Maintaining Income in Retirement

When tax-deferred isn’t all that

Tax-deferred income is typically positioned as the Holy Grail of retirement planning. The logic behind it is simple: clients will benefit most if they can defer taxes on a portion of their income during high tax years until the lower tax years of retirement.

Unfortunately for many, those lower taxes never materialize.

“The tax brackets tend to be wider than you might think,” says Cindi Hill, CFP®, CRPC®, a retirement solutions consultant with CUNA Brokerage Services. “Even if a client’s overall income is less in retirement, he or she could easily remain in the same tax bracket.”

What’s the solution? Some clients will benefit from using a Roth IRA rather than a traditional one. The income put into these IRAs is taxed in the year it’s invested, but that investment grows tax-free and can usually be withdrawn tax- and penalty-free after the age of 59 ½.

Use A Roth Conversion To “Fill Up” The Remainder Of A Tax Bracket

In some cases, a client may benefit from converting some of their funds into a Roth IRA, as long as they keep an eye on when they bump into the next tax bracket. As always, clients should determine if this option makes sense for them in consultation with their tax advisor. But you, as their financial advisor, should introduce the opportunity.

Have High-Worth Clients? Here’s Their “Backdoor” Option

As you probably know, there are income thresholds that determine who can contribute directly to a Roth IRA. But that doesn’t mean your high net-worth clients can’t benefit from this option: they just need to do what’s known as a backdoor Roth conversion. The process is pretty simple:

  • Make a non-deductible contribution to a traditional IRA.
  • After a suitable waiting period (more on that below), convert that amount to the Roth IRA.

Be aware that this strategy works best if the client doesn’t have any other IRAs. Why? Because all IRAs get lumped into one account when determining the taxable portion of a distribution or conversion. There isn’t a way to separate out the after-tax money, so if another IRA exists, the distribution or conversion will be taxed on a pro-rata basis.

More Background On The Roth Conversion Waiting Period

While this transaction requires a waiting period between the initial contribution and the conversion to a Roth, experts don’t agree on how long that period should be. Suggested time ranges from three days to 12 months. Alert your client to this issue and urge them to discuss it with their tax advisor.

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