The following is an edited transcript of a May 15 webcast, “Tax-Wise Ways to Draw Down IRAs and 401(k)s,” featuring certified public accountant Robert Keebler, a partner with Keebler & Associates LLP. He was joined by InvestmentNews deputy editor Evan Cooper and retirement reporter Darla Mercado.
Mr. Keebler: We're going to cover tax-aware investing and look at tax structures, tax-sensitive asset allocation, asset allocation, and most of what I want to talk about today is retirement distribution strategies to help wealth last for a lifetime. Now, this is an especially dynamic year, basically because of three issues.
We're up against the 3.8% health care surtax, which is almost certain to become law unless the Supreme Court knocks down the entire health care mandate. We're also up against the fact that in all likelihood, the capital gains rate for your wealthier clients is going to jump to 20% on Jan. 1.
There is a taxation of Social Security benefits. A lot of the knowledge we've created in the last six months getting ready for the 3.8% surtax is going to help us with minimizing the taxation of a person's Social Security benefits.
Finally, Roth conversions. Because of the re-characterization privilege, so many more of your clients should be converting to the Roth because of a fear of an increase in taxes or because we're simply hoping that one of the asset classes they convert moves suddenly during the year, and we pick up some of what we'll call “tax alpha” like that.
We will talk about tax structure. That is determining the optimum mix of investment vehicles and structures. I'm not talking about your asset allocation that you've used for many years with your clients — [this is] after you have done your work of coming up with an asset allocation model, how much in stocks, how much in bonds, what type of stocks, what type of bonds. We would then try to put to work how we structure this from a tax perspective to get the lowest tax rate possible, to get the highest after-tax yield.
What we're concerned with is trying to get the lowest income tax rate possible. The worst type of investment from a tax perspective, obviously, is plain-vanilla interest income. The best types of investment are Roth [individual retirement accounts] and life insurance because they're both going to be tax-free.
With this approach, you should be able to look at the tax system and just work within the loopholes. Now, where did all of this come from? Twenty years ago, I remember meeting with all of these very successful people who had accumulated quite a bit of wealth, and they were all worried about having to pay estate tax.
I wondered, how have these people done this? Because they're all in such diverse professions/industries. And then it dawned on me that I had represented no one who had worked for someone else, like a middle manager, who had accumulated any wealth. Everyone I was working with was physicians who had saved money in their pension plans, real estate developers who had accumulated real estate over many years. It was people with very large insurance portfolios. And it dawned on me that these people, whether it was by design or by pure luck, had operated within a section of the tax code where Congress has designed the law to give us a lower effective tax rate. So that was very much an epiphany, and we kind of went from there.
3 TYPES OF ACCOUNTS
Now let's talk about the basic information on the taxation of investments. Your clients are going to have three types of accounts, and this is self-evident. We're going to have taxable investment accounts, where the income generated within the account is taxed each year to the account owner. That's very easy.
Then we'll have tax-deferred investment accounts. There are traditional IRAs, traditional qualified plans, nonqualified annuities, deferred compensation. We're going to have things going on there where we're getting a tax break at least temporarily. So that income is not taxed currently.
And finally, we will have our tax asset class, if you will, of Roth IRAs and insurance — items that will never be taxed if we follow the rules within the Internal Revenue Code. And ideally, when a person arrives at their retirement, they will have some wealth in each of these baskets, making it easier for you to help them manage their annual income tax burden.
In a portfolio, you're almost certain to find some type of IRA, Roth accounts, maybe an [Employee Retirement Income Security Act of 1974] plan, tax-deferred investment annuities, life insurance, stocks, bonds, warrants, options. There may be some nonqualified or qualified stock options, senior executive's deferred comp. You're looking at real estate, maybe oil and gas. These are all the things that make up the mosaic of your client's estate plan.
So what we have to figure out is, how do we put all of this together to achieve the lowest possible tax rate? And we'll call that “tax alpha,” because there are really two ways to create alpha. One is by beating the market, which a lot of the studies say is becoming increasingly more difficult as news travels faster, but also by beating the tax law.
You have to be cognizant of the fact that one spouse will die first, and the survivor is going to pay tax at the single rate. That is going to become a major component of how we invest after the first spouse dies, or maybe it's even along the way — what we do in terms of Roth conversions. Because if you represent a 65-year-old doctor who is in increasingly poor health, and her husband is in perfect health, and his father is still alive at 93, and his grandfather lived to 104, you may say, “Wait a minute — he's going to be in the single bracket for a long time. Can we get some money in a Roth? Do we buy life insurance instead of bonds?”
So to get to the Buffett rule: The most impactful thing may be some type of presidential veto. It's six and a half, seven months away, and we have to see what happens in the election. But it's very possible that President Barack Obama would seek the high ground, let tax rates go up and then negotiate them back down from a position of great strength, instead of now negotiating somewhat from a position of weakness, because any tax increases will hurt the economy.
When you look at the tax code, there are so many incentives that we have to be cognizant of. Those incentives might be the long-term dividend rate, capital gains rate, qualified individual retirement accounts, Roth accounts, real estate depreciation, oil and gas, the [intangible drilling costs] deductions upfront, coupled with the depletion allowances. Life insurance is one of the most underrated tax shelters out there. I do not sell life insurance, just so we're clear on this; I'm not licensed. Nonqualified annuities, in certain instances, make sense. Master limited partnerships are becoming increasingly popular. We have clients that are investing in those. We have some clients that are hedging those with puts and calls — lots of very interesting things people could do to try to get their wealth into an area of the tax code where they're going to get a little bit better result.
The beauty of an IRA, or deductible IRAs and pension plans, is a big deduction upfront. We pay later when we eventually take the money out of the plan. And so with the regular IRA, we have tax-deferred growth followed by taxable withdrawals.
With [net unrealized appreciation], we want you to be cognizant of the fact that if you represent somebody that works at General Electric [Co.] or Exxon Mobil [Corp.], and they have stock in their pension plan, they can take that stock out of their plan and pay tax only on the cost basis. It's a major-league savings opportunity.
Do not underestimate how important Roth conversions are, especially with tax rates going up.
On the Roth side, I've put my 401(k) contribution into the Roth over the last five or six years. I'll pay a little bit of tax now, but when I arrive at retirement, I want to have the flexibility to figure out how to balance out my tax brackets.
InvestmentNews: Are you advising clients to put money into Roth IRAs rather than 401(k) plans?
Mr. Keebler: No, I'm saying I had a choice of putting money in my regular 401(k) or a Roth 401(k). I ran the numbers, and it was basically economically neutral. So I put [the money in] the Roth 401(k). The thinking is: Later, when I retire, I want to have some of my wealth in a basket that's tax-free, and the qualified-plan part of this I want to have in a regular qualified plan which someday will be taxable.
CHOICE ON ROTH
InvestmentNews: Are you dividing contributions between the two?
Mr. Keebler: Well, the pension plan side just kind of happens automatically. That is never a Roth. That's always deductible. But on the Roth side, you have a choice. And for some clients, I can imagine that sophisticated financial advisers are looking at the situation and saying, “You know, you can put $15,000 into a Roth; you're $10,000 over the 15% bracket, so what I'd like you to do is put $10,000 into the regular IRA, bringing you down to the 15% bracket. But once you're in the 15% bracket, it makes no sense to put more money into the 401(k). We'll put money into the Roth 401(k) because that deduction is not as powerful.”
So you would basically break that up.
One of the things that is important for all of us to understand is that right now under the law, we have these great qualified-dividend rates. That's about to disappear. This goes away on Jan. 1. And we have this great opportunity in the meantime. We'll take advantage of it. Hard to say economically what might happen to stocks that pay a rather large dividend that is qualified. Will those stocks become less valuable if we go back to regular taxation of dividends? I don't know. That's something we had have to look back over history to see what's happened when rates have changed.
One of the biggest struggles for those clients of yours that have capital gains property is what to do this year. We work very hard doing quite a bit of work for the [American Institute of Certified Public Accountants] on this, and I have a big seminar for the AICPA coming up on this where we're talking about should you harvest your gains this year?
And the general consensus is, if you're going to consume the money in 2013, 2014 or 2015, there are many instances where it pays to pay the tax in 2012 at 15% rather than either at 23.8% or 20% next year.
On the real estate side, a lot of the people we represent have done very well financially. And most of that is attributable to the tax shield that they're able to hide behind by depreciating an asset that's going up in value. If you think about that, how odd that is, and how we got to this concept of: You can buy an apartment building or a large commercial piece of property; in the right economic environment, that property is going up in value with inflation. In the meantime, you're depreciating and sheltering your cash flow.
When you throw in the leverage, many times in the past, we have represented clients for every dollar they had invested. Eventually, they were going to get $4 or $5 of depreciation. And that's what makes this look so good.
InvestmentNews: In the recent experience of the decline in real estate prices, has this held up or has it been of less value than it has been in the past?
Mr. Keebler: In the last six or seven years, real estate obviously got overpriced. And now anyone that bought during that peak has been temporarily crushed. And I don't know how long it's going to take for that to rebound. But people that buy slowly over time are going to come out just fine. We have clients that are nearly bankrupt because, quite frankly, they bought way too much real estate in the last five or six years before everything crashed, and now they're having a hard time making it work.
So I think you have to be careful, just like anything, if too much of your portfolio is weighted in one direction, you can easily get crushed.
One of the interesting things which I think we're going to pay more attention to if the tax rate gets up to 43.4% is how life insurance can fit into a portfolio. It's not for everyone, but there are going to be certain instances where people are subject to the 39.6% regular tax plus the 3.8% surtax, where they just basically say, “Wait a minute. What if we get a second-to-die policy? What if we buy a policy on the healthier spouse?” All the growth inside the policy is tax-free, and eventually, when that spouse dies, the life insurance proceeds are tax-free. So I think this becomes very important in that we have a great opportunity here to create some tax-free wealth.
The other nice thing about insurance is that when I retire, if I have a lot of basis in that policy, I'm able to take that basis out and not pay any tax. To the extent you can, for most of your middle-market clients, stay in a 15% bracket. For your wealthier clients, you want to stay in a 25% bracket for married clients if that's possible. Not every client is going to be in that luxurious of a situation.
One of the things that we look at is that you have nonqualified annuities, and do they work? Do they make sense? Here's where they can make sense. You represent a single woman. She's doing very well financially. She is basically a senior executive, and she's in the 39.6% bracket right now.
Well, what happens down the road? When she retires, she'll be in a lower bracket. If she can use an annuity to leapfrog over those high-income years from, say, 50 to 65 and then annuitize or take money out of the annuity later, we are going to, of course, save a lot of tax because we're keeping that investment out of the highest possible tax rate.
InvestmentNews: What do you mean by leapfrogging over those particular years?
Mr. Keebler: Let's say I was a very conservative investor and I had a $1 million bond portfolio. If I could find an annuity that's priced properly, I might put that $1 million into an annuity or series of annuities from 55 to 65. And I wouldn't pay a penny of tax, because all of that wealth would be trapped in the annuity. And then later, when I'm 66, when I no longer have my salary, I could start taking the money out of that.
And so I would be basically avoiding having to pay taxes at a higher rate, from 55 to 65, and then hopefully take it out at either the 15% or the 25% rate later on. So that's what I'm trying to do; I'm trying to leapfrog over those high rates.
One area where you can really add some tax alpha is by understanding the different withdrawal rules between IRAs, Roth IRAs, nonqualified annuities or life insurance. When I take money out of a life insurance contract, generally, unless the policy is a modified endowment contract, I'm going to be taking money out of my life insurance first, out of my basis, and I'm not going to pay any tax. Or if that were an IRA or an ERISA plan, I'd be taking money primarily out of my income. If it's an annuity, I'm primarily taking money out of my income.
By understanding these ordering rules, you can smooth out your client's income over time. The goal is to arrive at retirement with a variety of assets.
"REAL' CAPITAL GAINS
When you look at “real” capital gains rates, let's say that you bought a boring stock, and you just held it. Procter & Gamble [Co.]; you bought it 15 years ago. It's growing. And you're asking yourself, what is the “real” capital gain rate on it? Because you haven't paid capital gains every year when it goes up, you just pay when you sell. In present-value terms, if your cost-to-capital is, say, 6% and you're looking at a 15-year period of time, that gain, instead of being truly 15% in economic terms, is only about 6%. If you sell in Year Zero, it's 15%. But if you sell later down the road, that gain shrinks because of the value of deferral.
So this is very important. A lot of the clients we represent are down in the 20-, 25-, 30-year period of time where they've held stocks for a long period of time. They've not paid tax along the way, and they've enjoyed that deferral. Obviously, that only works for certain stocks. It only works for certain planning strategies, but to the extent it works, it works very effectively.
OIL AND GAS
InvestmentNews: Somebody in the audience wanted you to touch on oil and gas for a second if you could, and then we will come back to this.
Mr. Keebler: Sure. Oil and gas are two different investments. Natural gas right now, there's a lot of people on this call, and we have different views, but at $2 or $2.50, it's hard to see how that's going to work for two or three years. Eventually, there are things going on economically that should increase that price. On the oil side, we all see the oil once a week when we put gas in our cars. But from a tax perspective, what's important is, there are two major incentives that drive this investment. One is, if you are in the right oil and gas deal, you get to deduct about 80% to 90% of your investment in Year One. It's called intangible drilling costs.
So if you invest $100,000, you might get a deduction of $85,000. That hits your tax return, wipes out your income from your practice, from your other investments. This is pretty good. That's an exception to the passive [strategies]. The other thing, once you start taking oil out of the ground, you get a depletion allowance, and that's going to reduce your effective tax rate because depletion of an oil and gas investment is analogous to depreciation in real estate.
And typically, about 15% to 20% of your cash flow is going to be sheltered from tax. And that varies from deal to deal. A lot of CPAs that do a lot of oil and gas work will tell you that's a rough range.
We've learned that life insurance is extremely efficient. Tax-deferred annuities are sometimes more efficient than bonds because of the deferral. In theory, depending on what camp you're in on this, passive, low-turnover investments provide a higher after-tax return on investment than more-active strategies generating short-term capital gains.
LESS CAN BE MORE
We represent a client who is very, very smart, does a lot of writing puts, does a lot of covered calls against warrant positions. But on the other hand, everything is short-term. And sometimes I say to him, “Maybe it would be better just to buy a very passive portfolio and go fishing every day.” And the math is kind of questionable of what he should do. He is getting a real good return, but he's losing it to taxes.
The optimal retirement plan, in a perfect world, would include contributions that were tax-deductible and distributions that were tax-free. Obviously, that doesn't exist. And this became a lot more complicated now for many people because of the 3.8% surtax. We need to know what to do with Roth conversions this year because tax rates are going up, potentially.
For your clients who are dancing with the taxation of their Social Security benefits, we need to use some of the knowledge that we've put together in the last year, the 3.8% surtax, to beat the taxation of Social Security benefits.
Generally, deferral is a strong strategy, but too much deferral creates a disproportionate IRA problem. Every one of you represents some physician or perhaps lawyer who has a very large estate, and 90% of it is an IRA or qualified plan. And that limits your options, tax-planning-wise, and everything during that man or woman's retirement is going to be plain-vanilla cash flow. That is problematic.
So what do you do? Tax diversification. Let's say you need a retirement income of $150,000. And if you took it all out of your 401(k), you are going to pay tax, and some of that is going to be taxed at a very high rate.
On the other hand, if you are diversified and you take some of the money out of a 401(k) and some out of a Roth, or some out of life insurance, or a mix, then you can bring down your average tax rate.
The real moral of the story is if upfront, in my early retirement years, I do not have to tap into 4% or 5% of my portfolio every year to live on but only 2% to 4%. By bringing down that weighted average tax rate, we create more longevity for your client's retirement.
WHAT TO TAP FIRST
Six or seven years ago, a retired dentist and his wife came to see us. They said, “We have $1.3 million in an IRA, and we have $1.4 million in a brokerage account. What do we spend first? How do we make our money last for as long as possible?”
What we found very quickly is, if we took all the money out of the brokerage account first, the wealth would last longer. If you can fill up maybe the 10% bracket or you can take enough out of IRAs or annuities to offset itemized deductions, you're going to come out way ahead.
You want to understand the main types of retired taxpayers. You have low-income taxpayers, who are in the lowest bracket. Their Social Security benefits are generally not taxed. Then you have the middle/lower-income bracket. Finally, you have the middle/high-income taxpayers who are worried; they're already paying tax on 85% of the Social Security benefits. They're worried about the [alternative minimum tax]. And finally, you have the group of high-income taxpayers who have been very financially successful and are subject to the surtax or subject to, maybe next year, a 39.6% rate.
All of these groups require different strategies. And you're going to have to try to figure this out. Our goal is always to try to fill up, when we can, that 0% capital gains rate. So very often, we'll defer money in an IRA, only take out a little bit, and then we'll sell stock into the 2012 rate; when we sell stock, we're at a 0% rate.
And then next year, that rate jumps up to 5%. We will look at trying to have as many qualified dividends as possible. Up until now, someone would come to see you and say, “Well, we can take out another $3,000 before your Social Security benefits are taxed.” That is not the way to approach this. The way to approach it is to sit down with somebody when they're 55 or 58 and develop a long-term plan that will last until they're 80, and spread this out over time, and then figure out how do we weave into this some tax-sensitive planning.
We want to manage income tax brackets [and] use specific identification methods to sell high-basis securities first. Generally, we want to aggressively harvest outside portfolio loss. I think that's upside down in 2012, because in 2012, we want to aggressively harvest gains.
We're looking at how to make tax-efficient use of annuities and managing this 3.8% surtax. The good thing about the surtax, it has forced us to learn more about these deferral strategies which apply even to people that are not in the surtax. So the question becomes: Which assets should a client spend first? When do you do a Roth conversion? How do you take stock out of pension plans when appropriate? And how [do you] exercise [incentive stock options and nonstatutory stock options]?
You need to ask your clients, “What do you want to do with your ISOs and NSOs?” If they are deep into money options where you have a lot of equity, maybe you exercise in those late this fall, paying tax only at 35%. Remember, next year, that rate is going to jump to 39.6%, plus there's a little health care surtax of 0.9%. So the rate goes up for most people in the situation to just over 40%, an increase in rate of 5 [percentage points].
Let's say that the expiration date on these options is Feb. 14. Why would you not exercise at the end of December, all things being equal?
Now, what are our top planning ideas? What we typically want to do is fill up the 10% or 15% bracket. We want to do Roth conversions by asset class. We used to look at Roth conversions on a very tactical, math-heavy basis. But today, we get people into the Roth by asset class: large-cap, small-cap, by mutual fund. If we convert 10 mutual funds and one goes up in value by 30%, we'll keep that one in the Roth folder and re-characterize the rest. And for your wealthier clients, you should be able to do this with pretty good efficiency.
Generally, we spend from the outside portfolio first until we have filled up that 15% bracket. In general, bonds should be positioned in one's IRA because of the annual tax burden. And life insurance can also be a very valuable supplement to existing pension plans.
InvestmentNews: Does that go for all types of life insurance or are there certain varieties that might lend themselves better to tax strategies?
Mr. Keebler: I think, certainly, term doesn't help me at all. What I'm looking for is a tax shelter. And that tax shelter is going to be typically found under whole life and universal life. I would leave the policy selection personally to the financial adviser who has expertise on that. But my goal from a tax perspective is to get a good insurance policy that is going to give me a return, if possible, equal to what I would get in bonds, but give me that tax shelter that wraps itself around the return so [the client is] not paying income taxes on an annual basis.
InvestmentNews: From a tax point of view, does it make sense to buy these policies when somebody is in their late 50s or early 60s? Does it make sense to load up before retirement?
Mr. Keebler: I wouldn't look at it as loading up on insurance. I would look at it as: What is going to be my return on an insurance investment, versus a return in a bond-type investment? For example, if you bought a second-to-die policy on a husband and wife where there is a very low mortality cost, you have to ask yourself: “Am I going to have more wealth down the road than if I simply left that money in a very safe investment?”
Most people would buy these policies between 45 and 70, not between 70 and 90, because you need time for this to work, plus just the pricing of policies, it obviously gets more expensive as you get older.
During these accumulation years, our goal is to diversify our tax savings, some in regular IRAs, some in Roths. We want to look at that back-door Roth IRA where I contribute to the nondeductible IRA and then flip it over to the Roth. That's been very popular.
Sometime from age 46 to retirement, if funds are available, we look at deferred comp. We try to push as much out into the retirement years where we're going to pay a low income tax rate. Some of the executives we represent are allowed by their companies to put away 20%, 30%, 40% of their salaries. If they do not need to consume that, we save it, we take it and shelter it when we're in those high brackets, and then take it out later when we have arbitrage moving our way.
Now, at retirement, we look at, can we do [net unrealized appreciation]? Can we take stock out of our pension plans? We want to avoid [Internal Revenue Code] Section 72(t) wherever possible. We want to manage the basis in our IRAs and qualified plans. And we also want to manage qualified Roth distributions. Once we hit 70, if you have room in your brackets, doing Roth conversions to manage brackets can be very efficacious.
Timing is everything. And what we have found is that if we lived in a perfectly flat tax system, we would be indifferent to whether we took money out of our IRA or our Roth IRA first. But because we don't live in a perfectly flat tax system, what we found that the optimal mix is going to be taking some money out of my traditional IRA and trying to take the rest out of a tax-sheltered environment: a Roth, a life insurance contract, and avoiding getting into the 28% or 33% or 35% bracket.
In theory, when your clients are right at retirement, in the perfect world, they would have three types of investments at their fingertips: their tax-deferred IRA and 401(k) plans, their Roth IRA and Roth 401(k), and then their investment account. They could choose which to tap into. And that is going to give them absolutely the most flexibility in their overall planning.
And if we shared one thing today it would be: Try to build, or at least evaluate trying to build, some of that flexibility into planning. You want to structure your spend-down strategy as to maximize economic returns while considering income taxes, and you also want to develop some theories that work for the types of clients you have in your state, with your state income tax rules, and figure out the order at which funds should be withdrawn.
For many Americans, you have to work on reducing the surtax. For other people you represent, you are going to be worried about trying to minimize the taxation of their Social Security benefits. With the right planning, you can put a pretty big dent in the taxation of Social Security benefits simply by Roth conversions, money in life insurance, figuring out how to convert what normally would be ordinary income between 55 and when you start your Social Security benefits [at] 65, how much of that can you put into a tax shelter only paying tax at 15%?
InvestmentNews: There were a couple of questions about required minimum distributions. How do you handle those, especially cases where most of clients' wealth is in qualified plans and they have to pull it out?
Mr. Keebler: The RMD is a forced event. So when you chart this out from, say, age 60 to age 85, the RMD is a number that you can't do a lot to change. But where you can change the RMD is by getting some of that wealth into a Roth. So in those early years, to the extent that you have any room in your brackets from 60 to 70, if you think you are going to be in a higher bracket later, you want to flip as much as you can into the Roth. And our technique on the Roth, again, is to convert 100% to the Roth and then re-characterize 70% or 80% of that but keeping the best stuff that went up the most in value and trying to arbitrage that opportunity.
InvestmentNews: Do you agree that you should have the money to pay the tax on the conversion outside the IRA itself? So rather than just say, “OK, I'll take out extra and have that cover the taxes,” should you have that money separately?
Mr. Keebler: In theory, you're going to have a greater efficiency with a Roth conversion if you have outside funds. And part of that is that you're taking dollars out of the taxable account and sheltering them. But by the same token, you still may be giving up a great opportunity if you have money in an IRA, you have no other money to pay the taxes, convert it. If it goes up enough or the math justifies the conversion, leave it in the Roth. If it doesn't go up enough where the conversion is justified, walk away from it.
InvestmentNews: There are some questions alluding to this, that you really have to watch this. This isn't something where you can set it and forget it. If you are an adviser, you have to be on top of the Roth conversions and where the money is coming from and how it is allocated. It isn't so easy just to say, “Oh, let's keep to this” when somebody is 65 and leave it like that.
Mr. Keebler: That's precisely right. It's going to have to be updated. Maybe by next summer, everything I have talked today will be outdated, and everything we think we know, that paradigm will be shattered and we'll be building new paradigms. But for this year, I think the really important things are looking at the 3.8% surtax, harvesting capital gains, looking at the taxation of Social Security benefits, and how we should be doing Roth conversions.
InvestmentNews: Is it too late to do a Roth conversion this year?
Mr. Keebler: It's too late for 2011, but for 2012, if you convert today, you still have till Oct. 15, 2013, to re-characterize. And basically, all you're hoping for is that in the next 17 months, you get some volatility in your favor.
And we would never suggest anyone change their asset allocation. We're just suggesting that people stick to their existing asset allocation their financial advisers have suggested to them, and that we convert, and we basically will see which accounts go up in value, which go down in value. If there is substantial depreciation, we will keep that in the Roth.
I have a number of podcasts on my website that talk about these. We call them opportunistic conversions.
InvestmentNews: What about stretch IRAs? In terms of using IRAs for estate-planning purposes and having your heirs take over the IRA, how does the tax planning get involved in that scenario?
Mr. Keebler: The typical goal with a stretch IRA is, when I die, my children can take their money out of the IRA out of their life expectancy. And that is going to create a substantial wealth transfer. But you can also stretch a Roth IRA, which is even better because then all the distributions are completely tax-free.
As the generation we are doing estate planning for now — the people from 70 to 90 — age and pass on those IRAs, I think we're going to see a really good attempt at getting the best stretch possible.
InvestmentNews: How does claiming Social Security benefits fit in with the tax planning?
Mr. Keebler: There's undoubtedly going to be some people who, by waiting from 65 till 70, can increase their distribution by 40%. That is a major-league increase.
The only issue becomes, for some people, it may truly not be 40%, because of three scenarios. Of that 40%, 0% is taxed, 50% is taxed or 85% is taxed. And if you're in a situation where you push your Social Security benefits higher, and that results in 85% tax, compared with if you started them at 65, we want to run the math to see if you would be better off just starting at 65 and flying under the radar from a tax perspective, as opposed to waiting till 70.
We need to be real careful that we're not picking up additional benefits but giving all that back in the form of additional taxation. So again, I think that's math that we're going to get our arms around in the very near future here and try to come back to you with some ideas on that.