What Is a Financial Plan? Part IV — Taxes

The table below demonstrates the dramatic changes we expect to occur during Larry and Jill’s early retirement years. (The numbers are approximate and are intended to show the trends in retirement income and tax liability for a typical retired couple.)

Delay retirement account distributions � Larry and Jill have sufficient taxable investments to cover their first three years of retirement. By drawing on these funds first and delaying distributions from their retirement accounts as long as possible, they will dramatically reduce their taxes and allow for continued tax deferral on their retirement accounts for three additional years. 


Based on our projections of the Franklins� current and future taxes, we offer them the following recommendations:

Make Roth IRA conversions � Because they will be in a very low tax bracket during the first three years of retirement, Larry and Jill have a wonderful opportunity to move some of their IRA assets to a Roth IRA. The amount converted into the Roth IRA will be taxable but at their very low tax rate. Future earnings and distributions from the Roth IRAs will be tax-free. In addition, the amounts converted now will lower the required minimum distributions from their IRAs later because Roth IRAs are not subject to the minimum distribution requirements. The precise amounts to be converted will be determined each year as part of our yearly tax planning and preparation for estimated taxes.

Remove employer stock from Larry�s 401(k) � Recent tax legislation now makes it possible to distribute out employer stock from a 401(k). Ordinary income tax rates (maximum 35%) will apply to the cost basis of the shares (what you paid for them), but the appreciation will be taxed at long-term capital gains rates (maximum 15%) when the shares are sold. Since all distributions from retirement accounts are normally taxed at ordinary income rates, this can provide significant tax savings. The cost basis on Larry�s employer stock is $90,000 and the appreciation is $100,000. By distributing out the shares, he will pay 15% tax on the $100,000 appreciation. If he leaves them in, he will have to pay at least 25% tax on the appreciation when he withdraws the funds to live on. That�s a tax savings of $10,000.

Moving to Florida will produce dramatic tax savings � Florida does not have an income tax. Compare that with the marginal tax rates in Maryland that reach as high as 7.85%. If Larry and Jill stay in Maryland and take $70,000 a year from their retirement accounts, they�ll pay Maryland approximately $4,300 in income taxes. In Florida, the state income tax bill would be zero. However, Florida does have an intangible property tax on taxable investments, which is 0.1%. In their first year in Florida, this tax would amount to about $160.

Plan for estimated tax payments � During their transition to retirement, and through their retirement years, tax planning will be important to Larry and Jill. All government agencies require that you pay your taxes as you go through the year. Since taxes will no longer be withheld from their paychecks, they�ll need to plan to make quarterly estimated tax payments directly to the government. This helps them avoid penalties for underpayment of tax.

The value we bring with our comprehensive approach to retirement planning is to prepare our clients for the financial changes they can expect to encounter as they transition to retirement, and to give them the peace of mind that comes from knowing that their financial affairs are being monitored by an advisor who knows their needs intimately and is looking out for their best interests.

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At BWFA we understand that it�s difficult for people to find sound financial advice. That is why our approach is to provide straightforward solutions you can understand and act on. At BWFA you get the highest quality advice available anywhere, at any price.

We are dedicating this Special Edition of our quarterly newsletter to helping you understand what REAL financial planning is by illustrating a real-life situation. We hope you have as much fun reading it as we did writing it.

~ Saxon Birdsong, President and Director of Investments 
Part 1: The Client Profile
Part 2: Retirement and Estate Planning
Part 3: Investments
Part 4: Taxes