Once a person successfully reaches retirement, his or her financial priorities naturally undergo a shift. Where before you were in "build up my portfolio" mode, now you're in "spend down my portfolio" mode. But carefully, of course, because you don't want to run out of assets before you run out of time, and it might just be nice to leave a little something to your children.
In this segment of a Motley Fool Answers mailbag episode, hosts Alison Southwick and Robert Brokamp -- with help from Megan Brinsfield, director of Foolish Planning with our sister company, Motley Fool Wealth Management -- offer some advice to a retired listener who is planning ahead. He and his wife have a reasonable-sized IRA, and he'd like to ensure that when those assets get handed down, their heirs are in the best tax position possible. "Nice thought," respond our experts, "and we can help you with that. But you may just want to rethink your priorities."
A full transcript follows the video.
This video was recorded on March 26, 2019.
Alison Southwick: Next question comes from William. "I'm almost 69, and between my wife and me we receive $21,000 from a pension and $28,000 from Social Security each year. Our IRA is valued at $130,000 and we have other investments also worth $130,000.
"As we draw down the IRA account we will move the net amount, after taxes, to a taxable account. The long-term gains and qualified dividends from this account won't be taxed, though it may increase the amount of Social Security that is taxable. Should we draw out large amounts from the IRA but keep our income below $100,000 to stay in the 12% tax bracket or pull out minimum amounts and leave the taxes to the ones who later inherit this account? They are in a higher tax bracket at this time."
Robert Brokamp: Well, William, a couple of things. The general rule for when to withdraw money from your accounts in retirement if you have different accounts of different types is to withdraw money from the taxable account first and leave your retirement accounts alone. Unfortunately, at some point you do have to take money out of your traditional accounts at 70 and a half, and it sounds like that's what William is thinking about because he's getting close to that age.
It also sounds like he doesn't need the money, because he plans to just take that money out and then put it in a taxable account. He's saying that the dividends and capital gains will be free of taxes. That's because below a certain threshold and a certain tax bracket, you actually pay no taxes on dividends and capital gains as long as they're qualified dividends and long-term capital gains.
So it sounds to me like what he's thinking is maybe he should take advantage of that as much as possible to get money out of the IRAs and set that new cost basis, because it's eventually going to be left to his kids, so it's essentially saving his kids some taxes. If he leaves it in the IRA, when you inherit an IRA and take the money out, it's all taxable. Megan, I don't know if you agree, but it sounds like what he's trying to do is to lower the tax burden of the people who are eventually going to inherit this money.
Megan Brinsfield: Yes, it sounds like that's what he's trying to do, and it's especially nice of him, I thought, when I first saw this question. I was like, "You're already leaving them money. You want to make it tax efficient for them, too?"
Southwick: They'll never appreciate it.
Southwick: They don't know what you went through.
Brinsfield: Exactly. The troubles you've seen.
Southwick: The taxes you've avoided.
Brinsfield: Yes, all for them. One thing to consider, here, is that they seem to be in a place where they can afford to take on a little bit more tax burden each year. Just referencing my handy-dandy tax bracket sheet -- the other bracket in March...
Brokamp: Which we all have, by the way.
Southwick: Pull it out.
Brokamp: That's right! The other March bracket.
Brinsfield: As a married couple filing jointly, you can have $77,400 of income before you're taxed at the 22% rate. Everything under that is 12%. So if you consider the fact that you have to subtract a $24,000 standard deduction to get there in the first place, you could have a gross income of almost $100,000 and pay 12% on that, and that's going to be extremely attractive compared to almost any recipient's tax rate. So I think that's really wise of them to do, basically year to year. Because they're getting to that 70 range, they're going to have a minimum that they have to withdraw, but they could withdraw extra up to that roughly $100,000 threshold in order to increase the tax efficiency even further.
Brokamp: I would say to answer his question on whether I would do that or not, clearly they're able to live off the Social Security and the pension. But when you look at their actual savings -- a total of $260,000 -- for a retiree that's not actually a whole lot, and it may not be enough of a cushion if later on they have higher health expenses or long-term care. I would say just make sure that you're taking care of yourself. I like the fact that you're trying to be more generous to your heirs, but just looking at the number of assets that you have, I would still do everything you can to maximize your situation first.
Brinsfield: I think that's fair, because the other thing is they're not going to die at the same time, so there might be some loss of either Social Security and/or pension that then requires a higher reliance on those savings.
Brokamp: With every retirement plan with a married couple you always have to analyze what's going to happen if one's spouse dies -- what's going to happen if another spouse dies -- and see how that affects both income as well as expenses.
Southwick: The bottom line, William, is that's really sweet of you, but we're giving you permission to look out for yourself first.
Brokamp: Yes, that's it.
Southwick: Be selfish.