Below are some examples of the depth of our process and expertise1. The descriptions and circumstances detailed below are fictional composites of actual clients, which illustrate common circumstances we encounter, and the solutions we provide.
Capital Gains Tax Mitigation
Bob (64) and Judy (62) were interested in retiring as soon as possible. In addition to sizable IRAs and 401(k)s, they had a $500,000 diversified collection of highly appreciated stocks in a jointly held account. Although they did not want to hold these stocks for much longer, they were concerned about the massive tax bill that would result from selling them.
As part of our income tax planning process, we helped them create several near-zero income years early in retirement by postponing IRA withdrawals, Social Security benefits, and other income sources2. This allowed them to qualify for a special 0% federal tax rate on long-term capital gains that applies to low-bracket taxpayers. Each year, with the help of their tax advisor, we helped them sell just enough of their appreciated securities to qualify for this 0% rate. They used the proceeds from these sales to fund their living expenses for the first few years of retirement. Along with minimizing taxes, this strategy also increased the size of their eventual Social Security benefits through delayed retirement credits.
Social Security – “Claim Now and Claim More Later”
Jack and Diane retired together at ages 66 and 62 respectively. Both were in excellent health and expected to live longer than average, based upon family history. Their primary concern was ensuring that their money would last throughout their lifetime. Their age 66 Social Security benefits were $2,400 per month for Jack, and $2,000 per month for Diane.3
To help offset longevity risk, we recommended each defer their Social Security benefits to age 70, increasing each starting monthly benefit by 32%. We positioned their portfolio to create the income needed to bridge the gap between retirement and their benefit commencement date. In addition, we helped Diane receive four years of spousal benefits upon her retirement. When Jack began receiving benefits, Diane filed a Restricted Application, which allowed her to receive 50% of his normal benefit at her age 66. Four years later, she switched to her own benefit, which had now received the maximum level of delayed retirement credits. Please note that the option to file a Restricted Application applies only to those born prior to 1954.
Special Tax Treatment of Company Stock
Maria worked at a large company for 20 years, and accepted an age 55 early retirement offer. Her husband Tony decide he would retire alongside his wife (he was age 58 at the time). Maria’s 401(k) plan was worth $1,000,000, of which $400,000 consisted of employer securities. The stock had appreciated significantly over the past two decades, particularly the past few years.
Unlike the typical solution of rolling her entire 401(k)5 into an IRA, we pointed out that the company stock could receive more favorable income tax treatment. With the help of their tax advisor, we distributed the shares as a lump sum into their joint investment portfolio, and rolled the remainder into her IRA. Upon distribution, only the cost basis of the shares was recognized as ordinary income. The embedded gains (known as “Net Unrealized Appreciation3”) remained untaxed until the shares were sold over the subsequent years, at which point lower long-term capital gains tax rates applied. This income tax reduction strategy helped make early retirement possible.
Property Tax Relief
Max (62) and Anne (58) felt that their demanding careers were taking a toll on their health, and were looking to retire. They were considering selling their house of 25 years, which was now too large for their needs. They wanted to stay within Contra Costa County, near their friends and family, and move into a more secluded area. However, they were concerned about losing their Proposition 13 property tax protections.
When they came to us looking for a second opinion, we recommended they seek property tax relief under Proposition 606. This 1986 law allows California homeowners over age 55 to retain their property tax basis after moving under certain circumstances. Since their planned replacement home was less expensive and was within their county, they met the law’s requirements. To be sure, they double-checked with their County Assessor before making any purchase. Taking advantage of this overlooked strategy produced approximately $6,000 annually in property tax savings, which Max and Anne directed toward their travel budget.
Roth IRA Conversion
Steve (65) and Bill (57), who are registered domestic partners, have been retired for three years. They have been comfortably living off of the income produced by their jointly held investment portfolio, and have not yet tapped their IRAs. In one of our regular meetings, Steve mentioned he would like to sell his rental property, which he purchased in 2006 at the height of the real estate market. Selling the property would result in a tax loss of approximately $250,000. However, since Steve was in a low tax bracket, this loss would not produce much tax savings.
Working alongside their tax advisor, we recommended Steve convert $250,000 from his Traditional IRA into a Roth IRA upon selling the property. The income taxes incurred by the Roth IRA conversion were offset by the property losses. Since Roth IRAs are not subject to Required Minimum Distributions, this strategy will help prevent Steve from entering a higher tax bracket after age 70 ½. The Roth IRA will also provide a source of tax-free income for any future goals or needs that arise.
If you’re looking for solutions like these, contact us here to get in touch with one of our principals.
1 – Actual performance and results will vary. These case studies do not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed, and a financial advisor should be consulted.
2 - Yoder Wealth Management does not provide tax or legal advice. You should consult a legal or tax professional regarding your individual situation.
3 - In this illustrated example Jack and Diane met the age requirements under the Social Security legislation to implement this plan. He was age 66 and file and suspended by April 30, 2016 and she was age 62 by year end 2015. Otherwise this strategy is no longer available.
4 – See IRS Publication 575 for more details. Speak to your tax advisor to determine how these rules may apply to you.
5 - If you are considering rolling over money from an employer-sponsored plan, such as a 401(k) or 403(b), you may have the option of leaving the money in the current employer-sponsored plan or moving it into a new employer-sponsored plan. Benefits of leaving money in an employer-sponsored plan may include access to lower-cost institutional class shares; access to investment planning tools and other educational materials; the potential for penalty-free withdrawals starting at age 55; broader protection from creditors and legal judgments; and the ability to postpone required minimum distributions beyond age 70½, under certain circumstances. If your employer-sponsored plan account holds significantly appreciated employer stock, you should carefully consider the negative tax implications of transferring the stock to an IRA against the risk of being overly concentrated in employer stock. You should also understand that Commonwealth and your financial advisor may earn commissions or advisory fees as a result of a rollover that may not otherwise be earned if you leave your plan assets in your old or a new employer-sponsored plan and that there may be account transfer, opening, and/or closing fees associated with a rollover. This list of considerations is not exhaustive. Your decision whether or not to roll over your assets from an employer-sponsored plan into an IRA should be discussed with your financial advisor and your tax professional.