Tax Strategy

The Story

This client family had retired five years previously in their mid sixties and were increasingly concerned that their tax bill was about to get much bigger. They were worried that they would need to start drawing down their assets so quickly that it would impact their ability to spend on the life they wanted. They had a large extended family with three kids and spouses and eight grandchildren.

They had paid for both undergraduate and graduate school for each of their kids, helped them purchase their first homes, and wanted to be able to do the same for each of their grandchildren. They also liked to pay for a big family trip each year somewhere tropical like the Florida Keys or Hawaii and beyond those really loved their home and spending time gardening and staying fit.

They had accumulated what most of us would consider to be significant wealth with about $9 million in total net worth including a $2 million home and a few collector cars. The big challenge they faced was that almost $4 million of their assets were in a pre-tax Individual Retirement Account (IRA) and that in another three years they would hit the age that Required Minimum Distributions (RMDs) would begin. This would mean that they would be required to take about $150,000 from their IRA in the first year with the amount increasing every year after that.

They had been funding their lifestyle with proceeds from a four unit condo building they had owned and maintained for about two decades and income from a seller-carried note for a business they had sold about five years ago. Their concern was that the additional RMD income, which is taxed as ordinary income, would bump them into the 32% marginal tax bracket and they would be losing much of their IRA withdrawals just to pay the tax bill.

We developed a financial model where we could present several options for meeting their income needs and also manage to different tax targets. Our goal was to help the clients understand the tradeoffs between different strategies because often maximizing tax efficiency can impact flexibility over the long term. Ultimately the strategy the clients felt best implemented their vision involved a few key pieces. First, we were able to execute Roth conversions each year over the next three until they hit RMD age.

We were able to keep their total annual income below the 32% marginal bracket in each year and convert about 20% of their traditional IRA into a Roth IRA and reduce the size of the future RMDs. Second, we were able to help them use 529 savings plans for each of their grandchildren to take advantage of state tax provisions at funding and to allow the funds to grow without a tax impact on our clients. Third, we worked with their CPA on a strategy to update each of the four rental units in successive years to help them increase their long-term rental income potential and to reduce their taxable rental income in the years that they made Roth conversions.

Now their income is much more balanced between their pre-tax IRA, their rentals, and a post-tax Roth IRA. They have pre-funded much of their education support for their grandchildren. We were able to model in large annual family trips and larger future expenses that will likely occur as they help grandchildren with home purchases in the future. Their strategy is now much more tax efficient and flexible on delivering cashflow.

If you are looking at a future tax bill with dread, building a multi-year tax strategy can give you the information and confidence that you can manage that tax burden over the long term. Taxes should never feel like a black box beyond our control, our work ensures that you have good information to make the best decisions.