Tax strategies for high-net-worth retirees are aplenty

Simplifying strategies and balancing clients' assets across different accounts with different tax treatments can help HNW retirees

May 13, 2014 @ 11:53 am

By Darla Mercado

high net worth, retirees, taxes, tax planning
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Tax expert Natalie Choate

Higher taxes are the law of the land these days, but there are still plenty of strategies that high net worth retirees can take advantage of as they receive retirement income.

The secret to having a tax-conscious retirement income plan doesn't lie in one elaborate strategy, according to Natalie B. Choate, an attorney with Nutter McClennen and Fish. She spoke at InvestmentNews' Retirement Income Summit in Chicago on Monday in a session called “Lifetime Distribution Strategies for Retirement Benefits.”

Being “tax smart” will require advisers to simplify their tax strategies and turn to concepts such as balancing clients' assets across different accounts with different tax treatments.

“The happiest client is the one with some money in a Roth IRA, some in traditional plans and some outside as well,” said Ms. Choate. “You have three buckets: a bet on every horse.”

The other benefit is that the retired client with a traditional IRA and a Roth IRA can control the flow of income and the brackets he or she lands in. “If the client has losses, say large medical expenses, he can increase taxable income at an advantageous rate,” said Ms. Choate. “If he needs more money and he's hit the ceiling, take the excess amount out of the Roth IRA, which is tax free.”

More from Ms. Choate on how to manage taxable income during retirement.

This flexibility is particularly important when considering the income thresholds at which Social Security benefits are taxed. An IRA distribution could wind up putting the client over a threshold where 85% of his or her benefits become taxable.

Meanwhile, Roth conversions are still quite valuable. Just don't do one conversion of an entire account. Instead, Ms. Choate recommends converting different asset classes to different accounts: If a client has a $1 million IRA in 10 different stocks, each worth $100,000, then convert each of the 10 stocks into their own Roth account.

This way, the client has diversified in the event some of those stocks fall. The accounts holding the stocks that have lost their value can be recharacterized, as the client won't want to pay taxes on an asset that's no longer there.

“The way the law is structured, you can use a partial Roth conversion, but you can't cherry pick the assets [if all the assets were converted into one Roth IRA],” said Ms. Choate. “Don't do one Roth conversion of the entire account. Do 10 Roth conversions.”

Traps lay ahead for clients next year with respect to rollovers. The recent decision in the Bobrow case in Tax Court means clients will be limited to one rollover per year, starting in 2015.

Clients are most likely going to risk violating that rule if they end up investing their IRA in CDs. A bank will open a new IRA for each CD, and at the end of the term, the IRA's closed and the distribution goes to the client. And there's the violation of the rollover rule.

Finally, advisers ought to take a very close look at money within a retiring client's retirement plan. The immediate answer may be to rollover the assets that are there, but will the client lose anything by doing so?

Ms. Choate noted that some retirement plans offer subsidized annuities to retiring employees, while others are required to offer survivor annuities to spouses. These annuities are free, and they're worth a second look.

In the event a client has a plan loan, make sure that that amount is repaid before the client rolls over into an IRA. If the client fails to repay and then rolls into an IRA, he or she may end up with phantom income on the loan amount, plus more taxes.

Indeed, there are still some oldies-but-goodies for those who are still working in older age: Keep contributing to your retirement savings plan.

“It reduces your [adjusted gross income] and that's the gold standard. Keep doing it as long as you're working,” said Ms. Choate.

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