Tax Planning Scenario | Hauppauge NY

Achieving Goals By Reducing Taxes

The Situation

Susan, age 64, and Larry, age 65, retired two years ago. They were both successful business executives and planned well for their retirement. Although they felt comfortable with their retirement lifestyle, they were frustrated with the taxes they were paying. The couple wasn’t sure if they were doing everything possible to reduce their tax burden, which is when one of their neighbors, a current client of NestEgg, referred them to our group.

As a team, we reviewed Susan and Larry’s current tax position, income tax returns, Form 1099s and investment portfolio—all of which revealed several opportunities to reduce their taxes. One of these was to shift asset locations, which involves analyzing investment holdings to determine the best place to hold them.

Furthermore, we discovered numerous tax-inefficient mutual funds in their taxable investment account and although these holdings were performing well on a pre-tax basis, the after-tax results were inferior.

The Solution

Our first step was to sell the tax-inefficient positions held in Susan and Larry’s taxable account. With the proceeds, we purchased highly tax-efficient exchange-traded funds that rarely distribute unwanted capital gain distributions. Next, we re-allocated investment positions in the IRA accounts so that the overall portfolio investment structure remained intact. Then, we offset and eliminated all capital gains by harvesting unrealized capital losses meaning we were able to implement the above asset location strategy without any current taxation. The net result is that Susan and Larry will be saving over $10,000 in income taxes each year moving forward.

Further, we took a look at an investment account that Susan inherited from her mother who passed away 11 months ago. We noted that the cost basis associated with the positions in this account was never adjusted for a date-of-death step-up basis. Working with Susan’s accountant and the account custodian, we were able to make the step-up in basis adjustments to all the positions in the inherited account. These adjustments will reduce Larry and Susan’s future capital gains by over $200,000.

We then conducted a projection of future required minimum distributions (RMDs). Based on projected growth in Larry and Susan’s IRA accounts between now and their age of 72, these projected RMDs will be significantly in excess of the amounts Larry and Susan will need to support their lifestyle. Nevertheless, these RMDs will be fully taxable as ordinary income and likely subject to high marginal income tax rates.

To mitigate the problem, we implemented a Roth conversion strategy. We anticipated that in the years prior to their age of 70 and before they will be subject to RMDs, their taxable income will be significantly lower. Therefore, we recommended annual, partial Roth conversions. Although taxable, these distributions would be taxed at substantially lower rates.

Follow-Up

Larry and Susan now feel a sense of peace having a comprehensive tax plan in place and knowing that they are doing whatever they can to lower their tax bill. As NestEgg clients, we will be reviewing their income tax returns and Form 1099s every year going forward, we will coordinate with their CPA as required, and we will be prepared to modify their tax planning, if necessary, based on changes to the tax laws or changes in their personal circumstances.

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Important Disclosure

Fact patterns have been modified and fictitious names have been used. The Case Study is designed to illustrate how we may provide services to our clients, but these services may not be suitable for you. There is no assurance that NestEgg may be able to help any client achieve the same or similar results. The Case Study should not be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results or satisfaction if NestEgg is engaged, or continues to be engaged, to provide financial planning services. Projections and retirement forecasts presented in the Case Study are not guaranteed and may not be indicative of future results.