Unexpected Ways to Reduce RMDs, Optimize Retirement Cash Flow

Sexagenarian Strategies

For overall tax savings, one approach is to advise clients to take some money from their pretax accounts when they’re in their 60s: older than 59 ½, so the 10% early withdrawal penalty won’t apply, and younger than 70 ½, at which point RMDs greatly reduce the flexibility in your withdrawal approach. Closely monitoring such distributions can keep clients in today’s 12% , 22% and 24% tax brackets, which are low by recent standards, and reduce future RMDs.

Money that 60-somethings take from pretax accounts may be used for living expenses, if needed. This arrangement could help clients defer starting Social Security until age 70, for the largest monthly payout, partially untaxed — and possibly a larger lifelong payout for a surviving spouse.

Another option would include conversions to a Roth IRA, where there are no lifetime RMDs and future distributions are tax-free. Current tax law prohibits recharacterization of a Roth IRA conversion, so money shifted to the Roth side generates an indelible tax bill. It’s often best to wait for a Roth IRA conversion until late in the year, when taxable income might be estimated accurately — and also to rely upon a sophisticated software program (like the one I developed) to calibrate how much to convert without creating unexpected tax bills.

Multiple Choices

Clients may have other sources of cash flow to consider in retirement planning. Some will have health savings accounts (HSAs), which combine upfront deductions with tax-free compounding. Distributions from HSAs also will be tax-free, if they are used for qualified medical expenses.

Loans also may provide liquidity without delivering tax bills. A home equity line of credit might be tapped — and the interest may be tax deductible if the money is used to buy, build or substantially improve the home that secures the loan. A reverse mortgage might be an option for tax-efficient liquidity. In addition, clients who have permanent life insurance policies could borrow from the cash value, if a smaller death benefit is acceptable.

However you feel about deferred annuities, you may have some clients who hold these contracts when they retire. Are the guarantees greater than the actual value, inviting a drawdown that exercises their rider? Are there profits that should be realized? Should cash be accessed via taxable withdrawals or a partially tax-free annuitization? By reading the annuities’ terms carefully, you can decide when and how to best squeeze money from them.

A comfortable retirement is a prime goal for many clients. Look beyond your default method to plan for multiple streams of cash flow and add value by creating tax-efficient plans to keep cash flowing.

— Related on ThinkAdvisor:

• Roth IRA Conversions: How Much Is Too Much?
• Think You Know the Capital Gains Tax Rate? Think Again.
• Beware the Social Security ‘Tax Torpedo’

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Joe Elsasser, CFP, RHU, REBC, developed his Social Security Timing software in 2010 because, as a practicing financial advisor, he couldn’t find a Social Security tool that would help his clients make the best decision about when to elect their benefits. Inspired by the success of Social Security Timing, Joe founded Covisum, a financial tech company focused on creating a shared vision throughout the financial planning process.

In 2016, Covisum introduced Tax Clarity, which helps financial advisors show their clients the hidden effective marginal income tax rates that can significantly impact cash flow in retirement. In early 2017, Covisum acquired SmartRisk, software that allows advisors to model “what-if” scenarios with account positions and align a client’s risk tolerance with their portfolio risk.