Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
headshot of IRA expert Ed Slott

Retirement Planning > Saving for Retirement

Ed Slott: IRAs Are a Ticking Tax Bomb

Your article was successfully shared with the contacts you provided.

“It would almost be malpractice for any financial or tax advisor to ignore the coming tax storm,” according to Ed Slott of Ed Slott & Co.

That’s one of the central themes in his new book, “The Retirement Savings Time Bomb Ticks Louder,” Slott told ThinkAdvisor in a recent email exchange. “The taxes growing in the IRAs are what my book title refers to, a ticking tax time bomb.”

The main point of the book, Slott relayed, “is to help people prepare for that tax storm now, before it unleashes financial damage in the form of excessive and unnecessary taxes.” And advisors are at the forefront of helping their clients prepare for that.

Slott talked with ThinkAdvisor about his new book’s focus on the Labor Department’s new fiduciary rule and rollovers, as well as why he devoted entire chapters to how Roth conversions, life insurance and estate planning can withstand future assaults by Congress.

THINKADVISOR: You discuss retirement plan distribution and rollover strategies in the book — which align with the Labor Department’s new fiduciary rule. Please talk about what consumers and advisors should know as it relates to the fiduciary rule.

ED SLOTT: In my book … I title this section “What to Do with the Biggest Check of Your Life” which includes a 50-page section called “Roll Over, Stay Put, Withdraw, or Convert?”

The “biggest check” I refer to is the distribution from a person’s retirement savings in their 401(k) or other employer plans. This may indeed be the biggest check a person receives in their lifetime, in some cases the amount is even larger than the value of their home, so this is a critical, once-in-a-lifetime decision that people will be making when they retire from their job.

They may only have one chance to get this right, and don’t want to suffer adverse tax consequences if a mistake is made, or if they are advised to choose a distribution option that may not be best for them.

The Department of Labor (DOL) also recognizes that a large chunk of workers’ lifetime retirement savings needs to be protected, and they recently issued rules that are highly focused on “rollover” options from these retirement plans.

The DOL wants to make sure that financial advisors will help their clients with this important distribution decision and do that by putting their clients’ interests first. In fact, the DOL is so concerned about this situation that in the staggering 476 pages of this ruling, IRA rollovers are referred to 300 times!

That’s because the DOL knows this is where the big money is, and they want people to get the advice that serves them best.

In short, the DOL wants advisors first to be educated on the tax rules for each of the possible distribution options — meaning advisors should be able to explain both the benefits and drawbacks (pros and cons) of each option, have a process to do that, and then document that process with the goal of providing the advice that would best serve the client.

The three main distribution options are:

  • Roll over the funds to an IRA;
  • Stay put in the company plan, or roll the funds to a new company plan; or
  • Take a lump-sum distribution and pay the tax now

Of course this is such a big decision, involving a lifetime of savings, that consumers will need professional help here. But consumers also need to be educated, and this section of the book clearly lays out each option, providing the pros and cons, along with the tax consequences so that they can be better informed when seeking professional advice.

To that end, there’s also an in-depth section (beginning on page 73) on the lump-sum distribution option since the tax benefits of using the NUA (net unrealized appreciation) in employer securities strategy is probably the costliest oversight, especially given the stock market growth over the past decade.

There are potentially huge tax benefits here that should be considered, when applicable.

Due to the unforgiving nature of some of these tax rules, consumers may have only one chance to get this decision right, and there’s a lot riding on it for them, and their families.

In most cases, the IRA rollover may be the best option. But the DOL does not want advisors to simply recommend that option (which may be in the advisor’s best interest, since they gain access to the assets under management) without first going through the process of exploring each option with the client to see what will serve that client the best.

The message for advisors is to always put their clients’ interests ahead of their own. That’s good business in any business.

Can you talk a bit about the chapters on Roth conversions, life insurance and estate planning, and how they focus on new tactics designed to withstand future assaults by Congress?

Yes, this is an essential theme of the book.

I’m worried (and anyone with an IRA or 401(k) should be equally worried) about future higher taxes as our national debt keeps increasing. At some point, maybe sooner than we think, Congress will be desperately seeking revenue. Where will they look? That’s easy.

Congress will go for the low hanging fruit — retirement funds that have not yet been taxed. They are sitting ducks. At some point tax rates will have to increase.

As people’s IRAs and other retirement account balances grow, so does the tax bill within them, because these funds are only tax “deferred,” not tax- free.

Your IRA is an IOU to IRS!

These funds have not been taxed yet, but they will be and at likely higher tax rates on higher balances leaving people with less when they will need it most, in retirement.

The taxes growing in the IRAs are what my book title refers to, a ticking tax time bomb.

It’s not if, but when. These taxes will have to be paid, and the longer people wait to address them, the bigger the tax problem grows. Current tax rates right now are at all-time, historic lows.

Just look at the chart on page 28 of my book, showing the history of top tax rates from 1913 to the present, and show this to clients. They will be shocked to see how bad it could get. But since tax rates are low right now, now is the time to strike and start trimming these taxable balances, before the tax debt gets out of control.

This is why I have devoted entire chapters to each possible solution. Then I wind up the book with estate planning advice on passing funds to beneficiaries with the least amount of taxes (preferably no taxes), by using tax-free vehicles like Roth conversions and permanent life insurance with the tax-free cash value buildup.

It would almost be malpractice for any financial or tax advisor to ignore the coming tax storm.

Helping clients keep more of their retirement savings is not only good for the clients, but also great for advisors since more assets will stay in clients’ accounts, rather than Uncle Sam’s!

You state that there are solutions that are even better than the stretch IRA, and by following your guidelines in the book consumers can build a larger inheritance for their family with more control and less tax. Please explain.

Due to major recent changes in the tax laws, IRAs have become the absolute worst assets to leave to beneficiaries. That was not true even a few years ago.

Before 2020 the so called “stretch IRA” allowed beneficiaries to extend distributions from their inherited IRAs over their lifetimes, which depending on their ages could have been 30, 40, 50 years or more of tax deferral, and growth in the accounts.

But no more. Congress in their search for revenue eliminated this benefit that many counted on when making their plans decades ago.

The Secure Act eliminated the stretch IRA for most beneficiaries and replaced that with a 10-year rule requiring all the inherited IRA funds to be withdrawn by the end of the 10th year after death, shortening the window of total taxation, generally resulting in higher taxes which may fall on beneficiaries who would be in their own highest earning years.

Yes, Congress closed that door, but opened others.

If anything, IRAs were always a problem asset to inherit due to the complex and rigid tax rules. Even the stretch IRA was often lost due to mistakes or not understanding the tax rule requirements, especially in the trust area. Many trusts failed the IRA tax rules to qualify for the stretch and triggered high trust taxes.

While Congress downgraded IRAs as wealth transfer or estate planning vehicles, they indirectly upgraded solutions like Roth IRAs and life insurance as more powerful estate planning vehicles.

It’s time to start reducing IRA balances and leveraging those funds in tax-free accounts, where the compounding goes 100% to the clients and their families without having to worry about future taxes.

Even after paying taxes now, clients and their beneficiaries will end up with larger inheritances, more control (no more complicated IRA tax rules to worry about) and less tax. This is what every client I have ever had has wanted.

Today’s historically low tax rates provide the opportunity to move those IRA funds to tax-free territory and eliminate the ticking tax time bomb NOW!


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.