There is a line I use across the table that usually stops the conversation for a second. I did not come up with it. I learned it from Ed Slott and his team, and it is in my book because it does more work in ten words than I could do in a page.
IRAs and 401(K)s are joint accounts with the IRS and as they grow, investors pay even more taxes!
You have been saving with a partner for years. And the share that is not yours has been growing right alongside the share that is.
There are two numbers, not one
When I ask someone what their retirement savings are worth, I get the number on the statement. That is a fair answer. It is the number they have been watching for thirty years.
The problem is that a traditional retirement account has never been taxed. The contributions went in before tax. The growth has never been taxed. The account gets taxed as the money comes out, at whatever ordinary income rate applies that year.
So there are two numbers. The statement balance, and what is actually available to spend. The distance between them is not fixed. It moves with when money is withdrawn, how much comes out in a single year, and what else showed up that same year.
Most of the people I sit down with have never had the second number estimated. Many have built a retirement budget on the first one.
The tax is not the surprise. The timing is.
Almost nobody is surprised that a traditional IRA/401K account will be taxed. What surprises people is how much control they thought they had.
Under current rules, required minimum distributions begin at 73. They are not optional, and the formula does not ask what else happened that year. They land on top of Social Security. On top of a property or business sale. On top of whatever else pushed the year up.
And once the calendar turns, that year is finished. A conversion completed on January 2 belongs to the new year, not the old one. In most of financial life there is some way to revisit a decision. Here there is not.
The window before age 73 and 75.
The years between the end of full-time work and the start of required distributions are usually where there is something to be done about this. For a lot of households those years produce the lowest taxable income they have had as adults, and it is often a bracket they will not see again.
Two things become possible in that stretch.
The first is converting part of a traditional account to a Roth. Nobody wants to pay tax earlier than required, and for some households converting is not the right move. But the question is not really whether the tax gets paid. It is whether it gets paid at a rate you selected, in a year you selected, or at a rate determined later by a formula and a calendar. I spend all of Chapter 12 on this. It is called Getting to Tax-Free.
The second is the order you draw from. Most households retire with money across three different tax treatments, and each is taxed differently on the way out. Which one gets spent first changes the tax on everything else drawn that year, and again in every year after. There is no single right order, only the one that fits a particular set of accounts and a particular timeline.
I will say this much about the withdrawal question. It is the one most likely to have been answered by nobody at all, because it sits between the investment conversation and the tax conversation.
These years do not renew
The planning years are finite. Once required distributions begin, the flexibility narrows, and some of what was available at age 64 may not be available in the same form at age 74.
Waiting rarely feels like a decision. I put it this way at the end of my book:
Remember this: Tax Preparation costs you money, but Tax Planning makes you money!
Your accountant reports the year. To change a year, somebody has to be looking at it while it is still running.
One note for our neighbors
A lot of people in the Phoenix metro area own businesses, and business income is often irregular in the years around a wind-down or a sale. Arizona does not tax Social Security benefits, while distributions from traditional retirement accounts remain subject to Arizona income tax under current law.
Where this actually starts
Start with a plan, i.e. a professional strategy. How many years are there between now and the year your required distributions begin, and what does projected income look like in each?
The first section of Outwitting the IRS is free to read on our site, and nothing follows it. If you would rather talk it through, the first conversation is short and there is nothing to buy at the end of it.
Read the first section here: https://cleardirectioninvestments.com/outwitting-the-irs-book/
Take the First Step: https://cleardirectioninvestments.com/take-the-first-step/
None of this is tax advice for your situation. Please speak with your own tax and legal advisors about your circumstances.
Quotations are from Outwitting the IRS by Randy Stoltz, pages 144 and 174. The joint account framing is credited in the book to Ed Slott and his team, and is credited the same way here.
