The time comes in most retirees’ lives when they are struck by an “ah ha” moment that changes everything. After a working life of systematic saving that often came at the expense of luxuries and adventurous experiences, they realize that not only are they financially secure for the rest of their lives, but that if they maintain their current lifestyle, they will make their children and perhaps grandchildren financially secure as well.
It’s at this point that the mindset shifts from scarcity to abundance. Since enriching the next generations has never been their dominant financial goal, this is often disorienting. I find myself recommending weird things for a financial advisor. Pay more to sit in the front of the plane, if not first class then at least business class or premium economy. Order the appetizers and top-shelf drinks. Purchase the luxury car. If you think something will bring you joy, pleasure or even transient happiness, do it. Purchase it.
Such thoughts recently entered the head of my client Mark. It only took a decade of my stressing this in his annual financial plan progress reports. A modest lifestyle, systematic savings, a strong pension, Social Security, and a wife working through retirement years will catch up to you at some point. When it does, you have too much money.
Mark asked me if he should he start converting his traditional IRA to a Roth IRA so his children would pay less tax on their inheritance. Through my prattling, he was more than aware of the SECURE Act’s slaying of the stretch IRA, a slang term for the ability to withdraw inherited IRA funds over the life span of the beneficiary. With this new law in effect, all the money must come out in ten years, a change that potentially increases taxes on, and therefore decreases the value of, one’s savings.
“So, your goal is to optimize the after-tax value of your retirement assets over two generations?” “Yes,” he confirmed.
I told Mark that I wasn’t sure about the answer to his question. It was an empirical question and I’d need more information from him. Mark, of course, is getting older and he’ll soon be required to distribute money from his pre-tax (traditional) IRAs. These distributions cannot be converted to Roth IRAs.
“Would you consider your children high, moderate, or low earners?” I asked, not knowing exact details of his family. I had a hunch due to years of conversations, but I needed confirmation. It turns out his daughter is a teacher and his sons earn their money as a police officer and an auto mechanic.
Gotcha, I replied, so they are likely in the same or a lower tax bracket than you, correct? “Likely lower,” he said.
Gotcha, I shot back. I pulled up a spreadsheet loaded with the current federal tax brackets on my computer, since we were Zooming.
I punched a few keys and demonstrated that Mark would likely pay more in taxes just so his progeny didn’t have to pony up at lower rates. This destroyed wealth and was not smart. His goal was to make his family’s life better, not make Uncle Sam richer.
Confirming that his goal was to optimize the after-tax value of his life’s savings, I suggested an alternative. When your required minimum distributions (RMDs) commence next year, you should use them to fund Roth IRAs for your children. If you like and trust their spouses, I added, you should do it for them as well.
You have more than enough income prior to these withdrawals which you are going to take. If you put them in an investment account in your name, you’ll pay tax as you go. Given current proposals on capital gains taxation, you may get whacked again at death. Get the traditional IRA withdrawals into Roth IRAs for your kids, and they will have a better chance of escaping taxation, under the current rules at least. Congress may change these rules to confiscate more money in the future, but at least you will have a fighting chance.
I switched over to the software I use that’s loaded with historical investment returns. These are never a prediction of the future, just as Mike Trout’s last year’s batting average says nothing about how he’ll hit this year. But it is what happened. It’s not commentary.
I showed Mark that 20 years of Roth IRA contributions for his three children into investments that he currently uses, if started 20 years ago, would have produced just under $1 million. That’s all tax-free and since it’s funded with RMDs, this strategy is not increasing Mark’s taxes either.
He’s a thoughtful guy. He said I’d given him a lot to think about. My hunch is that when his pondering is done, his kids are going to get three new accounts. It’s a win for Mark, a win for his kids, and a loss for the IRS. In my book, that’s a win, win, win, or a triple play.
Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT, a member of Ed Slott’s Elite IRA Group and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. You can find more articles and videos at michaelwlynch.com. He can be reached at mlynch@barnumfg.com or 203-513-6032.
Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. CRN202406-267663.