What if you could transfer assets from your taxable individual or joint accounts into tax-advantaged retirement plans, Traditional IRAs, and Roth IRAs—all while saving taxes now and in the future?
We help clients do just that.
Over the past few years, we’ve had several clients with large taxable investment accounts that received major tax reductions while realizing ongoing investment tax-savings through savvy cash flow management and use of employer retirement plans and other tax-advantaged accounts.
To execute this strategy, we build a tax and cash flow planning strategy that maximizes current year tax savings and takes advantage of tax-deferred and/or tax-free growth—all while keeping the same current spending plan in place. This is done by increasing (often maximizing) employer or self-employed retirement plan contributions for the household and making maximum IRA contributions in the same tax year. Further, for clients with access to after-tax accounts within their employer retirement plans, we move assets that would normally be invested in a taxable account, and eventually taxed at some point in the future, to their Roth IRAs well above the normal $6,000 or $7,000 annual contribution limits based on their age.
To illustrate this planning technique, let’s use a married couple in the 22% Federal tax bracket who both have 401k plans through their employers and $500,000 in taxable investments in their joint account as an example.
Both are age 52—allowing them to contribute $26,000 to their 401ks annually with age-based catch-up contribution limits, but they are only contributing $16,000 each because of monthly cash flow needs.
Additionally, one of the spouses has an after-tax account in their employer 401k and is not a Highly Compensated Employee.
If the couple were to both increase their monthly contributions, they would soon run into debt as their spending would outpace their earnings.
When building their plan, we’d recommend they increase their 401k contributions to their maximum limits of $26,000 each. This increase of $20,000 in 401k contributions project to produce an annual Federal tax savings of $4,400 while also allowing the assets to grow tax-deferred. Tax-deferred accounts can then be managed in future years, often during retirement, to potentially be received at the 12% or another lower tax bracket. For investors with large Roth balances, they may be able to receive some of these assets in the 0% tax bracket.
With the addition of $20,000 total from their paychecks, their monthly spending deficit is now $1,667. We recommend simply replacing this income with assets from their taxable joint investment account. This strategy essentially transfers assets from their taxable account into their tax-deferred accounts.
In addition, the spouse with the after-tax account in their 401k can add another $32,000 (assuming no employer matching contributions for simplicity) into their Roth IRA by converting the after-tax accounts to their Roth IRA immediately, with no tax consequences. This spouse would need to have no tax-deferred IRA assets (SEP, SIMPLE, Traditional, Rollover, etc.) or would be subject to IRA pro-rata aggregation rules which make a portion, or all of the conversion taxable at current normal tax rates.
In the event they do have tax-deferred IRA assets, we recommend rolling those assets into their current employer’s 401k plan, which eliminates the taxation from IRA aggregation rules mentioned above. We then recommend replacing the reduced income from those extra after-tax contributions with taxable assets in their joint account.
Lastly, we recommend they make Traditional, Roth or backdoor Roth contributions up to the annual maximum IRS limits to get even more of the taxable assets into tax-advantaged accounts.
In the end, this couple in our example have taken $66,000 of assets that would eventually be taxed, even if at favorable long-term capital gains rates, and transferred those assets to tax-sheltered or tax-free accounts which will be used in future tax planning to control their tax bracket via qualified distribution, qualified charitable distribution, and Roth conversion strategies.
Lastly, there is the possibility of using the large Roth IRA balance prior to taking Social Security to realize long-term capital gains inside their joint taxable account at 0% and/or IRA distributions at the 0% or 12% Federal tax rate during early retirement years—saving another projected 10% in taxes on the same assets.
This tax and cash flow strategy can produce thousands, if not tens- or hundreds-of-thousands, in lifetime tax savings for your family. If tax rates rise in the future from their current historically low levels, this strategy will pay off even more.
If you’re in a similar situation, setup a no-cost initial planning consultation with Oak Street Advisors today to discuss creating a financial plan that will incorporate this strategy and many others in order to optimize your finances and minimize your current and future taxes.
