Commentary: 2 Considerations for tax-deferred savings when nearing retirement
In our column last week, we discussed strategies for readers who may be retiring in 2017. The reality is that while we suspect some of our readers will retire this year, there are a number who are several years away from retirement and are just b...
In our column last week, we discussed strategies for readers who may be retiring in 2017.
The reality is that while we suspect some of our readers will retire this year, there are a number who are several years away from retirement and are just beginning to think about how best to position their savings so that they can be more likely to get off on the right foot in retirement.
One such area of concern is how to manage tax-deferred savings when approaching retirement. These savings may be in the form of a traditional IRA, a tax-deferred employer-sponsored retirement plan or in a deferred compensation plan. How best to utilize these tax-deferred dollars is different for each person, but there are two key fundamentals that everyone should keep in mind when it comes to managing tax-deferred savings in the years leading into retirement.
Don't View Your Tax-Deferred Savings in Isolation
In order to know how best to handle tax-deferred savings, you need to consider your
overall financial plan. Part of this analysis considers the ideal asset allocation for your tax- deferred savings. Will you need to tap into these savings early in retirement? If so, you'll want a more conservative asset allocation. On the other hand, if you have a more reliable stream of income and have no need for your tax-deferred savings, you can afford to be a little more aggressive.
This ties into what we so often write about in this space: You should have different buckets of money for different time horizons. Being able to identify whether your tax-deferred savings belong in your short-term, medium-term or long-term bucket is critical when analyzing how best to allocate those assets.
Consider the Tax Implications of Your Decision
Any tax-deferred savings are, in essence, a large IOU to the IRS. Think about it: You may have been saving for decades, deferring taxes on your contributions and any gains you may have earned. It's a great deal, and this tax-deferral can greatly increase the amount of money you're able to accumulate for retirement. The caveat is that, one way or another, the IRS will collect taxes on those dollars. Because there is this looming tax bill, it's prudent to think about that tax liability and the strategies that you may be able to utilize to limit how it may impact you down the road.
The strategy we typically implement with our clients is a Roth conversion, meaning paying
the tax bill on a portion of those tax-deferred savings and moving those savings to a Roth IRA. For someone who may want to retire at 62 once they're eligible for Social Security, that gives you potentially 8.5 years to move money out of a tax-deferred account into a Roth before being eligible for required minimum distributions. This reduces the size of your future required distributions and increases the amount of tax-free dollars you can spend in retirement.
Because of the impending tax liability, maximizing the impact of tax-deferred savings can take a bit of finesse. Yet with proper financial planning, those tax-deferred dollars can be better positioned to provide a stream of long-term income throughout the duration of your retirement.
This information is not intended to be a substitute for specific individualized tax advice. We
suggest that you discuss your specific tax issues with a qualified tax adviser.