I am a 54-year-old woman. I don’t know whether it is more tax efficient for me to retire or continue to work.
Currently, I am employed with an annual salary of $200,000 a year. I have $3 million in a rollover IRA brokerage, which is holding 17,000 shares of Apple
with a $10 cost basis and other investments with similar low-cost basis. I also have $600,000 in a 401(K), $1 million in a regular brokerage, $100,000 in a Roth brokerage, and a home with no mortgage.
Because I am still working, I can only slowly transfer my securities from my rollover into the Roth account to stay within my tax bracket. I feel that I need to take action and convert more into my Roth now as the tax-deferred investments are growing too fast.
I can live comfortably on $40,000 a year, which would cover my expenses. I have dual citizenship, my expenses would be even lower if I live in my home country. I do want to leave a legacy to my one child but I don’t want him to be burdened with taxes since the stretch IRA has been condensed to 10 years. I am looking for the most tax-efficient strategy — whether to continue working or to retire. Please advise.
Congratulations on building such a sturdy nest egg — that hard work will certainly pay off when you retire.
Deciding when to retire involves many factors. Tax efficiency is of course one of those factors, but it alone should not be the driving force behind your choice of when to leave the workforce. “It’s a significant event that should be based on lifestyle issues, not taxes,” said Daniel Galli, a financial adviser at Daniel J. Galli & Associates.
If you’re wondering if it is feasible to retire now, then financially speaking, it appears so, said Mackenzie Richards, a financial planner at SK Wealth Management. Dividing your investments by your annual spending shows you could retire now and live comfortably for the rest of your life, but that calculation also does not take into consideration inflation, portfolio growth or lifestyle changes.
Before jumping into retirement, think carefully about whether this is the right move, regardless of tax implications. Richards said you should ask yourself if you enjoy working now, or if you’d rather continue working but in another job. Since you’re also only 54 years old, think about what you’d even do in retirement, which can last three or four decades from this moment. “If she can earn $200,000 in her current position, it’s likely that she could earn at least $40,000 to cover her expenses doing something she enjoys more, possibly even part-time,” Richards said. “If she did go this route, she would be in a lower tax bracket, which would provide more breathing room to convert larger portions of her traditional IRA/401(k) to a Roth IRA.”
Let’s also address rolling over assets into a Roth account. You can actually convert whatever amount you want from your individual retirement account to your Roth IRA. “It’s just a question of how much tax she wants to pay,” Galli said. “She can make an estimate of how much conversion can be done in a year to keep her from moving to the next tax bracket.” In other words: if you were to convert a majority of that money now, yes, you would be paying quite a bit in taxes, but you can also wait until it is time to retire — whenever that may be — and you’re in a lower tax bracket before you begin converting those assets.
You can also spread out the rollovers, so that you’re not bumping yourself into a higher tax bracket right now.
Now onto the Apple stock. The problem with having so much of that stock is not the low basis, because it is in the IRA and will not get capital-gains treatment, said Tim Sobolewski, president of The Financial Planning Center. It does sound as though it is highly concentrated in your portfolio, which means you might want to diversify your account and move away from that stock. Of course, working with a financial planner to go over reasonable alternatives would be the best choice. A financial planner can create an asset allocation that makes sense for you based on your savings, your risk tolerance and your goals.
Need suggestions on how to improve your retirement savings? Check out MarketWatch’s column “Retirement Hacks”
Financial advisers also suggest you not underestimate your living expenses, whether that be in the U.S. or abroad. “From what I’ve seen in the past with cases like this one, her expenses seem somewhat low for her income,” said Juan HernandezAriano, director at WealthCreate Financial. “Very often, once we do this budget verification, we find some expenses that hadn’t been accounted for.” You should also account for additional expenses, such as an emergency situation, and eventually how those monetary needs may change as you age. Healthcare, for example, can become a huge burden on your budget when you’re older.
And lastly: the legacy. Leaving an inheritance for your son is another good incentive for starting a Roth conversion, Sobolewski said. And having an early retirement with a conversion strategy could also be efficient for lowering tax liabilities as well, HernandezAriano said. But again — it’s important to remember that these figures and estimates can change based on a comprehensive look at your finances. It’s another reason working with a financial planner before making this big decision could help you in the long run.
As for the inheritance, there’s one other beneficial option: a life insurance in a trust, which would allow you to create an income tax-free legacy, Galli said. Again, you shouldn’t be too worried about the taxes in this scenario, he added. “She seems to be letting the tax tail wag the dog,” he said. “There’s no burden as the taxes are paid from the assets. I realize this is a perception issue: Is the glass half-full or half-empty? However, it’s also like bemoaning winning the lottery because you have to pay taxes on the winnings.”
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