In preparing for retirement, one accumulates as much money as possible. Most strategies focus on qualified accumulation, which defers income tax until the distribution phase when a person presumably has fewer exemptions and deductions. For high-income earners paying taxes at the highest levels during the accumulation phase, this is an advantage. For those at lower levels, income tax during the distribution phase can be challenging.
With a market more volatile than ever, investors need to create balance within a retirement portfolio.
Vincent Serratore, senior managing director of Heritage Wealth Management, explains: “Many retirees are exposed to more risk than usual because they are not taking into consideration their current age, time horizon and future distributions. We do believe that a portion of a client's investments should be in the stock market to keep up with inflation, but limited to quality, dividend-growing companies and not the hot-flying stocks of the year.”
Mr. Serratore supports this with his “reality check” of 30+43=0, where a loss of 30% the previous year needs a 43% growth in the next to recuperate.
High-income earners can use Roth conversions and the Roth loophole, but the conversion requires paying taxes and the inability to use the funds for five years.
One option both levels of income earners rarely use can be done in the early stage of retirement planning: Creating nonqualified, tax-deferred growth during the accumulation phase and tax-free distribution during retirement or sooner.
Recently, I met a 35-year-old high-income earner who was looking for ideas for retirement planning. He was interested in learning more about how a permanent life insurance plan would help him offset his qualified contributions when he retires. We presented him with the opportunity to save for retirement while providing for his family if he dies prematurely.
In summary, a $16,000 annual premium, structured properly, will provide him with $157,000 a year, tax-free, from age 65 for the rest of his life. It will also provide his family with several million dollars depending on when he dies. Although the annual premium is taxed, the growth is deferred and will never be taxed.
This and his Roth accumulation will counteract the need to pull from his taxable qualified funds beyond his required minimum distributions and will help minimize his income tax during the distribution phase. Furthermore, the fixed life insurance program helps balance an investment portfolio against a negative market. Since this type of program grows at a steady rate, generally 6% to 8%, it creates stability and provides an opportunity to cushion your investment portfolio distributions during retirement.
Most moderate- to high-income earners will use trusts in coordination with these strategies to minimize estate tax.
“Estate tax is payable within nine months of your death or delayed until the surviving spouse's death,” said Lawrence S. Zaharoff of Zaharoff & Zaharoff Attorneys at Law. Creating separate entities to house assets reduces the size of the estate, minimizes estate tax and opens the door for government-funded programs while increasing inheritable wealth.
The biggest threat to moderate-income earners' retirement portfolios is the need for long-term care, which must be funded with qualified assets before making use of government-funded programs. An irrevocable IRS retirement trust can't protect qualified funds while the income earner is alive.
“The goal is to protect your assets that you spend a lifetime accumulating,” Mr. Zaharoff said. “The IRS has given people ways (LTCI and trusts) to protect their assets, but many people are unaware that the means exist.”
Moderate- to high-income earners will generally create a financial strategy using assets to pay for services needed, often using asset-based long-term-care plans associated with annuities, life insurance and a Medicaid trust. Positioning investment assets using insurance programs and trusts will help deter paying more income tax than needed.
Mark Cardoza is a certified long-term-care specialist and is certified in the area of trusts and estate planning. He is the author of “Positioning 4 Retirement.”