Advisers ramp up efforts to create tax-conscious retirement withdrawal strategies

Money saved here can go toward extending the life of clients' nest eggs

May 3, 2015 @ 12:01 am

By Darla Mercado

Tax considerations are becoming a larger piece of the retirement income puzzle for clients, requiring advisers to work with accountants to create tax-conscious withdrawal strategies.

When President Barack Obama signed the American Taxpayer Relief Act into law at the beginning of 2013, a whole new set of rules came into play for high-net-worth clients. Managing those taxes becomes a key concern in retirement, as clients generally have a limited pot of assets. Money saved on taxes can be reinvested and can go toward extending the life of the nest egg.

“What people need to be aware of is managing their tax brackets,” Mackey McNeil, a certified public accountant and chief executive of Mackey Advisors. “Managing taxes looks into the future.”

But be warned: Tax management strategies for retirement income teeter into tax advice, so be sure to bring a CPA to the table when sketching out a plan.

(Related read: 8 tax saving strategies for client portfolios)


Robert S. Keebler, a partner at Keebler and Associates, recommends performing a 15-year projection for individuals in order to manage their tax brackets and drawdown strategies.

Should we take money out of an IRA in particular years to create a reserve for the next year's expenses? Those are things to focus on.— Robert S. Keebler,  partner at Keebler and Associates

Advisers and accountants need to identify points in time at which it may make sense to do a Roth conversion or to take more money out of an individual retirement account. Whether it's wise to do so will depend on the client's tax situation at that point in time. A Roth conversion comes with an income tax bill at time the money is converted; clients have to pay income taxes on money that's withdrawn from a traditional IRA.

Another thing to bear in mind is the order in which a client taps accounts for withdrawals, and in which accounts a client should place an asset in order to maximize tax efficiency.

Clients will generally have three accounts: taxable, tax-deferred and tax-free. Brokerage accounts tend to make up the first group, while tax-deferred includes retirement accounts. Roth IRAs and life insurance provide income for the tax-free bucket.

“You look at making the portfolio as tax efficient as possible,” Mr. Keebler said. “Look at the opportunities to take money out of IRAs, to buy insurance, to do Roth conversions. Should we take money out of an IRA in particular years to create a reserve for the next year's expenses? Those are things to focus on.”

(Related read: Use tax time to focus on retirement)


Know that identifying a client's buckets of retirement income is only part of the job. The order in which a client takes withdrawals from those accounts can vary from one year to the next, according to Susan J. Bruno, a CPA, personal financial specialist and managing partner at Beacon Wealth Counseling.

“Your retiree may have a pension that's taxed at the ordinary income rate,” she said. “Now, if I take money from an IRA, every dollar I take is going to raise my taxes because it's ordinary income. But if I have unusual medical expenses, I should take from that bucket this year. Next year might not be the same.”

The beauty of it is converting to a Roth as a resident that doesn't have state income taxes.— Susan J. Bruno,  personal financial specialist and managing partner at Beacon Wealth Counseling

That's because clients can deduct medical and dental expenses. Those who are over 65 can deduct the amount of expenses that exceeds 7.5% of their adjusted gross income. Younger taxpayers can deduct expenses that go over 10% of AGI. Taking income from the IRA might also not be bad in a low-income year, Ms. Bruno added.

Clients who are at retirement's doorstep may want to bite the bullet and start a Roth conversion to create that tax-free bucket. In that case, don't forget about the impact of state as well as federal income taxes. “A lot of retirees are flocking to states with no state income tax, and the beauty of it is converting to a Roth as a resident that doesn't have state income taxes,” Ms. Bruno said.

Be ready to make a host of changes and file the appropriate paperwork if a client's already planning a move to Florida or some other no-income-tax locale. Taxpayers must be able to prove their residency in the new state by living there most of the time and having the voter and vehicle registrations to help back it up.


A client who already has an insurable need might want to consider using life insurance to create that tax-free income bucket. Universal life policies are best-suited for this kind of strategy because, unlike other types of permanent life insurance, clients can apply more of their premium dollars toward building cash value within the policy. In the future, that client can use the cash value as a source of tax-free income.

Ms. Bruno has been recommending indexed universal life for these strategies. She prefers IUL because it provides growth that's based on the performance of an index, subject to a cap, and the cash value doesn't suffer losses when the index is down. During “down” periods, the cash value receives no credited interest.

Unlike variable universal life, indexed universal life isn't invested directly in the market. Rather, behind the scenes, the insurer purchases a basket of call options to reflect the performance of an index.

Ms. Bruno warns that such policies aren't for every client: The costs in the early years of the policy are very high, and clients need to be comfortable with committing hefty premiums to grow the cash value.

Advisers also need to be comfortable with monitoring the policy's performance. Policies with a cash value that rises too quickly due to overfunding premiums risk becoming a modified endowment contract, which means the cash value drawdowns will be taxed.

“When nobody is servicing the policies, that's when the wheels fall off,” Ms. Bruno said.

If everything goes as planned, the client will be able to withdraw the basis in the policy tax-free as a source of income in retirement, and he can also take tax-free loans from the cash value.

(Related read: As indexed universal life sales climb, be sure to mind the risks)


What kind of entity it should be is based on how much risk — liability — is involved in the business. — Susan Tillery,  personal financial specialist and CEO of Paraklete Financial

Susan Tillery, CPA, personal financial specialist and CEO of Paraklete Financial, has guided clients from the 9-to-5 life to one in which they can pursue their passions as an entrepreneur. One client retired eight years ago at age 62 to become a professional photographer, and thanks to the tax planning work Ms. Tillery did for him, the business expenses are deductible.

A lot of work went into preparing the client with the appropriate business entity to ensure that the photography startup had the right structure.

“What kind of entity it should be is based on how much risk — liability — is involved in the business,” Ms. Tillery said. In this case, the client became a sole proprietor, meaning that the business had to be registered with the county. On federal returns, the client has to attach Schedule C to his Form 1040 in order to account for the business' profit and losses.

“He traveled the world taking photos, and he set up a site where he can sell them as stock images, and he can legitimately deduct the expenses,” Ms. Tillery said.


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