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Financial Planning > Tax Planning > Tax Deductions

4 Retirement Planning Moves That Can Yield Big Tax Savings

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What You Need to Know

  • Many investors underestimate how much their decisions about drawing income from untaxed investment accounts can affect their overall tax burden.
  • With support from tax-savvy advisors, clients can often significantly reduce their capital gains taxes.
  • While many factors impact a client's tax liability, asset location is among the most important and most controllable elements.

William Sweet, the chief financial officer at Ritholtz Wealth Management, recently joined the hosts of the Compound’s Portfolio Rescue podcast for a lively discussion of topics ranging from utilizing leverage in real estate portfolios to understanding why the yield curve is inverted.

During the discussion, Sweet took time to respond to a number of audience questions focused on how to make efficient withdrawals from 401(k) accounts and how to tactically offset capital gains as part of an overall retirement planning strategy. According to Sweet, many investors significantly underestimate how much their overall tax burdens and lifetime wealth accumulation are affected by their decisions about when and how to draw income from untaxed investment accounts.

As such, Sweet noted, by keeping a few key principles and concepts in mind, investors can significantly boost their retirement outlook and ensure their hard-earned dollars are available when they are needed.

1. Mind the Rule of 55

As Sweet explained, clients leaving their employer at age 55 or older often fail to realize they can utilize a fairly obscure element in the tax code known as “the rule of 55.” This rule allows people to withdraw funds from their current 401(k) or 403(b) penalty-free (but not tax-free), so long as the plan has elected to offer this option.

Notably, the rule can only be utilized with respect to the client’s current plan at the time they leave the employer, meaning retirement plans at prior employers and private individual retirement accounts are not eligible. Furthermore, some public safety workers may be able to take advantage of this option as early as age 50.

Sweet pointed out that this ability to avoid the 10% excise tax that would otherwise apply to such withdrawals can make the early retiree’s current 401(k) plan a more attractive potential source of bridge income, especially for those who want to wait until 65 or 70 claim Social Security.

2. Consider 401(k)-to-HSA Transfers

During the podcast, one audience member who plans to leverage the rule of 55 raised the idea of taking the early 401(k) distributions and then depositing the maximum allowed into their family’s health savings account.

Generally speaking, Sweet said, this is indeed a potentially useful strategy.

“If you time the 401(k) plan withdrawals and the HSA contributions in the same tax years, the tax implications will effectively net out to zero,” Sweet explained. “And then in the future, assuming you will use the money for qualified medical expenses, there will be no taxes on those amounts in the future. This is a neat idea and a good thing for people to consider if it fits their circumstances.”

That said, Sweet suggested that this individual should probably get in touch with a certified financial planner or certified public accountant to cover their unique situational details. Tax issues, as Sweet noted, can get very complex very quickly, and a general rule of thumb that applies broadly may not always help a given individual in a given tax year.

3. Take Advantage of the 0% Capital Gains Tax Bracket

Another listener offered up their personal income situation in 2023 for Sweet’s thoughts about the best approach for reaping capital gains. The individual is 45 years old, is married, has a salary of $65,000 and is carrying an impressive $300,000 in unrealized capital gains. Next year, his wife will be taking a leave from work (i.e., earning no anticipated income), which means the couple’s combined income will be just $65,000.

Thinking over this situation, Sweet said there is a great opportunity for the couple to use this expected lower-income window to harvest a significant amount of capital gains while paying very little in taxes.

As Sweet explained, the couple can earn as much as $83,350 in net taxable income while still enjoying a 0% capital gains rate. Assuming the couple plans to take the standard deduction of $25,900, this implies the couple can have a max adjusted gross income (across work income and capital gains) of approximately $109,000.

Sweet suggested one good approach would be for the working spouse to put, say, $20,000 into their workplace 401(k) plan, which means his stated income from work in 2023 would be reduced to $45,000. Taken all together, this implies the couple could realize up to $64,000 of tax-free capital gains during the year.

“What’s also great to see is that this couple’s overall tax burden is going to be very low, as well,” Sweet said. “According to my basic calculations, they would owe something like $2,000 in taxes on the $129,000 in total gross income. That’s something like a 1.5% tax rate.”

According to Sweet, anecdotes like this show just how powerful tax-aware financial planning can be, but he again urged investors to work with advisory professionals to ensure they are not overlooking any potential tax pitfalls or other issues.

4. Use Roth Conversions to Reduce Capital Gains Taxes

Sweet and the other podcast guests emphasized that asset location is always something for advisory professionals to consider in the course of investment and tax planning for clients.

In the current market environment, converting traditional IRA assets to a Roth IRA remains an attractive strategy for some clients, given the losses experienced in 2022 and the current low tax rate environment. Such conversions can help clients avoid capital gains taxes in several ways.

On the one hand, holding stocks with high growth potential in a Roth will negate any taxation of future capital gains for those securities. Secondly, assets in an inherited Roth IRA are tax-free to beneficiaries upon withdrawal, as long as the original owner had met the five-year rule prior to their death. This includes any capital gains that were realized in the account along the way.


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