At Hill Investment Group, we recognize that when a few clients raise the same question, it’s likely that more have similar thoughts. To better serve you, we’re introducing a new segment in our newsletter where we’ll address common questions and how we approach them. To submit questions for future newsletters, email us at info@hillinvestmentgroup.com

Hey Hill, how can I reduce my IRA Required Minimum Distributions (RMDs) and related retirement tax liabilities? 

Contributing to traditional IRAs and 401(k)s is a great way to save for retirement. You get a current-year tax deduction, and your money grows year in and year out without being hindered by taxes. The IRS never sleeps.  You either pay them now or later.  Therefore, at some point, when you need to access these tax-deferred funds, whether that’s by choice or because you must begin taking Required Minimum Distributions (RMDs), any withdrawals you make from your IRA will be subject to ordinary income tax rates. Therefore, it’s critical to understand the different ways to plan for this most effectively. 

First, what is an RMD? The IRS requires that an individual begin taking systematic withdrawals from their pre-tax/qualified retirement accounts (e.g., 401(k), 403(b), traditional or rollover IRAs, etc.) at age 72, 73, or 75, depending on your date of birth. This annual required mandatory distribution is known as an RMD. You can calculate your projected RMD using the Schwab RMD Calculator. 

While we want our pre-tax retirement accounts to grow and be as large as possible, the taxes that will ultimately be due also grow. An investor can use three strategies to optimize this tradeoff between growth and taxes.

ROTH Conversions

One strategy is to convert assets from your traditional or rollover IRA to a Roth IRA before RMDs begin. When investors are in a low tax bracket, there are often many years between retirement and the RMD start date. Therefore, investors can save a lot in taxes by converting assets during a lower income period.

Let’s consider an example to showcase how this strategy works.

Betsy has just retired at 65 and has $500,000 in her traditional IRA. She must begin taking RMDs at age 73. Her projected RMD at 73 is about $30,000 per year. This amount might bump Betsy to a higher tax bracket in the future and may even increase her Medicare premium costs.

Since Betsy is retired, her reduced income level moves her from the 22% tax bracket to the 15% tax bracket. She decides to convert some of her traditional IRA into a Roth IRA. She withdraws $40,000 annually for the next five years from her pre-tax traditional IRA to fund her Roth IRA. Each year, she pays income tax on the $40,000 distribution but at her new, lower tax rate. This is known as a Roth Conversion. Her money has moved from one tax-advantaged account (the Traditional IRA) to another (the Roth IRA), the taxes are “pre-paid” at a lower rate, and her invested money in the Roth will continue to grow and never be taxed again. By age 70, she has successfully reduced her traditional IRA balance by $200,000, and her RMD at 73 is now projected to be only $18,000 rather than $30,000.

QCDs

But there is even more she can do. Starting at age 70.5, the IRS allows you to distribute funds from your IRA without paying taxes if the funds are gifted directly to a qualified charitable organization. Betsy currently gives $10,000 to her church annually by writing a check from her bank account. Instead, she should direct her Hill advisor to make those payments on her behalf from her IRA. This approach takes advantage of the Qualified Charitable Distribution or QCD. If Betsy’s RMD following her Roth Conversion was projected to be $18,000, by donating $10,000 from her IRA, she will only be taxed on $8,000. By planning 8 years into the future, Betsy’s Hill Advisor has reduced her RMD from $30,000 to $8,000, she will pay less in taxes, and she has a growth Roth IRA for her future needs.

Asset Location

Finally, behind the scenes, Hill manages portfolios by locating the higher-growth assets away from pre-tax accounts and locating the income-producing assets within the pre-tax accounts. This asset location strategy helps minimize future retirement taxes across your entire household. By doing this, you reduce the income taxes you pay year to year and ensure that your high-growth assets get taxed at lower capital gains rates rather than higher income rates.

Both the Roth conversion and the QCD approach, along with Hill’s asset location strategy, are not just tax savvy; they are also strategic moves that can enhance your financial security. By taking the long view on your IRA funds, you can minimize the taxes due and maximize the total dollars you have available to you as you enjoy your retirement.

This information is educational and does not intend to make an offer for the sale of any specific securities, investments, or strategies. Investments involve risk, and past performance is not indicative of future performance. Return will be reduced by advisory fees and any other expenses incurred in the management of a client’s account. Consult with a qualified financial adviser or tax professional before implementing any investment or tax strategy.

Happy tax season! I realize that’s probably an oxymoron for most people, but I have a confession: I like it. Suppose you’re obsessed with numbers and details like me. In that case, digging through diligent records in your file cabinet at home, ticking and tying every dollar of income, dividends, and interest, and accounting for every possible deduction is not a bad day, in my opinion (and it just might be how I spent my Sunday afternoon this weekend. There’s no more football, what else am I supposed to do?). And when the amount due matches precisely what you had calculated six months earlier… boy, does that feel good.

I know I’ve lost most people by now, but to anyone who has read this far, I reward you with some last-minute reminders as you gather up your tax documents to send to your CPAs (or for the brave, as you fire up your preferred tax preparation software and do it yourself!).

1. You probably hear this every year, but there is still time to make a 2023 contribution to an IRA or Roth IRA! You have until the date that you file your 2023 taxes to contribute. We generally prefer the Roth IRA if you’re below the gross income limits for 2023 (single filers: $138,000 / joint filers: $218,000). If you’re above the income limits, you can still choose to make a Backdoor Roth contribution. This would involve making a nondeductible 2023 IRA contribution and then immediately converting that amount to Roth. These rules can vary from person to person, so please reach out to us if you’d like to discuss this!
2. Don’t forget about Roth IRAs for your kids! The only requirement to contribute to a Roth IRA is “earned” income. Babysitting, mowing lawns, washing cars…it all counts, even if no W-2 or 1099 is issued. There is no age limit as long as there is real earned income. I emphasize real because doing chores around the house or babysitting for siblings one night doesn’t count. As a general rule of thumb, the Roth IRA is fair game if you have your kids file a tax return for their income. Each child is limited to the higher of $6,500 or their earned income (so if they earned $1,000, the limit is $1,000). Another great benefit is that they don’t have to use their money. You can make the contribution on their behalf.
3.   If you have a high-deductible health plan with a Health Savings Account, ensure you and your employer contributions have hit the 2023 maximum ($3,850 for self-only coverage and $7,750 for family coverage). Add an extra $1,000 to that if you’re over 50. You have until your tax filing date to top off those contributions with after-tax funds.
4.  If you live in a state with no state income tax (where two of our three Hill offices reside – sorry, St. Louis), you will likely get a deduction for sales taxes you paid in 2023. You could collect every receipt and total the sales tax on every item you purchased in 2023 (and I would not judge you), or you can do what most people do and take the IRS’s estimated amount. Most people don’t realize, however, that you can also add sales tax from significant purchases on top of the estimated amount. If you bought a car, boat, or Super Bowl tickets (really anything that made you wince when you swiped the credit card), don’t forget to tell your tax preparer! Unfortunately, state and local taxes are limited to a total deduction of $10,000, so there’s a good chance your property taxes already exceed that limited amount anyway.
5.  If you have self-employment income (as reported on Schedule C), don’t forget to make a SEP-IRA contribution. The limit is based on your amount of self-employment income, but the contribution itself will also count as an “expense” against your self-employment income. Your tax preparer can tell you how much you can contribute to a SEP IRA.
6. Lastly, here’s a list of a few pesky little forms that can be missed. Don’t forget to send these to your tax preparer!

• Form 5498: If you have an IRA, you have a 5498! This is an informational form that tracks contributions and distributions from IRAs and Roth IRAs. You can file your taxes without it, but giving these to your CPA will ensure that your IRA cost basis information is kept accurate year over year, especially if you’ve ever made nondeductible (after-tax) IRA contributions.
• Form 1099-SA: If you took money out of a Health Savings Account in 2023, this form will report that amount. A copy of this is also sent to the IRS, so you might get a letter in the mail if you forget it.
• Qualified Charitable Distributions (QCD): If you sent any portion of a required minimum IRA distribution directly to a 501c(3)charity, your form 1099-R will NOT specify that. It’s the tax preparer’s responsibility to note any QCDs. If HIG facilitated a QCD for you in 2023, you have nothing to worry about. We’ll let your tax preparer know.

And if you’ve made it THIS far, I applaud you and thank you for sticking it out. I leave you with a quote:  “Of life’s two certainties, there is only one where you will be granted an extension.” –Anonymous.

This information is educational and does not intend to make an offer for the sale of any specific securities, investments, strategies, or tax advice.  Investments involve risk and, past performance is not indicative of future performance. Return will be reduced by advisory fees and any other expenses incurred in the management of a client’s account. Consult with a qualified financial adviser or CPA before implementing any investment or tax strategy.

Congratulations are in order for our lead advisor in Nashville! Julia Humphrey (husband Joe) welcomed their son and littlest Titans fan, William James, on Sunday, September 17th at 11:16 pm, weighing 7lbs 3oz. Everyone is happy, healthy, and ready for kick-off.

Julia will enjoy the next month with little William and gradually phase her work life back to full-time in the fourth quarter of 2023.

If you’re a Nashville client, please don’t hesitate to get in touch if you need anything at all. Our entire team is here to serve you.