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Taxes & Your Wealth: How to Keep More of What’s Yours

Transcript

Vasu Kakarlapudi:

Hello, I'm Vasu Kakarlapudi, Otolaryngologist and Founder of Apta Investment Group. It's a pleasure to welcome you to the Surgeons Wealth Summit. We put a lot of blood, sweat, and tears into becoming surgeons so that we can be at the top of our game. Doesn't your money deserve the same level of attention? Our driving force has always been to bring world-class education and opportunities in that arena.

I'm excited to bring to you our newest partnership that truly embodies being the best of the best. I met Peter Mallouk at a finance meeting, and in talking to him, it became very clear that our two organizations shared Midwestern values, having both of us have grown up in Kansas City, and that aligning our interest with that of our community so that we all win together.

We've teamed up with his fiduciary firm, Creative Planning, in fact, the largest fiduciary firm in the country, manages over $280 billion in assets to provide you, our fellow surgeons, with insights and strategies for financial success. We believe that perspectives from a surgeon fiduciary team go together like peanut butter and jelly for our community. It's important to note that Creative Planning is a fiduciary only firm, meaning that they're legally bound to look after your best interest, and are only compensated for their expertise and not for the investment decisions that you make.

Today marks the start of the Surgeons Wealth Summit Strategies for Tax Efficiency and Investment Growth. We felt that this being tax season, that this would be a great place to start. This series is more than just a collection of webinars, it's a comprehensive journey designed to empower you to take control of your financial futures.

Over the coming months, we'll delve into critical topics such as tax efficiency, strategic asset allocation, and the pursuit of uncorrelated assets. Our goal is to not only equip you with the knowledge and the tools necessary to navigate wealth management confidently, but also to inspire you to take proactive steps towards financial independence and security.

Now, let's introduce our first speaker, Kim Riewerts. As a Managing Director at Creative Planning and a certified financial planner, Kim brings expertise in investment, tax, retirement, estate, and charitable planning. Today, she'll share essential strategies for optimizing your tax position and preserving your wealth. Kim expertly explains tax bracket maximization, stressing the importance of understanding the U.S. Federal income tax brackets and using them strategically.

She'll also introduce tax efficiency strategies like Roth conversions, tax loss harvesting, and strategic charitable giving, all while careful planning and evaluation. Although the rates that she references are from 2022, the 2024 rates are the same. The cutoff points are a little bit higher due to the fact that they're inflation adjusted. And we've used the increments of a hundred thousand dollars as nice round numbers as a general framework. So I hope you find this series valuable, now let's get started.

Kim Riewerts:

Taxes and your wealth, how to keep more of what's yours. Hello and welcome. Thank you for joining me today for a discussion about taxes and your wealth. Today I'll talk about several tax strategies to optimize your wealth so you can keep more of what's yours, and in particular we'll dig into the benefits of a Roth conversion.

My name is Kim Riewerts and I'm a managing director here at Creative Planning. As a certified financial planner professional, I help clients navigate a wide range of financial challenges. But I particularly enjoy finding ways to help clients save on taxes and maximize their wealth. Not many people actually like talking about taxes, but I do. That's why I'm excited to be here with you today.

Before I get into it, however, just a quick note that if you have any questions as we go through today's webinar, you can submit those using the chat feature on your screen. If you don't get your question answered today, we'll follow up with you as soon as possible with a response. Okay, let's get started.

Benjamin Franklin once said that the only certainties in life are death and taxes. While it's true that we can avoid either of those, we can take steps to minimize the amount we owe to Uncle Sam. A great way to do so is through a strategy called tax bracket maximization, which essentially means implementing strategies to reduce your taxes in high income years by realizing additional income and lower earning years.

To get us started, here's a quick refresher on the 2022 U.S. Federal income tax brackets. The United States use the progressive tax system, which means that the taxation percentage increases as an individual's income grows. Lower income taxpayers pay a smaller percent in taxes than higher income earners. When we work with clients, we consider a wide range of factors in determining what tax bracket an individual will fall into. But here's a simple example of how graduated tax brackets work in real life.

Our client, John Taxpayer, is a single filer with a taxable income of 100,000 in 2022. Under our graduated tax bracket system, the first 10,275 of John's income is taxed at 10%. The amount between 10,276 and 41,775 is taxed at 12%. The amount between 41,776 and $89,075 is taxed at 22%, et cetera. You can see on the screen what John owes in taxes at each bracket.

Using this example, what if John could avoid bumping up into that 24% tax bracket? He could essentially save 2,622 in taxes. While it's not always possible to remain in a lower tax bracket, there are some strategies we can implement to maximize John's existing tax bracket.

First, it's important to know what sources of income may factor into these tax brackets. I've listed some common sources here. They include employment income, dividend payments, interest earned from bonds and CDs, capital gains, pension income, social security, basically, anytime you bring in money, it's going to be counted as reportable income for tax purposes. As wealth managers, it's our job to identify and implement strategies to help minimize your taxes and maximize your tax brackets.

To do so, we utilize several strategies. Roth conversions during market downturns or years of reduced earnings, tax lost harvesting, strategic charitable giving, including donating appreciated securities, tax-efficient withdrawals in retirement, deferring discretionary retirement withdrawals in high earning years, aside from required minimum distributions, health savings accounts for tax-efficient healthcare savings. These are all topics your wealth manager should be discussing with you on an ongoing basis. At Creative Planning, it's standard practice to incorporate tax planning strategies into all clients' financial plans. If you have questions about any of these strategies or would like additional information, please reach out using the chat feature at the bottom of your screen.

I absolutely love discussing various ways to help clients maximize their tax brackets. Believe me, I could talk at length. For the sake of time however, I'm going to focus today on one particularly effective and timely strategy, the Roth conversion.

To start the conversation, a quick refresher on the tax treatment of various types of retirement savings. Here you see three buckets. We have tax deferred, taxable, and tax-exempt. Tax deferred distributions are taxed later at ordinary income tax rates. Those include 401Ks, 403B, 457B plans, traditional IRAs, and pension income. Taxable, which means subject to taxes in the current year, include bank accounts and CDs, non-qualified investment accounts such as stocks, bonds, mutual fund distributions, et cetera, social security benefits, real estate income, and annuity income, and finally, we have tax-exempt. Taxes are paid upfront and no taxes when dollars are withdrawn. Those include your Roth IRAs and Roth 401Ks, certain municipal bond interest, life insurance benefits, and certain withdrawals.

A Roth conversion is a tax strategy that adds to the after-tax bucket by converting pre-tax retirement funds such as traditional IRA assets to after-tax Roth assets. To do so, you must pay taxes in the current year on the amount, ideally at a lower rate than you may be subject to in future years. A Roth conversion is particularly effective for taxpayers who have never qualified to contribute to a Roth IRA based on their income, because it allows you to still reap the benefits of after-tax retirement savings. Be aware, however, that once you complete a Roth conversion, you are subject to the five-year rule, which states that you cannot withdraw earnings tax-free for five years, following the conversion. For most taxpayers, this isn't a major issue because they don't plan to withdraw from the account for more than five years, but it's important to be aware of. Once the funds are converted to a Roth IRA, they continue growing and can be withdrawn, exempt from taxes and retirement.

It's important to carefully consider your current year's tax situation before initiating a Roth conversion. There are some years in which a conversion makes sense and other years in which a conversion could really hurt you tax-wise. Under what circumstances does a Roth conversion make sense? You experience a year in which your income is lower than normal, such as a job loss, market fluctuations, etc. You believe you will fall into a higher tax bracket in the future. You recently made a large charitable donation that reduced your taxable income. Or maybe you wish to reduce the amount of your required minimum distributions in retirement. You also might wish to leave a tax-free inheritance to your loved ones.

Completing a Roth conversion may be a smart move, if you're expecting a lower salary than normal. Maybe you're in between jobs or you chose to take time out of the workforce to raise children. Or perhaps you made a larger than normal charitable donation that reduced your taxable income in the current year. Maybe you're having an average year income-wise, but you'd like to take steps to lower your future require minimum distributions or leave tax-exempt inheritance for your children. These are all situations in which a Roth conversion may make sense.

I have a specific example for you. A client chose to retire after working the first quarter of this year. His partial income from three months of employment, put him in the 22% tax bracket after his standard deduction. He has two children and a few years before other retirement income sources will kick in, which means his income this year is less than in the past or in the future. He's at a low point income-wise. He has an opportunity to complete a Roth conversion to maximize his 22% income tax bracket. If he's ever going to do a conversion, now is a great time.

Okay, so now we understand situations in which a Roth conversion makes sense. Let's go over some situations in which a Roth conversion can do more harm than good. When not to complete a Roth conversion. If the conversion will put you in a higher tax bracket for the year, maybe you have higher taxable investment gains, or you expect to be in a lower tax bracket in the future. Maybe you don't have enough savings to pay for the conversion tax, or you plan to leave your IRA to charities after you die. It's typically better to donate appreciated securities which can be passed along tax-free. Or you will need the money in five years or less, as there is a five-year waiting period to withdraw converted assets without a penalty.

Maybe you recently sold an investment, had higher than normal standard compensation, received a large bonus, or a deferred compensation payout. Any large income events have the potential to push you into a higher tax bracket, which likely makes it unwise to complete a Roth conversion. You have reached age 65 and are collecting Medicare. A Roth conversion may push you into higher income threshold resulting in higher monthly premiums. We'd want to weigh this impact in future required minimum distributions to make sure this is truly beneficial.

I typically do not recommend executing a Roth conversion if it'll put you in a higher tax bracket for the year, or if you are higher than normal income for that year. It's also not a smart move, if you have high taxable investment returns, expect to be in a lower bracket in the future or don't have enough savings to pay the associated tax. Also, if you plan to leave your IRA to charity, it's more tax-efficient to leave the assets in a pre-tax account, which can be directly transferred to the organization of your choice without triggering a taxable event for either your estate or the charity.

Let's pause here for just a moment. All the factors I have mentioned so far are financial considerations. As we all know, planning for your future is about more than just numbers. It's about achieving your personal financial goals. Sometimes personal goals outweigh financial ramifications. Your decision of whether or not to complete a Roth conversion may be influenced by reasons not related to tax savings. And we can certainly help you with that as well.

For example, maybe you don't have children, have elected charities as your beneficiaries, and are simply not concerned with how taxes will unfold for those who inherit your wealth in the future. It might not be worth it to bother with a Roth conversion. On the flip side, maybe neither charities or children are a priority. And you simply wish to diversify your income sources by creating a bucket of assets that can be withdrawn free of tax in your later years. Or maybe you have children and believe they will fall into the same or higher tax bracket in the next 20, 30, or 40 years. You may want to use a Roth conversion as this estate planning strategy to leave tax-exempt assets to those you love. It may be worth it to you to pay extra taxes today in order to maximize your legacy.

In other words, it's important to factor in both the financial and personal considerations as you decide whether or not to complete a Roth conversion. As you're making a decision, it can help to discuss your specific situation with a qualified wealth manager. As part of our process when working with clients, we run various projections to help decide whether a Roth conversion makes sense.

Getting back to it, let's discuss exactly how a Roth conversion can help you save on taxes. Using our example from earlier, John Taxpayer, with an income of 100,000 this year, falls into the middle of the 24% tax bracket. While it would be ideal for him to fall into a lower tax bracket, that's not possible, due to his current income. Instead, John wishes to max out his current tax bracket without moving up to the next one. John is pretty confident that his income will continue to increase in future years. Maybe he feels good about his career trajectory and believes his salary will continue to go up. Or perhaps he knows he's eventually going to inherit a loved one's IRA, which will generate additional investment income. Whatever the reason, it may make sense for John to consider a Roth conversion in order to max out his current tax bracket before he moves up to the next one.

As a reminder, here are those tax brackets again. As you can see with 100,000 of income, John is currently in the middle of the 24% tax bracket. He has a traditional IRA worth 90,000 that he'd like to convert to a Roth. Because he anticipates his income will only increase in the future, now may be the year to initiate the conversion of some of those assets.

John and his wealth manager complete a careful analysis of his tax situation, taking into account his standard deductions, itemization status, et cetera. After considering all factors, they ultimately decide to convert 70,000 of the 90,000 he holds in his traditional IRA to a Roth. The benefit of making this conversion now is that John will pay taxes while in a lower bracket, while establishing a tax-exempt source of retirement income for future use.

Just a note on this before we move on. Notice that in this example, it did not make sense for John to convert all of his traditional IRA assets to a Roth IRA account, as that would've pushed him into a higher tax bracket. Roth conversions are flexible in this manner, allowing you to choose to convert the dollar amount that's right for you in any given year. You can then convert additional assets in future years, if it makes sense down the road.

There's another important reason you may wish to consider completing a Roth conversion sooner than later. The sun setting of certain tax changes created by the Tax Cuts and Jobs Act of 2018. This resulted in lower tax rates for certain tax brackets. However, those rates are set to expire in 2025. If Congress takes no action, tax rates for individuals will revert to their 2017 amounts in 2026.

Here's an example of those individual income tax rates. If you expect your income to be lower in the years leading up to 2026, it may make sense to initiate a Roth conversion sooner than later. For example, if you're between the ages of 60 to 72, are retired, have not yet started receiving income from Social Security, required minimum distributions or pensions, it may make to complete a Roth conversion now rather than waiting until 2025.

I work with a family that retired this past year and will not be receiving pension payments or social security income for the next three years. Their income this year will include only dividends and interest, which will keep them in the 12% tax bracket. Their current situation may make them ideal candidates for Roth conversion, because once their other income sources kick in, they'll fall into a higher tax bracket. In addition to having lower than normal income this year, the market is currently quite volatile, which means they may also be able to experience additional tax-free growth as the market rebounds and they're able to take advantage of tax-free appreciation.

If the idea of completing a Roth conversion is resonating with you, you may be wondering about the process to properly convert. There are three main ways to complete a Roth conversion, a rollover via check, a trustee to trustee transfer, or an in-house trustee transfer. For a rollover check, if you receive a distribution from your traditional IRA in the form of a check, you have 60 days to deposit that money into a Roth IRA. A trustee to trustee transfer, where we can help you request a direct transfer from the trustee of your traditional IRA to the trustee of your Roth IRA. And then there's an in-house trustee transfer. If both of your IRAs are held by the same trustee, we can coordinate the process of transferring assets from one account to the other. Or you may be able to complete a conversion of assets inside of your 401K or 403B account.

Whichever method you choose, you'll need to report the conversion on an IRS form 8606 when you file your income taxes, in addition to filing IRS form 5498. Again, there are a lot of intricacies to this, but don't worry, we'll be here to help you every step of the way. Let us know your questions by chatting with us. We'll get back to you as soon as possible.

As we near the end of our time today, I just wanted to provide a quick summary of what we discussed. Tax bracket maximization is an approach to tax planning that aims to reduce your taxes in high-income years by recognizing additional income and lower earning years. There are quite a few tax bracket maximization strategies to consider, and we overly covered one today, Roth conversions. As I mentioned, Roth conversions don't make sense for everyone and they don't make sense in every year. I highly recommend you meet with a qualified wealth manager before completing a Roth conversion or any other tax bracket maximization strategy. We'll help you explore all potential opportunities to help determine the best strategies based on your specific financial situation and goals.

Our approach at Creative Planning is that we help clients map out their future years through careful planning, calculating, and evaluating future required minimum distributions and cash flow events. And looking for opportunities to complete a Roth conversion or other advanced tax planning moves. We believe tax planning should be an ongoing process, not a one-time discussion. We continuously review our client's tax status and revisit any potential tax savings opportunities on an annual basis. We believe your tax strategies should continue to evolve as your changes occur in your life and finances.

So, why partner with us? The great thing about working with Creative Planning is that our wealth managers understand the importance of incorporating custom tax planning strategies into each client's financial plan. We begin by conducting a thorough analysis of your current financial situation, goals for the future, and any potential changes to your tax situation. Using this information, we develop strategic solutions to help lower your lifetime tax liability. Roth conversions are just one of the many strategies we implement to help you save on taxes while pursuing your personal financial goals.

When you work with us, you are supported by a full team of certified financial planner professionals, CPAs, attorneys, risk management specialists, and more, who work together to achieve your version of financial success. Thank you for joining me today. Again, if you have any questions or would like to schedule a confidential, no-obligation meeting with a member of our team, please don't hesitate to reach out.

Vasu Kakarlapudi:

Thank you for joining us all today on this enlightening discussion on tax efficiency strategies. I trust you found Kim's insights as valuable as I did. Remember, advanced planning can allow you to defer or accelerate your income in years to minimize your taxes. And timing of Roth conversions can be a powerful tool to reduce your tax burden. Make smart decisions for your estate planning and create a legacy.

So before we conclude, I want to remind you to watch in your inbox for an invitation to our next webinar in the Surgeon's Wealth Summit Series. Our next session titled, The Election and Your Portfolio: Critical Advice You Need To Know, will be led by none other than Peter Mallouk. Peter will give you essential guidance on navigating the complexities of the upcoming election and its impact on your investment portfolio. So, be sure to join us for what promises to be another informative and insightful topic.

Keep an eye out in your inbox for more details and registration information. Thank you once again, for your participation. We look forward to welcoming you on our next webinar. So until then, stay informed, empowered in your financial journey, and have a wonderful day.