I am 60 with $1 Million in IRA Retirement Savings: How to LEGALLY Avoid Taxes?

Did you know the entire value of your IRA could go to taxes? Hey, I'm Casey Weade, CEO and founder here at Howard Bailey Financial, also a certified financial planner practitioner. And we're here to talk about how the entire value of your IRA today could end up going to Uncle Sam, which I know is not what you want to happen. I know that may sound far-fetched, but I'm going to run the numbers in just a moment so that you can see exactly how this works and how this is possible.

And then we're also going to be giving you some strategies to hopefully keep more money in your pocket where it actually belongs. In order to get to the math though, first, I want to talk a little bit about how things are going to evolve over your lifetime and some rules that have changed not all that long ago. And we're starting with required minimum distribution.

So you have this IRA or your 401k that you're eventually going to roll over to an IRA. You've put money in there for years, maybe decades on end. You never paid taxes on those dollars.

You got a tax deduction for putting it in. It grew tax deferred. And eventually, Uncle Sam, whether you want to take distributions or not, Uncle Sam is going to force you to take those distributions from that account.

And those are called required minimum distributions. Those required minimum distributions for my entire career up until a few years ago, they started at age 70 and a half. So in the year that you turned age 70 and a half, you didn't have to start taking required minimum distributions yet, but you did in the following year.

But if you waited until the following year, after age 70 and a half, you'd have to take two distributions. So anyways, 70 and a half, we start taking distributions. And then Secure Act came along.

Secure Act 1.0 came along and said, hey, we're going to push that age back to age 72. People are living longer. They're working longer lives.

And so since they're working longer, since we're actually going to be living a longer life, why don't we push that age out a little bit to age 72? And then Secure Act 2.0 came along. In Secure Act 2.0, they pushed that required minimum distribution age back to age 73 and back to age 75. So now we don't have to take those distributions out as early as we used to.

And everybody cheers. Great. They're securing retirement for the future for us.

And I would question and I would challenge you to question whether that's really the best deal for you or is that actually the best deal for Uncle Sam at the end of the day? How does this work? Well, if you were born 1950 or earlier, then your required minimum distribution age, it's no longer 70 and a half, it is age 72. If you were born between 1951 and 1959, your required distribution age will be 73. 1960 or later, that is going to be age 75.

Now, when you first start taking these distributions, say at age 70 and a half, then that amount you have to take out is around 3.5% a year. But it's all determined by your life expectancy. So the shorter lifespan that you have ahead of you, the larger the distribution becomes.

Because it's all based on life expectancy tables given to us by the IRS and they give us divisor numbers. So we take that divisor that they give us over at the Social Security Administration's website and then we take our IRA value, divide it by that divisor, which is our supposed life expectancy. That divisor gets smaller and smaller the older that we get.

So if we're waiting until age 75, those required distributions are going to be larger than if we were 70 and a half. And we just left our IRA alone for several years as well. So the IRA got larger, the divisor got smaller, our distributions get bigger.

As those distributions get bigger, now we have taxes going up, of course. We have our marginal tax bracket continuing to potentially increase, increasing our effective tax rate. But we could also see increases in our Social Security taxes.

As your Social Security taxes are based on how much income that you earn. That's actually combined income. You can check that out in depth in some of my other videos.

And then we also have Medicare premium penalties that could be increasing as well as those RMDs get bigger. If you have any questions about these things as I'm going through it, please just drop them in the comments section and I'll answer each and every one of your questions that you drop in there as quickly as I possibly can. But now let's get into running the numbers.

So what we're going to do is we're going to take an example of someone who has a $1 million IRA. And we're going to look at different RMD ages, 70 and a half all the way to age 75. So with a million dollar IRA, we turn 70 and a half, that divisor is 27.4. And I want to point this out, we push that out to age 73, the divisor is 24.6. Out to age 75, that divisor is 22.9. So we can see the divisor getting smaller.

And what we're doing with that divisor is we're taking the IRA value, we're dividing it by that divisor to give us a required minimum distribution, which starts, as I said, around three and a half percent, about $35,000 a year. By the time we're 80, that is now about $70,000 a year. So it has doubled over the first 10 years.

By the time we get out here to age 90, our required distribution is about $130,000 per year. And the taxes paid are going up over time as well. Now, in order to do these projections, we had to make a couple of assumptions.

And we're going to be looking at things from a high level here in order to really understand the tax impact for you and your heirs of deferring those RMDs into the future and how much taxes we're going to pay over time. Now, we're using a 20% effective tax rate here. Now, is that realistic or is it not? I think between federal, state, local taxes, it's a fairly realistic number today.

And we're probably being pretty conservative as well because we're saying that the tax rate's going to be 20% when we have a $35,000 distribution or we have $130,000 distribution. So again, looking at this from a high level, when you're working with our team, we'll dive much deeper and leverage some software and apply it to your own unique situation to really refine the numbers for you. But today we want to understand the concept, which is also why we're using a rate of return of about 7.5% per year, 7.54%. This is a benchmark index return that is given to us by Morningstar.

This is Morningstar's moderate benchmark return. This is what it's averaged over the last 15 years as of the time that we're recording this. This isn't a specific product you can invest in nor is this a specific rate of return that we're promising that we get for our clients or for you for that matter.

It's going to be dependent on the tools that you use and the strategy that's ultimately put in place. We want to look at this from a high level. So 7.5% on a million dollars, 20% tax rate over a 20 year period, say through age 90, we're going to pay $315,000 in taxes.

Another assumption that this is making is that this is a couple. And what if you were a couple, maybe paying a 20% effective tax rate, and then one of the two of you passes away. Now you have a surviving spouse that's a single filer instead of married filing jointly, the taxes could go up as well.

So again, look at nice round numbers here, $315,000 in taxes over the life of this IRA, taking those distributions at age 70 and a half. If we take it to age 72, now we're going to find that the taxes paid over the life of that IRA are about $320,000. So we went from what? About 315,000 to $320,000.

We go out to age 73, now it's 323,000 and change. We go out to age 75, it's $327,000 and change. So yes, we're paying marginally more in taxes during our lifetimes as those RMDs get deferred further and further out.

It is a marginal difference though. The real impact and where Uncle Sam captures the majority of these dollars will most likely be upon your death. And I know nobody wants their biggest beneficiary to be the IRS.

How could that be? Well, along with the SECURE Act pushing back those required minimum distribution ages to 72, 73, 75, it also changed how beneficiaries take those distributions. Non-spouse beneficiaries are now required to distribute the entire value of your IRA left to them over a 10-year period. They also recently announced that they have required minimum distributions over that 10-year window, but the entire balance has to be distributed over a 10-year period of time.

So let's take a look at the impact on the beneficiaries when we start taking distributions out for them, which is what is probably most likely the peak of their earning years. So let's leave this IRA behind in each one of these scenarios at age 90 to say our beneficiaries that are going to be age 55. So they're in their mid 50s and let's look at all of these different scenarios that we have here.

So we have a couple of different scenarios we're going to look at, each one of those being 70.5, 72, 73, 75. And when we look at each one of these scenarios, we're going to see that each time we defer that RMD further down the road, we're leaving a larger IRA balance. If we're leaving a larger IRA balance, then that's going to be more taxability to the heirs, more tax deferred dollars going to them.

And let's assume that they distribute those dollars over a 10-year period of time, make the same effective return you were making before at a tax rate that's now 30%. And I think, again, we're being fairly generous because let's take these examples. We have equal distributions in each one of these scenarios, somewhere between $225,000 up to $275,000 a year over a 10-year window if they're really responsible beneficiaries and they're not taking out in a lump sum, which the majority of beneficiaries do, distribute the entire IRA balance over a 12-month period.

And so let's distribute it out over time. In the peak of their earning years, if they're earning $100,000 household income at $350,000 a year now in taxable income, they're going to have an effective tax rate under current tax law that's around 30%. And so do we think taxes will be higher in the future? Well, we have to take that in consideration as well.

In all likelihood, given the current state of government affairs, debt, and our GDP, we can see that in all likelihood, we're going to see higher and higher tax rates in the future because it's either lower spending or higher taxes. It's most likely going to be higher taxes. I think that's what we have to bet on.

And if that's the case, these are very conservative numbers, maybe not just for you, but especially for your beneficiaries. Let's summarize all these numbers up. After we summarize all of these different numbers here, we can see at that age 70 1⁄2 RMD age, you're paying about $315,000 in lifetime taxes, survivors paying about $700,000 in lifetime taxes, cumulative taxes of a little over a million dollars.

Go down to age 75, you're paying about $330,000 in lifetime taxes. The survivors are paying about $825,000. Your cumulative taxes are almost $1.2 million.

Again, I believe these are all fairly conservative scenarios. And we just took a $1 million IRA and sent a million dollars to the IRS out of that IRA. This is how the entire value of your IRA today could end up going to Uncle Sam if you don't take some steps to preserve that IRA and keep more money in your pocket where it belongs.

Let's talk about a couple of those strategies. First and most obvious of these strategies, probably the most impactful one as well, will be that Roth conversion strategy. That means you're taking dollars from that IRA, paying taxes on them today, and moving them into a Roth IRA that does not have required minimum distributions and can be passed on to the heirs tax-free.

Now, they're still going to be forced to distribute those dollars out of that Roth IRA. However, they're going to be distributing them tax-free rather than on a tax-deferred basis, again, in a period of time which is probably a higher tax rate environment. And let's think about someone that's 70 to 75.

Rather than deferring those RMDs until age 75, what if we took $20,000, $30,000 a year and converted that over to a Roth IRA, effectively lowering our required distributions out over the rest of our lifetime? That could be a strategy that you want to deploy in order to reduce those lifetime taxes. Another strategy that may be less obvious are Qualified Charitable Distributions or QCDs. Qualified Charitable Distributions allow you to take dollars from your IRA and send them directly to a charity so they never hit your tax return.

Now, if you are finding that you're in that gap of 70 to 75, you used to have to take a required minimum distribution, now you can wait till age 75, but you're someone that tithes, you give to charity on a regular basis, then this may be a strategy for you to start giving dollars out of your IRA instead of giving those dollars out of your income or your taxable dollars and removing some of those dollars out of that IRA to reduce the long-term RMDs. You can currently give $105,000 a year out of your IRA directly to charity, and that is adjusted annually for inflation. It must be done by December 31st.

And if you have a charitable remainder trust, there's also an opportunity to do a one-time $50,000 distribution to a charitable remainder trust that would also allow you to get a tax deduction, different than sending those dollars directly to charity, but it may be right for you if you still need income from those dollars you're distributing as part of this Qualified Charitable Distribution. Next up, Qualified Longevity Annuity Contracts, also known as QLACs. QLACs allow you to defer your RMDs up until age 85.

These are guaranteed income contracts allowing you to set aside up to $200,000 of your IRA into an annuity that will kick out guaranteed income at some point in the future and won't require distributions along the way. Is that a good thing though? There's a lot of cons. There's some pros, but there are a lot of downsides with these contracts.

Number one, they're irreversible decisions. Once you've done this, it is irrevocable. You cannot make a change to that contract.

Your beneficiaries will also only receive your deposit minus any withdrawals that you've taken, so there will be no growth on these funds for your beneficiaries. Then we have HSA conversions. You can do a one-time health savings account conversion.

So if you are enrolled in a high deductible healthcare plan, an HDHP, you can't be enrolled in Medicare and you have to remain eligible for 12 months post-career, then you could contribute up to the HSA contribution directly from your IRA over to an HSA. So again, we can see how that's going to help us, but we can see in all of these scenarios, whether it's an HSA conversion, whether it's a QLAC or it's a QCD for that matter, the most impactful thing you'll probably be able to do is implement a Roth conversion strategy. In all of these different scenarios, the best strategy is going to be unique to your own individual situation.

So give us a call at the number on your screen to schedule a time to visit virtually or in person with one of our personal financial planners, wherever you find yourself in the country, and we'll run you a free income tax analysis to see if we can keep more money in your pocket where it belongs.