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Retiring with a $9 million nest egg might seem like a dream come true, but for a couple in their 60s, the reality is complicated by a looming tax burden. On November 15, 2024, they shared their concerns about how taxes will impact their carefully planned retirement. This scenario highlights the complex interplay of financial success and tax obligations for high-net-worth individuals.
The couple—a 62-year-old man and his 58-year-old wife—has spent decades building their wealth. The husband earns $180,000 annually and contributes to both a 401(k) and a Roth 401(k). His wife retired in 2021 with a $70,000 annual pension and a robust 401(k) account. Their assets include $4.3 million in a tax-deferred 401(k), $400,000 in a Roth 401(k), and $2.2 million in the wife’s 401(k). They also have $2.5 million in liquid investments and generate $24,000 annually from rental properties.
While these figures are impressive, the couple is acutely aware of the tax challenges they face. Their financial planner, who does not provide tax advice, encouraged them to increase spending to enjoy their wealth. They’ve taken vacations and upgraded to luxury cars, yet concerns about tax liabilities linger.
The couple is exploring options to manage their finances strategically. Key considerations include relocation, adjusting contributions, and leveraging tax-efficient investment strategies.
Relocating to a state with no income tax, such as Florida or Texas, is an appealing option. These states offer significant tax savings compared to high-tax states like California or New York. Alternatively, some retirees explore moving abroad to countries with lower living costs and favorable tax structures.
Adjusting financial contributions is another avenue. For example, the husband could direct funds from his Roth 401(k) contributions into a Health Savings Account (HSA), which offers pre-tax contributions and can cover qualified medical expenses tax-free.
Turning hobbies into a business is another creative strategy. By establishing a legitimate business before retirement, the couple could potentially reduce their taxable income. Expenses related to the business, such as transportation and materials, may be deductible. Additionally, the IRS allows businesses to operate at a loss for three out of five years, providing flexibility to manage tax liabilities.
Their investment portfolio also requires careful planning. With a mix of tax-deferred, post-tax, and taxable assets, they aim to maximize growth while minimizing tax exposure. Municipal bond funds, which are tax-free, offer one solution. State-specific municipal bonds can provide additional tax relief for residents in states with income tax.
Post-retirement, the couple may prioritize withdrawals from their Roth 401(k) and liquid investments. These accounts have already been taxed, reducing their overall tax burden. Tax-deferred accounts, such as traditional 401(k)s, will be tapped later, ideally when they fall into a lower tax bracket.
Tax regulations also play a role in their strategy. The IRS mandates required minimum distributions (RMDs) from tax-deferred accounts starting at age 72. Delaying withdrawals until this age allows the funds to grow, but it also requires careful planning to avoid significant tax penalties.
While their financial planner offers general advice, the couple recognizes the importance of consulting a tax specialist. Understanding and navigating IRS rules will be crucial to preserving their wealth while fulfilling legal tax obligations.
This story underscores a critical reality for retirees with substantial savings: financial success comes with its own set of challenges. Strategic tax planning is essential to ensure unnecessary tax liabilities enjoy rather than diminish that hard-earned wealth.
As they continue to evaluate their options, the couple remains optimistic about their future. They are determined to find a balance between enjoying their retirement and managing their financial responsibilities wisely.
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