Death and Taxes
November 08, 2016

Death and Taxes

“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”—Benjamin Franklin, in a letter to Jean-Baptiste Leroy, 1789. Even Mr. Franklin couldn’t have foreseen the frustrating complexity of the 74,608 page-long federal tax code. Understanding the tax code is a necessary step to a proper wealth accumulation strategy and, in turn, your retirement income strategy.

Under federal tax laws, some qualified investment accounts (401k, 403b, IRA and employer profit sharing plans) are often referred to as tax-deferred plans. Your income is invested into a qualified account before you pay tax on it. This gives these accounts certain tax advantages.

With a non-qualified account, taxes are paid prior to the investment. Non-qualified accounts are often referred to as taxable accounts. In spite of their substantial differences, you can hold any type of equity (stocks, bonds, and certificates of deposits) in both taxable and tax-deferred accounts.

Our portfolios employ an investment strategy – asset location – designed to reduce taxes and maximize growth. In order to realize the value of asset location a client needs to have both a taxable and tax-deferred account. We determine which securities should be held in tax-deferred accounts and which should be held in taxable accounts, enhancing after-tax returns. For a client with 60/40 equity-to-fixed-income ratio, for example, we optimize equity into the taxable account while putting fixed income into the tax-deferred account.

Upon retirement, we employ a tax-smart retirement income strategy designed with an eye toward tax-efficiency. We manage your required and optional withdrawals with a tax-efficient, tiered approach, while maximizing the ability of your remaining investments to grow.

The first tier of withdrawals includes required minimum distributions (RMDs) from tax-deferred accounts. RMDs represent the minimum amount you are required to withdraw each year. These withdrawals begin at age 70½.

The second tier of withdrawals comes from your taxable accounts. This allows you to take distributions and pay capital gains tax on assets that have appreciated. Capital gains tax rates are traditionally lower than the ordinary income tax rates paid on withdrawals from tax-deferred accounts.

The third tier includes discretionary withdrawals from the same tax-deferred accounts your tier one RMD withdrawals came from. You will pay ordinary income tax rates on withdrawals from these tax-deferred accounts.

The one account type we haven’t discussed yet is the tax-exempt account. After-tax money is used to fund contributions to to tax-exempt accounts (Roth IRA, Roth 401k, and Roth 403b). These accounts are employed in special instances, and provide useful liquidity in later years. You can make withdrawals for significant expenses, such as a medical event, without creating a tax liability. In addition, the Roth IRA can support bequest motives without tax liability.

For the past two years, we have been building an innovative, patent-pending, liability driven investment (LDI) solution – Retirement Income. Retirement Income provides the retiree with a longevity and inflation-protected monthly payment. This income stream maintains your standard-of-living while providing confidence you won’t outlive your money. This is accomplished with the tax efficiency to maximize your income and your security. Contact one of our advisors to learn how to maximize the tax-efficiency of your retirement plan.

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