Looking at all the charts above, it is clear to see that in comparison to years past we have pretty low tax rates.
The Tax Cuts and Jobs Act, passed in 2017, lowered tax rates, with a sunset provision that would raise taxes back to where they were in 2025 if nothing is done.
This means now is an optimum time to do a number of things that could dramatically lower the amount of taxes you pay in retirement.
The most common strategy used to reduce taxable income is a Roth conversion. A Roth conversion is where you take money from your traditional IRA or 401(k) and transfer it into a Roth IRA.
Traditional IRAs and 401(k)s are tax-deferred, meaning you do not have to pay taxes when you put the money in the account but pay taxes when you take distributions from the account. Roth IRA contributions are not tax-deductible, but withdrawals are tax-free.
Performing a Roth conversion means that you will have to pay taxes on the money being moved. For this reason, it requires a well thought out plan.
At Cardinal, we specialize in helping people with Roth conversions. We understand how the rise in taxable income is going to affect all your finances, now and in the future.
For example, if you took a large distribution from your traditional IRA and moved it into a Roth, it could increase your taxable income so much that you would be required to pay IRMAA, a surcharge on your Medicare Part B and Part D. This surcharge can increase your Medicare bill by thousands a year.
For one client, we were able to come up with a plan that allowed them to do a Roth conversion, taking advantage of the current low tax rates, and avoid IRMAA. He was in his last year working, so due to his retirement, he was able to file an appeal to IRMAA as this was what qualifies as a “life-changing event”.
For others, we look very closely at their income and come up with a plan for how they can pull out just the right amount of money to avoid any unintended consequences.
Let’s look at the couple we mentioned earlier with the combined $45,000 of income. Looking at the 2021 tax brackets, they could pull about $36,000 from their IRA and have it be taxed at the 12% rate. They would also not trigger IRMAA charges.
Not only would they be paying a very low tax rate on this $36,000, they would then have access to over $30,000 of tax free money in the future.
If we did this same type of planning every year, they would eventually be able to move most, if not all, their IRA money into a Roth, paying low taxes and setting themselves up with tax-free retirement income.
Starting this strategy sooner rather than later is going to pay off in the long run, though anyone at any age can use a Roth IRA conversion to their advantage.
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