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The Blueprint to Tax-Efficient Retirement: A Financial Architect's Guide

The Blueprint to Tax-Efficient Retirement: A Financial Architect's Guide

| April 30, 2024

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At the heart of our practice lies a singular focus: to help our clients protect and grow what it took them a lifetime to accumulate. With this purpose in mind, we construct and implement tax-efficient financial plans. We understand that minimizing tax liabilities preserves wealth; according to published studies by Dr. William Reichenstein, CFA, as cited in his book Income Strategies, creating tax-efficient withdrawal strategies to generate retirement income can add up to seven years of longevity for a retired household’s portfolio.

It's rare to encounter a prospect without some underlying fear of financial scarcity in retirement. Recognizing this concern, we emphasize the importance of hiring not just an advisor or broker who focuses solely on investment management, but one who focuses on being an income and tax planner/manager as well. We call this comprehensive approach “Holistic Wealth Management.”

We believe that getting retirement ready is like building a new home. Consider that your retirement savings are your plot of land; the next step would be to hire an architect. The tax planner acts as the architect of your financial plan. A tax planner will consider your unique dynamics, assess the lay of the land, and assess your aspirations for retirement. They will create the blueprint for your retirement income, investment, and tax strategies.

With the blueprint in hand, the next crucial step is execution. Enter the tax manager—the builder who translates these blueprints into action. Their role encompasses constant oversight, ensuring the implementation of tax-focused investment strategies, tax-efficient withdrawal strategies, and forward-looking tax reduction strategies. This ongoing proactive management distinguishes them from tax preparers, the “Inspectors,” who serve as financial historians who memorialize the past.

A good tax manager understands that there are three distinct time phases to manage:  the working years, the retirement years, and the ultimate transfer at death. 

The 7 Steps of a Tax Manager:

Step 1. Understand the Order of Money

Not all money is taxed the same; how you initially save your wealth will determine how it is ultimately taxed. Think of dividing your money into three funnels.   For instance, IRAs, 401(k)s, etc., are pre-tax vehicles, and although they grow tax-deferred, every dollar that comes out of them is taxed at ordinary income tax rates.  After-tax accounts, (your Individual, Joint or Trust accounts), contain money that has already been taxed, but any growth will be taxed at the usually preferential capital gains tax rates. Then there are your tax-advantaged accounts, such as Roth 401(k)s, Roth IRAs and Health Savings Accounts, which were created with after-tax dollars and grow tax-deferred, and every dollar that comes out of them will be tax-free (as long as specific rules are followed).   

Step 2.  Create Tax-Efficient Withdrawal Strategies

This step involves considering your long-term plans and executing them year to year to create a growing and tax-efficient paycheck in retirement that you cannot outlive. By understanding the order of money, the tax manager can decide which levers (funnels) to pull each year to create your desired income with tax awareness and tax efficiency accounted for.


Step 3.  Measuring your Brackets:

This step is all about understanding your tax brackets at three distinct times: 

  1. What is your current top marginal rate?
  2. What is the top rate you are forecasted to spend the most time in during retirement?
  3. What projected rate will the surviving spouse be in once they revert to a single tax filer?

We gather this information from the “blueprint” that we create for clients.  Why is this information so relevant?  Because armed with this data, we can do some thorough forward-looking tax management!

Step 4.  Pay Now or Pay Later

This covers all time phases of tax management. First, it is how best to save if you are still working.  Let’s say you have five years before you anticipate retiring.  Where does it make the most sense to save?  Is it to your pre-tax retirement plans, to the Roth side of your retirement plan, or should you build up your after-tax positions?  The more “tax-diversification” a client has, the more strategies we have for creating tax-efficient paychecks. Secondly, it’s also about understanding how to get money out of the IRA and paying the least amount of tax possible.  Once you’ve measured your brackets in Step 3, we can begin to solve for this, i.e., if we know that we can get money out of your IRA today in the 22% bracket, and you are projected to spend most of your retirement years in the 28% bracket, Roth conversions now may make sense.  (To understand how best to think through partial Roth conversions, download our free booklet “The Consumer’s Guide to Partial Roth Conversions). Lastly, it is also essential to understand when to pay the tax from a legacy standpoint.  If you are currently in a low bracket and the surviving spouse will be in a higher bracket as a single tax filer (or anticipate your beneficiaries will be in a much higher bracket,) then paying tax now by accelerating money out of the IRA before you have to may also make sense.

Step 5.  Allocating Assets

Part of building your dream retirement portfolio is understanding which type of investments to hold in which types of accounts.  Certain types of investments, such as actively managed mutual funds, may be better off parked inside of retirement accounts to avoid unexpected taxable capital gain distributions.  Corporate bond interest is taxed at ordinary income tax rates, so why not park those inside of IRAs where you will give nothing up from a tax perspective?  For taxable accounts, consider individual stocks.  Individual stocks let you do some finely tuned tax-loss harvesting, enabling you to build a war chest of losses to offset current and future taxable gains (they also allow for easier tax-gain harvesting to reset cost basis on concentrated positions to avoid runaway gains.)

Step 6. Gifting

This is a very situational and customized step.  We look at this through 2 lenses:  Charitable gifting and intra-family gifting (and here is where we point out: “don’t give more to Uncle Sam than necessary-- he’s not even your real Uncle!)  There are strategies here that can be implemented such as Qualified Charitable Distributions, Charitable Remainder Trusts, Gifting Up, Gifting down, etc.).  The tax manager will understand which strategy to recommend and why it will support your unique estate plans.

Step 7.  Managing your Dynamic Bracket

This final step is the tax manager understanding how your different forms of income:  distributions, dividends, interest, gains, and losses stack up on top of each other and impact your ultimate tax bill.  Throw Social Security’s provisional income calculations into this and watch how wacky things can become!  It is important for the Tax Manager to understand the tax traps that come online with retirement age, such as the Social Security Tax Torpedo, IRMAA surcharges and the loss of some specific state deductions on retirement account distributions.  They need to understand how large your future Required Minimum Distributions will become and how that will stack on and impact your future taxable income. It's also important to understand how best to source additional unplanned income for life’s surprises in such a way that it doesn’t take your tax plan off course.

The Bottomline:

Reflecting on these 7 steps underscores the pivotal role of a tax planner/manager in orchestrating retirement income, investment, and tax strategies. Consider evaluating your current financial relationships—does your advisor integrate tax planning seamlessly into your financial blueprint? Coordinated strategies have the potential to extend the lifespan of your wealth. As you navigate towards financial security, remember: it's not just about returns on investment; it's about how much you actually keep. Take charge today to ensure your financial future withstands the test of time.