Does it matter what type of IRA I contribute to or take money from first?Submitted by Financial Planning Solutions, LLC on March 14th, 2019
That matters and then some.
Last week, a new couple came in that was referred to me by a client of many years.
They were planning on retiring this year and their main concern was not running out of money.
Up to this point, they pretty much did everything right. They maxed out their workplace retirement plans for most of their working career, they contributed to traditional IRA's and Roth IRA's when eligible (and they felt they had the money to fund them), and they even did a little estate planning in case something bad happened.
Now that they were entering a different phase of their lives, namely going from accumulation to withdrawing, they wanted to make sure they did the right things going forward.
They were very organized. Brought in all kinds of spreadsheets with budgets and lists of assets. "John" felt it made sense to rollover their traditional 401k money to their Roth IRA's so the money would grow tax free.
Since they were both over 62 (but under their full retirement ages for Social Security) he felt it made sense to start taking that money right away to minimize how much would have to come out of their various retirement accounts.
"Susan" had an opportunity to work for a family member for a couple of years and would earn about $40,000 a year. Again, their thought was it could delay taking more money from their retirement savings.
I felt it made sense to walk through all of these ideas to see how everything fit together. One thing I have learned over the last 25+ years is financial planning cannot be done in a vacuum. There are all sorts of pieces that can affect other things. Here is what I mean.
"John's" idea of rolling over their traditional 401k's to their Roth IRA's would be a great idea except the rules don't allow a pretax 401k to go directly into one's Roth IRA. They would need to do a Roth IRA conversion by paying ordinary income tax on any money they want to put into the Roth first. Now, if the 401K had contributions that were 401k Roth contributions, those could indeed transfer directly into their individual Roth accounts and continue to grow tax free. They also wouldn't be subject to the Required Minimum Distribution (RMD) rules at age 70 ½.
When to take Social Security is a whole other matter. We spend a good amount of time figuring out the best time to start SS to optimize the amount you (and a spouse) could receive over your lives.
Age 62 is the earliest one can collect however, one's full retirement age (around age 66 and up) is the time to start considering collecting for a couple of reasons. One, once you are at your full retirement age for SS, the earnings test goes away. Social Security takes money back if you collect before your full retirement age and are working and earning over a certain amount. In 2019, Social Security will take back $1 for every $2 you earn over $17,640 this year. Since "Susan" was planning on making close to 40k, Social Security would be taking back a good portion of her benefit. If she waited to make 40k after her full retirement age, the earnings test does not apply and you keep 100% of the benefit. (There could be taxes to pay on your SS benefit but that's a whole other story)
With married couples the plot thickens even further.
There are strategies we can use to maximize our SS benefits greatly. Since our benefit increases 8% each year we don't take it from full retirement age to age 70 (the latest one can wait to collect) it could be very prudent to not collect at one's full retirement age. Under certain conditions, one can collect a spousal benefit, let their own benefit grow and then switch to their own higher benefit later. (If it sounds confusing it is). And let's not forget Medicare. You want to talk confusing just give me a call.
When it comes to investment accounts, one has to decide where to take money needed for retirement. Out of which account to pull from first?
Well, again, we need to take a holistic view and look at not just retirement accounts but also non-retirement accounts.
Here's an example. "Angelina" had bought Apple stock way back and was sitting on a very large capital gains tax. While working and earning over $300,000, she would have had a big tax bill if she sold. By selling this stock in 2019 (if she retired in 2018), based on her income, she may not have any capital gains tax to pay. This money from this stock could provide income for a year or more and allow her to leave her IRA money alone until the required minimum distributions kick in. On top of that, diversifying a concentrated investment into a more broadly based mix of investments could be smart as well and doing it without severe tax implications is an extra bonus.
Back to those IRA's and distribution rules. Once we are at that magic age of 70, the options go down as we have to adhere to those pesky required minimum distribution rules (RMD).
However, let's say you are 70 ½ or older and you are charitably inclined (maybe you give to a charity or your place of worship each year) there is a way to use this RMD to your advantage by giving it directly to your charity.
Lots to think about for sure. We are happy to discuss your particular situation as they are all different as you can see.
*John and Susan not their real names
If you have any questions, give us a call.
We are here to help.
All the best.
Rick Fingerman, CFP®, CDFA™, CCPS®
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.