Achieving a Tax Free Retirement

[Music] all of your investments or savings of any kind they're all going to fit into one of those three buckets right and you remember what we call them we have the taxable bucket the tax deferred and the tax-free right now where do you think most retirement dollars are sitting today in this country it is going to be about 80 percent of all retirement dollars are sitting in the tax deferred bucket now why why is this so heavy and and uh tax free is so light we've got maybe 15 percent over here uh and then you've got maybe five percent if we're lucky um people that have their money in the tax free bucket and so as i um explain this we talk more about the tax how you get your money to the tax-free bucket i'm going to go through a scenario or an example client and as i do so i realize everyone's situation is different so it's not going to fit you perfectly but i can promise you that there will be things conceptually that will apply to you specifically and so so we're going to start with a 50 year old male and a 50 year old female okay married couple the joneses and they are earning a combined annual income of 100 thousand dollars okay now they also have in their combined iras five hundred thousand dollars they have they also have a hundred thousand dollars and um just a plain old mutual fund that's their emergency fund they're also contributing 10 into their 401k and but they're getting no match okay they're also putting paying two thousand dollars a year um for life insurance and they're paying four thousand a year for long-term care insurance okay now what would happen if this couple walked into the traditional financial advisor's office now when i say traditional i'm talking about the the mainstream tax deferred paradigm mindset now i can tell you over the years i've worked with many financial advisors around the country and not only worked with them but trained literally hundreds of them in various capacities and so i can i'm very familiar with their approach and their mindset so let me tell you how the conversation would go if if the joneses walked into the traditional financial advisor's office they would say congratulations you've done a good job in saving for retirement but as we look at this ira looks like last year all you earned was seven percent and we think we can get you eight so roll that over to us we'll manage it for you as far as your mutual your emergency fund it's a great emergency fund um but in your mutual funds you only got three percent last year we think we can get you five so roll that over to us as well and we'll we'll manage that as well as far as your 401k with no match keep on doing it if you ever change jobs give us a call we'll roll this into that get everything under one roof maybe save you some break points save you some fees and as far as your uh your life insurance and long-term care not really what we do but who are we to say that you shouldn't keep on doing it and so that is and that is the conversation that i've heard literally many many times now if this client was to come into our office we see red flags all over the place first off i'm not too concerned about the amount they have in this ira i'm more concerned about what that ira is going to grow to if it's growing at eight percent per year and so these folks are planning to retire at age 65. so what will this 500 000 ira grow to at 8 per year over 15 years well if we use the rule of 72 we take the rate of return which in this scenario would be eight we divide it into 72 and that tells us how many years for this to double so this is going to double in nine years so we've got a million dollars by every time we get another six years it's going to be about 1.6 million okay now that sounds great right but what's wrong with having 1.6 million in your tax deferred bucket right it's the taxes the the minimum required distributions alone on 1.6 million it's going to put them in one of the higher marginal tax brackets and which is also going to pretty much guarantee that their social security will be taxed you know in perpetuity and so what we might suggest or what some people may suggest why don't we do a roth conversion right so a roth conversion says you can take money out of the ira and convert it into a roth ira so long as you do what along the way pay the tax and what rate well it would be whatever the tax rates happened to be in the year in which you make the conversion right so let's assume a conversion is going to be 40 so what's 40 percent of five hundred thousand two hundred thousand now new mr mrs jones have an extra two hundred thousand dollars lying around that they would just love to earmark to pay this bill no they don't and so now some might suggest well why don't we just take the tax right out of the ira and what would happen if we did that it's it's pre-59 and a half so they're going to we'll have a distribution which would be a 10 penalty on top of the tax and so it's really not feasible at this stage of the game for them to do a roth conversion and so is there any other way that we can get money out of the tax deferred into the tax free so at this point we may recommend what we call a 72 t it's a little known section of the irs tax code section 72 subsection t and what it says is we can take money out of an ira pre-59 and a half with no penalties so long as we do it in even yearly installments for at least five years or until age 59 and a half whichever is longer and we can take out about five percent and so what is five percent of 500 000 25 000 and so we're going to send that 25 000 each year to the tax free bucket okay so let's look at this hundred thousand dollars they have in mutual funds this would be in their taxable bucket and so this is their emergency fund do they have too much or too little and probably too much so based on their annual income looks like the right amount would be about 50 000. and so because it's in mutual funds means the problem is getting bigger each year so what we may recommend is that we capture all of the growth and part of the principle and we shift it to the tax free each year until you know we do that such that when they reach 65 they end up with the perfect amount so based on five percent return that's going to come out to about six thousand dollars per year all right now how do we feel about 401ks with no match now this is the one thing that suzy orman dave ramsey clark howard they can all agree upon and that is that we contribute into a 401k up to the match but not one penny above and beyond and so we want to do whatever we need to do to get the free money but then move on to our next best option and so if we're trying to prevent this ira from getting any bigger and we're contributing to a 401k are those two strategies conflicting i mean that's a conflicted strategy and so because there's no match we're going to capture all ten percent of their hundred thousand so that'd be ten thousand but we can also shift into the tax free bucket okay so how do we feel about life insurance and long-term care well we feel that it's incredibly important to mitigate against those two risks which could really upset your financial apple card leading into retirement but we feel like there's probably a better way to accomplish that and so we're going to send that to tax free as well all six thousand so how much should we free up on an annual basis we can shift the tax free forty seven thousand dollars now we don't really have forty seven thousand dollars because we have some taxable events here right this is a taxable event and this is a taxable event and so if we add those together that's 35 000 of additional income and so we'll assume a 30 rate so we're looking at five 10 dollars of additional tax now to mr mrs jones happened to have an extra ten thousand five hundred dollars that they would just love to pay each year in tax no and if i were to suggest to them that they cut back on their lifestyle stop eating out stop going on vacations are they going to be my friend for very long no so what i'm going to recommend is we take that ten thousand 500 and we subtract it right out of the 47 000 that we freed up so that way we're going to have no out of pocket expense and we're not going to impact the current lifestyle at all that's going to leave 36 500 that now we can shift into tax free each and every year so the big question here where can we put this 36 500 to where he can truly grow in a tax-free way now the first thing i'm probably going to recommend is a roth ira now if this scenario was a little bit different and this the joneses happened to be business owners then i would take a hard look at their 401k and i would probably recommend that we upgrade and improve his 401k plan to include a roth 401k and not only that but to give him a better selection of of the underlying investments that can put so he can have some protection against market flexible you know fluctuations but that's not our scenario and so we're going to recommend funding two roth iras and so how much can two fifty year olds put into a roth ira well it's gonna be sixty five hundred each for a total of thirteen thousand so if we take that off it's the 36 it's going to be 23 500 that's left now why do we like roth iris so much and the reason is because as long as you're 59 and a half when you start taking money out there's no circumstance in which you would pay a tax not only that but the money coming out of a roth area is not going to impact your social security it is not going to cause your social security to be taxed like the tax deferred accounts would now where can we put this 23 five such that it grows in a truly tax-free way now at this point i may recommend a bucket and as we start putting money in and your bucket begins to feel as your money grows in this bucket the irs says that they're going to treat it differently than all of the other buckets we've talked about they're going to say that if you want to access this money pre-59 and a half you can do so with no penalty can you do that with your your 401k or your ira no they're also going to say there are no 1099s which means there's going to be no no tax on the growth then when the money comes out they're going to say there is no tax which means this is a truly a tax-free bucket they're also going to say that there are no contribution limits what were our contribution limits on the roth 6500 per year right per husband and wife they're also going to say that there are no income limitations meaning [Music] regardless of how much money you make so let me ask you a question can bill gates do a roth ira no he cannot why because he makes too much money as soon if you make more than you know north of about 184 000 then you're phased out of your ability to contribute to a roth ira so no income limitations and last but not least they're going to say no legislative risk so what do you think i mean when i say no legislative risk basically meaning that if you have the bucket you get to keep the bucket regardless of what laws might change so the laws for this bucket they have changed three times since 1982 and every time they simply said if you if you have the bucket you can keep the bucket based on the old rules and the new new rules only apply to you know the new people from this point forward so what do we call that clause we call it a grandfather clause right so as you look at this you might say wow this sounds incredible almost too good to be true right why don't i put all my money into this bucket well first off is it ever a good idea to put all of your eggs in any one basket no it's not and also the irs says if we're going to give you all basically an unlimited bucket of tax free dollars with all these benefits we there is going to be a cost of admission and we are going to require that there be a spigot attached to the side of this bucket which flows on a monthly basis some expenses and what do those expenses go for they go towards the cost of life insurance now let me ask you an important question if you're rapidly heading into retirement your mortgage is paid off your kids have all moved out is life insurance really all that high on your priority list probably not and the companies that sponsor these programs they recognize that and so they've done something to sweeten the pot they simply say that should you need long-term care they will give you your death benefit while you're alive for the purpose of paying for it so let me give you an example let's say you have four hundred thousand dollars of a death benefit they will give you two percent or eight thousand dollars um per month for four years for the purpose of paying for long-term care now if you have looked into traditional long-term care then you know that it can be quite expensive and it's the percentage of people who are going to need long-term care in america it's about 70 will end up needing some form of long-term care but what if you pay pay for 20 years and then you end up dying peacefully in your sleep are they going to send your money back no and so that can be a source of you know heartburn for a lot of people because we don't like paying for something that we hope we're never going to have to use but in this scenario right here if we pay these drops for 20 years and then you die peaceful in your sleep never needing long-term care someone of your choosing is still going to inherit the death benefit so we don't have this sensation of paying for something that you hope you're never going to have to use so what do we call this bucket by the way we call it l i r p stands for life insurance retirement plan why life insurance because the irs says that in order for this bucket to work it has there has to be a cost of insurance coming out why retirement plan because the whole purpose is that we have a large bucket where we can accumulate tax free dollars that you can use at some point down the road when tax rates are likely to be a lot higher than they are today so now have mr mrs jones have they already decided that they need and want life insurance and long-term care yes they've already budgeted for it and so all we're suggesting is that instead of sending the six thousand dollars off in the form of an expense every month why not divert that into their tax-free bucket let just a portion of the expenses drop out and then take advantage of this huge bucket of tax free dollars that they previously would not have had access to now before i go any further i have a very important question to ask and the question is this if you could be in any tax bracket of your choosing during retirement which bracket would you choose now it may not have even occurred to you that a zero tax bracket even exists or that it would even be attainable but it does it is and it's vital to protect your retirement dollars and so if getting to the zero percent tax bracket is our goal let's see how we we have done here with the mr and mrs jones okay we know they're putting 13 000 into the roth ira each year right so as long as they're 59 and a half or older before they start taking money out will they pay tax no tax uh the lirp will have quite a bit of money coming out of it um by the retirement age and regardless of what age they start taking the money will there be any tax no tax okay now they've got this ira so let's come back to that uh you remember we did not want the ira to get any larger inside of the tax deferred bucket right so if we did a good job how much should be in that ira at retirement age it should be 500 000 right now is there any way that we can take money out of this ira and spend it in retirement without paying a tax now if you remember absent any deductions if we were to retire today you would get a deduction right it's a standard deduction plus personal exemptions for a married couple it comes to twenty one thousand dollars and does the irs index that number for inflation each year yes they do about three percent and so in 15 years um this number is going to be a lot closer to 30 000. okay so so how much money can mr mrs jones take out of their ira in retirement and pay no tax up to 30 000 okay so we now have an ira with no tax so if we have no tax no tax no tax what do you think that impact that has on our social security no tax okay so if we have no tax no tax no tax and no tax what tax bracket does that put us in zero percent now why do we make such a big deal about the zero percent tax bracket because what's the next best tax bracket it's not one percent right this as of this year it's 10. you had another fight for state and you're looking at 15 percent so that's the next best thing and then if what david walker says is going to happen comes to pass and tax rates double in the future now we're looking at 30 percent and so the next best option is really not looking all that great now are we suggesting that um you put all your eggs in any one basket no what we're suggesting is that you have multiple streams of income all of which are underneath the radar of the irs now what i did for mr mrs jones is i created a before and after now you've probably seen diet photos of before and after well we can do the same thing with your retirement projections so mr mrs jones if you take a look here we ran a scenario saying what if mr mr jones never met us and they just continued to do what they were were going to do when would they run out of money and this is assuming that tax rates do stay the same no change they they would actually run out of money at age 88. however you can see the difference here in the two graphs um if they were to implement everything that we've recommended still assuming the tax rates stay the same how much can we increase and extend the retirement dollars and they they basically never run out the money is goes well past their life expectancy and they will have money left over now what was what would happen if tax rates do increase so the tax rate's double they're going to be running out of money closer to age 77 and what happens to their on this column if they do implement this if they're in the tax free or the you know the zero percent tax bracket what happens if tax rates double absolutely nothing right two times zero is still zero and so when you are in the zero percent tax bracket you have you are effectively off the train tracks right and you are isolated you have protected your retirement dollars so it doesn't matter what the tax rates do at that point now one of the questions that i get from time to time is can i be a good citizen and be in the zero percent tax bracket now are we suggesting that you never pay taxes no all we're suggesting is that rather than delaying or deferring or postponing the payment of taxes in retirement when tax rates are likely to be much higher that we we actually pay them now while tax rates are historically low it actually brought mr mrs jones they're gonna be paying ten thousand five hundred dollars in taxes just to get to zero percent tax bracket uh now i have a quote here this is from learned hand he's a judge he's the most famous judge to never be on the supreme court he said anyone may arrange his affairs so that his taxes shall be as low as possible he is not bound to choose that pattern which best pays the treasury there is not even a patriotic duty to increase one's taxes over and over courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible everyone does it rich and poor alike and all do right for nobody owes any public duty to pay more than the law demands so can you be a good citizen uh and can you be in a zero percent tax bracket and still be a good citizen absolutely [Music]

Channel: Financial Fast Lane

Views: 80,304

Keywords: retirement planning, life insurance, tax free retirement, taxes in retirement, financial planning, tax-free retirement, retirement income, tax free retirement income, tax free income for life, tax free retirement account, required minimum distributions, tax planning, financial advisor

Id: 6cQ0cZ5noEc

Length: 25min 27sec (1527 seconds)

Published: Fri Jun 24 2022