Spend the right money first when you retire
For over twenty years I have advocated “Pay taxes later, except for the Roths”. This applied to the accumulation stage when you accumulate money for retirement, the distribution stage when you decide which assets to spend first, and even the estate planning stage. I’ve always said there are a few exceptions to this basic principle, but it was a great starting point for general advice.
Since the SECURE law came into effect on January 1, 2020, the exception to this general rule has become much more important for many owners of IRAs and pension plans.
The following is from our latest book, Secure retirement for teachers, which contains great information for all IRA owners. Non-professors could skip the chapters on TIAA and still get a lot of value from the book.
Here is an excerpt from Secure retirement for teachers:
The next big question is: in what order should you spend the money you’ve saved for retirement? With exceptions, you should spend your after-tax dollars before your pension plan or IRA dollars.
Please look at the graph below. Both couples start out with the same amount of money in a regular brokerage account — which I call after-tax dollars — and in their retirement plans. The chart below indicates, with exceptions, that most readers should spend their after-tax dollars first, then IRA and pension dollars. The solid line shows what happens to the first couple who spend their after-tax dollars first and only withdraw the minimum from the IRA when required to do so (more on RMDs in the next section). They pay-taxes-later. The dotted line shows what happens to the second couple who spend their IRA first. They pay-taxes-now.
Figure 1.2: Spend the right money first *
The only difference between the dotted line and the solid line on this graph is that the first couple kept more money in the tax-deferred IRA for a longer period. Even from age 65, the decision to defer income tax as long as possible gives the first couple an extra $ 625,591 if they live to age 87. If one of them lives longer, paying taxes later will be even more valuable to them.
With exceptions, I generally prefer that you not spend your Roth IRA dollars unless there is a compelling reason. The Roth IRA grows tax-free for the rest of your life, the life of your spouse, and for 10 years after you and your spouse leave. Plus, no minimum distribution is required for you or your spouse with a Roth IRA.
So, in general, the last dollars you want to spend are your Roth IRA dollars. Of course, there may be times when it makes sense to spend your Roth dollars before other pension dollars if that keeps you in a lower tax bracket.
That said, with exceptions, you and your spouse will realize a benefit by deferring income taxes owed on your retirement plans for as long as possible and generally withholding spending your Roth IRA. And with the SECURE Act now part of the law, your children and grandchildren (subject to certain exceptions for minor children, people with disabilities, and other exceptional factors) will have to pay taxes on the traditional inherited IRA. within 10 years of your death.
A new wrinkle in our basic principle
Since the SECURE law was passed, adhering to the rule of paying taxes later at the distribution stage may not always be the best advice. With income tax rates likely to rise, for some professors it might make more sense to plan for a transition from the taxable world (most TIAA, IRA, retirement assets, etc.) to the non-taxable world. (Roth IRAs, 529 plans, life insurance, your children’s Roth IRAs, etc.). To get the best result, it is best to analyze each situation on a case-by-case basis.
In short, the SECURE law considerably speeds up the taxes on your retirement plan after your death. For your children, losing the life of a legacy retirement account can be a huge tax burden.
A reasonable strategy for some professors with IRAs and large pension plans that are unlikely to spend all of their money is to make taxable withdrawals from the pension plan and / or IRA, pay tax, and then donate. the net proceeds. The donation could be invested in something that grows tax-free like a 529 plan, your children’s Roth IRAs, life insurance, etc. This serves to withdraw money from your estate and allows tax-free growth for your children.
As a result, for many faculty members, an earlier transition from the taxable to the non-taxable world might work better than the standard “pay taxes later” rule.