I Have $1 Million in Taxable Accounts and $1 Million in IRAs. How Can I Prepare for Higher Taxes?

If you've built up $1M in your IRA and $1M in taxable investments, David McKnight has a warning: every year that money stays put, the IRS gets to vote on your tax rate. 

He breaks down a retirement planning strategy for gradually converting your IRA to Roth – fast enough to beat rising rates, slow enough to avoid painful brackets.

• In this episode, David McKnight looks at what you should do if you have accumulated $1M in taxable investments, and $1M in traditional IRAs and are concerned about the possibility of higher taxes in retirement. 

• He stresses that having money in IRAs is like going into a business partnership with the IRS – every year they get to vote on what percentage of your profits they get to keep…

• The solution to the IRA problem is relatively straightforward: start doing Roth conversions. 

• True, by doing so, you’ll pay taxes on the conversion today, but you’ll be doing so at near historically low tax rates.

• Remember: the key is to convert money slowly enough that you don’t rise into a tax bracket that gives you heartburn, but quickly enough that you get all the heavy lifting done before tax rates go up for good.

• David predicts that, given the trajectory of the American national debt, the window of time to execute that strategy is about ten years.

• Beware: just because you believe taxes are going to increase, it doesn’t mean that you should reflexively convert all your money to tax-free.

• You want to leave enough money in your traditional IRA to take advantage of your standard deduction in retirement.

• If you’re married and retiring today, your standard deduction is $32,000. Single? Then, it’s half that amount.

• David shares a couple of strategies that can help you skinny down the $1M in your taxable bucket.

• The first and most efficient way to shrink this bucket is to use it to pay the taxes on your Roth conversions.

• The second strategy, which applies if you’re still working, is to fully fund your Roth 401(k) or Roth 403(b).

• One challenge with this approach is that those contributions must come out of your paychecks, which may lead you to have less money available to cover your monthly lifestyle.

• The next strategy comes into play once you retire and it’s about living out of your taxable account during the first few years of retirement (which may be the lowest income years of your adult life).

• Furthermore, you may want to consider repositioning a portion of your taxable account into a properly structured cash value life insurance policy – such as an indexed universal life policy or IUL.

• David warns that IULs are not for everyone, as they require a sufficient funding period, careful design, and ongoing policy management.

• However, when structured correctly, IULs can serve as a volatility shield in retirement.

• The idea is, in the year following a down year in your stock market portfolio, to pay for your living expenses out of your IUL.

• Doing so gives your portfolio a chance to recover before you take further distributions.

• That act alone can increase the sustainable withdrawal rate of your stock portfolio from 4% to as high as 8% with a 95% confidence rate.

Mentioned in this episode:

David’s national bestselling book: The Guru Gap: How America’s Financial Gurus Are Leading You Astray, and How to Get Back on Track

DavidMcKnight.com

DavidMcKnightBooks.com

PowerOfZero.com (free video series)

@mcknightandco on Twitter 

@davidcmcknight on Instagram

David McKnight on YouTube