Latest / Federal Retirement Advisors | FedLegacy / Tax Sequencing and Roth Conversion Windows
Transcript
- William Smith: I got a call. I got a call this week and it's one of those calls that I that I absolutely hate to get. And it was a it was a call from a client. She works for the VA and she was just letting me know that her mom, her mom had just passed. Now she we have been talking about it for quite a while because her mom, her mom had Alzheimer's. But, know, you just always just have this hope that, you know, you're just never going to get the call that we got that I got last week. And so When I got that call, you know, obviously I had a relationship with the mom and the client for quite some time. I think she's been a client of mine for at least 13 years, at least 13 years. And, you know, so you just have a good relationship with them. And as we're talking through their do the the life insurance because the mom had life insurance and things like that, or when the process of helping her with that, you know, one of the conversation pieces that we had. was, well, what do I do with all her TSP money? Because the mom was the mom was a retired federal employee as well. service, but she had a bunch of money in TSP. And then she had she had some money from her pet, dad that the mom had, too. So ⁓ she has all this money. A lot of it sitting in that's getting ready to come to a lot of it sitting in traditional accounts. ⁓ and another way of saying that is sitting in qualified accounts, meaning the money had not been taxed yet. Right. And so Because of that, we've done some rough stuff for the mom, but we just couldn't do it all in the right timing for a variety of reasons. But now we're talking about the mom pass, life insurance has come in. You know, your mom has all this money in retirement accounts. But the kicker is the client, makes she makes a lot of money in the government. Right. And so because she makes a lot of money in the government, we're going to have we're going to start having to have a tax conversation because of. what happened in 2021 with the Secure Act 2.0 and how the 10-year rule came into effect. And this particular client is thinking about retiring soon, all good, but there's certain things that she's going to have to do or she's going to be affected by that she really has no control over anymore because now this 10-year rule has come into effect. And so we're going to talk about that tonight because it's a big deal. everything going on with the IRS, with Trump and all that type of stuff. Like taxes to the middle class Americans were really getting hit hard by this stuff. And it's the stuff that people just don't talk about. much of this person's income is going to get taxed. And you're looking at because they live in D.C. because she lives in D.C. She has the state tax of D.C. She also has the federal taxes. I mean, we're looking at almost up to 40 percent of what her mom is leaving her being taxed by the IRS and the state. combined. And so what we're going to talk about today is how to avoid this type of situation and how to navigate it so that you're not as you can get ahead of it for you and your family. Right. That's just a super huge thing. And that's the reason why we started Fed Legacy to have these conversations because, you know, I'm when my parents were coming up, parents were raising me and I was in my twenties and I tried to have these conversations with them. They just didn't have the education. Nobody taught them the education. And I don't blame them. My dad is a pastor, Seventh-day Adventist Church. My mom worked for the Seventh-day Adventist Church School. They did the best to raise me and my brother the best they can. They just didn't have the education. And so the reason why I started Fed Legacy, because I wanted you, my people, to have the education so that you're not hit with these 40 % tax traps that was just set up under the Secure Act, you know? And so we're going to go into that so that we can have strategies. to limit, know, there's no way you can avoid taxes but you can definitely reduce the amount of taxes you pay, which is a huge, huge, huge win. So I I talk about this stuff lot, ⁓ but the reason why I talk about it a lot is it's so important. mean, you're at the difference between saving ⁓ hundreds of thousands of dollars in taxes to your family and just hundreds of thousand dollars in taxes saved, but it's just ⁓ avoiding the headache of having to be in a 10 year with the IRS when you don't need to be. And so when you was a federal employee, when you retire, your retirement income is going to get taxed, right? Your pension has taxes, your TSP has taxes when you take it out, your social security, all of it's not taxed, but a portion of it's taxed. So you're still dealing heavily with the IRS once you retire. You have to know your numbers, right? And so one of the things that we talk a lot about is tax, clean up versus tax strategy. Now, most people that... we run into and I love having this conversation, especially with folks that are really curious about their retirement and they're really curious about like leaving wealth and making sure that they're enjoying their retirement and their money's growing and they just really want to know, you know, how to navigate. I love saying this line all the time. It's like, okay, especially if you have a decent amount in your TSP, a decent amount can be anything to anybody, but I'll just leave it at a decent amount of your TSP. Always say, okay, your TSP is going to continue to grow. And so you no longer, you no longer are trying to survive, but you got to break that mindset. And the reality of it is you now welcome to the fact that you now have rich people problems. And when you think about what rich people always talk about all the news and places like books, whatever, it's always how to reduce the taxes. Okay. And so what I love to say is this, the tax person you had, it was just following your, your, ⁓ turbo tax stuff that just It's just that doesn't work anymore when you're retired and you're thinking about RMDs, Irma, ⁓ Roth Converge and stuff like that. You really need a more experienced person to help with this. Just filing a tax is getting in return. Those days are over. Right. When you retire because the because being passive about it can be so expensive. So what I always say is like you don't want to have a tax cleanup person. You want to have a tax strategy. This means The person that's doing your taxes needs to be somebody that can be proactive. Look at multi-years because you have to, when you retire from the government, you have your pensions being taxed, your social security is being taxed and your TSP is being taxed at income. Those are three different sources. So it's already gonna put you in a higher tax bracket than most retirees just because you're receiving more income. But as your TSP continues to grow, you're gonna run into RMDs which we're gonna talk about in a minute. And so... You need to have a person that's supporting you in a on a multi-year strategy, because as your TSP grows, you're kicking down the road, which are going to owe to the IRS. And it's super, super important to be able to have somebody who's following your taxes, who understands that journey so that you can save hundreds of thousands of dollars. So if you're on here and you just got your your cousin or your person from church still doing your taxes, doing H &R Block type stuff. It's really you should really start to seek somebody else that understands multi-year strategies because that just saving up, getting somebody cheap to do your tax returns is a super expensive thing. The longer you punt that down the line. So. And the reason why it is because you need to know these things, right? We talked about this last week. What income comes out first? Need to know. Are you taking Social Security? Are you taking are you taking your TSP? How are you doing that? ⁓ What account is tapped in first? You're Roth, you're traditional, you have some old IRAs. When should you start Roth conversions? These are the conversations you want to be having with your tax person. How do you avoid unnecessary tax pressure later? Super important. And this is why we as Fed Legacy, we really spend a lot of our time studying taxes. That's why we have a CPA that we work with on staff. These are just important things because once 2021 and the Secure Act came on board, it just became critical because it became an emergency for people because that 10 year rule was so, it's it's so crucial when it comes to how much of your wealth you keep versus how much the IRS gets. And so your pension is the taxable base, right? Your pension, you're to pay taxes on that, right? Depending on what state you're in, if you have state tax or not, that matters. You know, do you the survivor benefit, all that type of stuff, all that matters. And so what you also want to look at is what should TSP future tax bill. And how you know that is you wanna be able to look at what tax brackets you're in now, one, right? You wanna know when you're doing Roth conversions, how much should you do and why? You wanna know when you project out what your RMDs will be, that will help you understand what your future tax bill will be, right? So here's what RMDs look like. Well, is this is a PowerPoint, but this is more interactive. When you have, when you're doing your RMD, this is the requirement of distribution expense chart. Distribution chart, call it expense chart, but here's how you calculate it, right? So when you get to 73, if that's the age you start, some is 74, but this is the 2026 chart. When you get to this age, what you do is you take, you take what's your... what your TSP balance is, or your traditional IRA balance, any money you have in qualified accounts. So that's any money that you haven't taken any taxes, that your taxes have been deferred on, okay? Qualified money. Typically that money comes from a 401k or a TSP. If you have a old 401k, it'll come from there. If you have a traditional TSP, it'll come from there. So any balances you have, or inherited money. that came from somebody else's qualified account. They take that money and they look at it. Let's say you're 74. Let's say you have 500,000. So what happened is you then divided by this 25, you divided by 25.5 and then that's how much your RMD is for that year. Okay. And the older you get, the lower that number gets, meaning the bigger you... the bigger your RMD is, right? And so one thing you have to keep in mind is your money will continue to grow every year. And so what often happens is, and then your pension's also growing because you're getting cost of living increases, your social security is growing, you know, and so, or you might even be taking some money out of TSP, but like, you have to keep this in mind because once, as that money increases, so do these RMDs. And what ends up happening is it can start to push you. into higher and higher tax brackets. And so what you want to do is you want to look at what we call the Roth conversion window. And so the Roth conversion window, this says 59 and a half. That's if you retire 59 and a half. But, you know, if it's 62, fine, it could be any of those. Right. But what you want to do from that 62 or 59 when you retire, you want to start doing you want to start looking at what your current tax bracket is. figure out how much more you have room to have in that tax bracket. And then you want to start converting that money into Roth, Roth IRAs or Roth TSPs, whatever you want to use. So that by the time you get to 73, this number they're for the distribution period is much lower, right? So let's say you had 500,000, but then you moved 200,000 over that time period into the Roth IRA. Now it's 200 divided by 25 to the 500. And so it was much less, is the chances of you going into higher tax brackets is harder. And even though that 200 might be growing every year, cause it's still in this, in a growth account, you're not paying as much in taxes because you're starting with a much lower number or no number at all. But that's how you want to think about it. So here's an example of a client, you know, he had, he had, projected to have 1.6 million by RMD age, 60 to 90K is what his range was gonna be with RMDs when we looked at it per year, which will push his lifetime tax bill up to about between 400 to 450K in total tax bill. Now, what we did before that, A, while the account was still at 640, we started moving $45,000 a year. which freed him up to a ton of tax-free income over that 13 year period, because he retired at 60. Right? And so now all that, as that 640 grows to 1.6, the majority of that money is tax-free, which makes a big difference because now his kids are shielded from the 10 year rule, his spouse, when he passes. isn't subject to going down into the single ⁓ to file in single with the tax brackets are much smaller and it's easy to get into the higher higher brackets. So it saves them. It saves his family tremendously by him just doing those Roth conversions in that conversion window. Another thing is Irma. Somebody asked a question about this last week and I'm like, I don't talk enough about this. So if you're taking Medicare. Right. You want to you want to you want to understand what your Erma premiums are because your Erma premiums have a two year look back. OK. And so if you're doing Roth conversions and this is something that's super important or you're just taking money out of your TSP, you just if you just take your money out of your TSP and you have no strategy and you take your Medicare, right. Medicare Part B, then you can push yourself into into a higher premium bracket just by doing that. And you're not knowing. And so here is the Irma income bracket for married filing joint. You know, if your single was a different one, but you know, if you, if you, if you're under two 18, that's a premium 202. You go up to two 18 to two 74, it goes to two 85 and so on and so on and so on. But it has a two year look back. So if you get into those brackets, you get into those brackets, a higher brackets, you'll be paying that premium for two years until your bracket drops back down. if you're doing like Roth Convergence or you're taking huge withdrawals. So you have to be very, very careful when it comes to how you distribute money in retirement. I hate that these rules exist like this, because I feel like now that you're retired, you should be able to coast and not have people finding different ways to get into your pockets. But these are just things that exist, right? And you just have to have a strategy around it because if you don't... You could just unnecessarily be paying more money than you need to. Because at end of the day, our goal is to make sure you retire on time and with confidence and to make sure that the money that you work so hard to earn stays in you and your family's pockets, especially if it's just simple things around education that can make all the difference. And it can. And so things like understanding your Irma, your Irma premiums are huge. Like I'll talk to people sometimes and. We're talking and like, yeah, I had to take a I had to take a I had I wanted to pay off my house, for example. People say I want to pay off my house. And, you know, they did it. But then they had this huge tax bill they didn't think about for some reason. The Irma bills up now and it's stuck there for two years. And it's just different ways, right? You can pay your house off, but you do it in increments that respect your tax bracket over and respect Irma. Right. And you get the same result is just doing it the right way with the plan. not just haphazardly. know, taxes and retirement, as I've been mentioning, it's just everything's tax, right? Your pension's tax, social security's tax, TSP withdrawals are tax, your RMDs are tax. You know, how you do your survivor, like when your survivor survives you, they no longer can file, Mary filed it jointly. So now they're paying more taxes on the money that they have coming in, because they have to, they want to continue to. keep the same quality of life. You know, when you're married, filing jointly, you pay one thing in taxes when you're single, but you're still making the same income, you're paying more in taxes in some cases. So you have to think about that. Plus you think about your investment income and the taxes there. So you want to make sure you have a tax strategy in place that addresses all of those things. And that's a lot of the work that we do at Fed Legacy because it's just so important. So one of the questions I was asked you like, do you have If you have a tax strategy, type yes in this chat. If you don't type no in the chat. And what I would love to do is we can set up a time next week. We're booked out for the rest of this week, but we can set up a time next week. We could try to squeeze you in. you really need to meet this week, we can do it. But like just type plan in the chat. And what we would do is we will make sure me or one of my other advisors, we would get on the phone, take you through our retirement readiness session. and make sure that we help you create a tax strategy that addresses all those things. And the thing about it that's good is once we create that, we help you on an annual basis to create that multi-year plan that's super important. It can give you that peace of mind that you deserve. Right. And so here's what tax plans break and why is the risk just using your run of the mill, turbo tax person. And if you're that turbo tax person, which a lot of people are, That's fine. we, we, we, we, we, we love to support you with that. We just ask you to send us your tax return and we'll help you see what the vision is. Cause we put all the information into our retirement analyzer. We get our CPA to look at it. He didn't necessarily have to follow it or nothing, but we just look at it, go over with you and kind of coach you on, how to do it. So you can have that multi-year strategy. And that's super fine too. Or if you have a tax person and you love them, you've been working with them 20 years or whatever. We'll hop on the phone with them too and say, all right, here's what we need to think about. Here's how you need to structure it. It's just unfortunate that most tax preparers like that, they just don't have, they just so used to their whole motivation is how do I get this person a bigger return? And once you retire that you're managing, you know, the amount of money you've built up in your TSP, getting a big return is no longer the goal. Right. And so sometimes those people just aren't qualified to support you where you are. did their job while you was working though. But Okay, but here's here's where a tax plan breaks, right? Waiting too long for off conversions. Assuming retirement equals lower taxes. It doesn't always equal that. Oftentimes it's very close. And then when you start taking out TSP and stuff like that, it can go higher. Forget, especially or spouse passes, things like that, right? Forgetting survivor benefit bracket strength, right? Huge thing. Huge thing that a lot of people forget. And again, it goes back to like what I was saying in the story at beginning. is when you're grieving, you're not trying to think about the IRS and things like that. That's the worst time to be thinking about that type of stuff. But these things happen and it's unfortunate. So taking TSP income without bracket planning, something I see people do all the time. They just start taking money, not realizing that it's impacted Irma, impacting the higher amount of money they're going to pay in taxes. And again, our goal is to keep as much money as yours in your pocket. not the IRS, A lot of times the middle class is so busy working and they just don't understand the stuff. They're not reading legislation. And they tell you like, OK, we'll save money on the tax brackets. Yeah, they saved you a little bit of money on the tax bracket, but they killing you with this 10 year rule. Let's just straight kill you where you're killing you. Like where you're paying 40 percent of your of your TSP money back to the IRS. Like that's just like, OK, you helped me out a little bit here saving me about five thousand dollars in taxes this year. but then boom on the back and we getting you with the 40. Like it's just bad, but you have to know this stuff. And there are strategies to avoid it. And we're talking about this stuff right now. So if you wanna book a call with us, you can book a retirement readiness review. We will again, walk you through this tax strategy. We talk through income, we talk through long-term care. We talk to all that stuff, but. The thing that we've really, really, really focused on is the tax strategy stuff because it's super important to accomplish.