to the required minimum distribution age, it will mean that you will be required to take less out, but you'll be required to take less out for every year after that too. And so just what we do this year will have effects all the way through your retirement. So that effect compounds over time. So even a modest conversion now can be worth many times what it looks like it's worth once you take a look at the whole retirement.

Speaker 1 (09:02):


Speaker 2 (09:02):

Can I ask you? You could ask what other effects can these conversions have? You talk about income taxes, are there any other benefits that come along with that?

Speaker 1 (09:20):

So you talk about income taxes. What other benefits come from this kind of planning?

Speaker 2 (09:25):

Yeah, so the whole idea of taxes is actually, there are a lot of different facets to taxation. So we usually talk about projected federal income tax, but it has an effect on capital gains tax. Capital gains are taxed in a different set of brackets, but a lot of people can be in a 0% capital gains bracket if we can get their income low enough. And it doesn't really have to be that low like this year up to, if you're a married couple filing jointly, you can make up to $83,000 before you have to pay tax on any capital gains. So you could realize a whole bunch of capital gains this year and not have to pay any tax on it. But the bigger one is social security and social security does not necessarily have to be taxed in retirement. A lot of people think it's a tax-free benefit. It's not.


It's taxed depending on how much you make in any particular year or so. If we can minimize taxes long-term, not only will we pay less income tax just on your income, but we can actually prevent more of your social security income from being taxed. So up to a certain threshold, you don't have to pay tax on social Security, but up above that threshold, you pay tax at your top marginal rate, but on only 50% of the social security and above a higher threshold, you have to pay tax at your top marginal rate on 85% of your social security income. So not only we'll do the projections of federal income tax, but you may also be able to harvest more capital gains and not pay tax on it, and you may get taxed on less of your social security. So these are all cumulative benefits that ends up saving you a lot more than you might think by planning this stuff ahead of time.


So these long-term strategies, if you have a long-term written tax plan, it might suggest that you, for example, withdraw money from your IRAs and defer claiming on your social security for a few years. You might want to work down the balance in your deferred accounts before you start collecting social security because that means, for example, that you'll get a higher stream of Social Security, but you may have worked down your IRA balance to the point where maybe less of your social security is taxable, so you get a higher income from Social Security and less of it is taxable. That's all possible if you have a long-term written plan. It may also suggest that you start taking your IRA distributions earlier than you might think, because again, you may want to take more out of those accounts when you're in a low bracket because it helps work down the balance and you get lower long-term rates because you've drained that account a little bit. But all of that is only possible if you have a long-term strategy documented by a long-term written tax plan.

Speaker 3 (12:26):

Your retirement is at risk, not from the stock market, not from inflation. Taxes are putting your retirement at risk. I'm certified financial planner, Steve Waring and I specialize in helping people create low tax retirements. Unmanaged taxes can take 30, 40, even 50% of your retirement income. Learn how to defend yourself against excess taxation. Our complimentary webinar will cover all the principles you need to know to protect your money for you and your family and keep it away from the government. This free webinar will cover how taxes are different in retirement, the taxes you pay in retirement that you don't have to pay during your working life, how to move savings into a tax-free environment, the Widows Tax, the Secure Act, the Secure Act 2.0 and what they mean to you. The webinar is free, but you have to register to save your spot. So go to focused wealth advisors.com/webinars and find out more and sign up right there. Even if you're not planning to retire for the next five or 10 years, this information will be critical for you. The longer you have to put the strategies into effect, the more you can accomplish. That's focused wealth advisors.com/webinars to find out more and to sign up today.

Speaker 1 (13:53):

Lots of information to digest there. Lots to unpack as people like to say these days. Yes. What's your 30 minute action item?

Speaker 2 (14:00):

30 minute action item. Look at your financial plan. And do you have a written tax plan in that document you deserve to? It should be there. Take a look at your financial plan, see if it's there.

Speaker 1 (14:12):

All right. And if you don't have one, you know who to call Steve Wershing from Focused Wealth Advisors. Don't call me because I won't be able to help you, but I can help you if you have a podcast or something. That's Scott Fitzgerald at Roc Vox recording, and we will catch you next time. Three zero minute money. Thanks for listening and watching.