3 tax-savvy wealth preservation strategies

Allworth co-founder Scott Hanson shares how forward-thinking tax planning can help you hang on to more of your money.

Do you like paying extra in taxes?

How about fees? What’s your personal philosophy on paying extra in fees?

Okay, let me rephrase this because most of us don’t mind paying… something.

What most of us do object to is making a mistake or missing a deadline (or receiving bad advice) and paying more than we should have.

Because, when it’s done legally and fairly, there isn’t a person I know that minds saving money.

Even on taxes.

Here are three instances where you’re likely to spend more than you should, and how to get around them.  

1. Make sure your rollover has a one-way ticket to IRA Ville

Be it from downsizing, retirement, or a new job or career, let’s say, for whatever reason, you leave your place of employment.

While, in some circumstances, it might be best to keep your traditional 401(k) with your former employer, you may want to roll that money over into a traditional IRA instead.

Rolling it over means you’ll have full control over the funds (and potentially better investment options) and it still grows tax-deferred.

But it’s during this transfer that I’ve seen lots of people make an innocent mistake that costs them dearly.

First, if you don’t have one, set up an IRA. The key is to have it set up in advance (even if the balance is temporarily zero).

Because if you aren’t proactive and your former company gets impatient and just writes you a check for the balance in your 401(k) or uses an electronic transfer to put the money in your bank account?

20% of that payout will probably be withheld to pay the federal income tax.

It then becomes incumbent on you to come up with that missing 20% and get it into your IRA within 60 days.

If you can’t, you’ll not only have to pay taxes on that 20%, in all probability (depending on your age), a 10% early withdrawal penalty might also be applied.

Here’s an example: You have $500,000 in your 401(k). You quit your job, and then you’re shocked when your employer sends you a check for $400,000.

You’re just 48 years old, you don’t have any extra cash lying around, and so now you need to come up with $100,000 or you’re going to have to pay income tax and the 10% early withdrawal penalty on that money.

To avoid this, usually, the best thing to do is make certain your former employer arranges a “direct transfer” into your IRA.  

2. Remember: Probate is punitive (and unnecessary)

Probate is a mostly clerical process that can tie up property and assets for months and drain up to 5% of your estate’s value.^[i]

Sure, most of us hate to think (or talk) about death.

But people also dislike the stress, delays, and expense that take hold when a simple will shoots an estate into probate in the aftermath of the death of a loved one.

One of the best ways to avoid the expense of probate is to create a revocable living trust with yourself as the trustee. You’ll then name a “successor trustee” who will take over in the event of your death or incapacitation.

This enables your estate to avoid probate because your property is already distributed via the trust.

One of the reasons we recommend working with an estate planning attorney is because we are in the business of asset preservation.

Simply, if it saves you money and, as a bonus, has the capacity to lessen heartache and stress for your heirs, then that’s certainly something that merits careful consideration.

3. Consider tapping your retirement account earlier than you legally have to

Be it $500,000, $750,000, or $1 million or more, one of my favorite appointments is when a client achieves a retirement account savings milestone.

But you needn’t reach a milestone before calculating (depending on your age) whether tapping your retirement account(s) for income before Required Minimum Distributions (RMDs) kick-in might be a wise decision.

That’s because one of my least favorite appointments is when I meet with an older client for the first time, only to find that they paid $10,000 or $20,000 or more in taxes than they had to.

How could this be?

While the process behind these RMD calculations is longitudinal, complex, and takes into consideration your savings, other income, age, and tax bracket projections (among other things), paying more taxes than you might have had to is not at all uncommon.

But with a little forward-thinking tax planning, it can be avoided.

That’s because, if you’ve saved well and you’re going to be receiving Social Security (or you already are), and perhaps you have a pension, a retirement account, rental property, a brokerage account, and other savings, it’s common to think it’s best to just let your tax-deferred retirement account(s) grow. But waiting could make your RMDs so large that your tax bill becomes unnecessarily high.

For good savers, planning your future income sources is an art form.

Remember, you can start pulling money out of your tax-deferred accounts (without the early withdrawal penalty) after you turn 59½. But waiting until the official RMD age – while seemingly logical and even satisfying – might trigger a monster tax bill.

Newsflash: The U.S. government loves this!

But as for you and me? Probably not so much.

I understand. It stings to touch those precious tax-deferred accounts. Every uptick in interest feels a little like “found” money.

And the chances are that you’ve been saving that money for years or even decades.

But… one way or another, the day of reckoning is approaching. So, keep as much of your money as you can by forward-thinking tax planning, and that includes the possibility of tapping these accounts sooner rather than later. (Maybe use it to open a Roth IRA.)

Want to save money on fees and taxes?

Talk to your advisor, your estate planning attorney, and your accountant to figure out the best courses of action for you.

[i] https://www.thebalance.com/how-much-does-probate-cost-3505268