Monster Retirement Accounts

By Paul R. Ruedi, CFP®

From a retirement planning perspective, people with high incomes have the wind at their backs. A high income allows people to save a large amount more quickly than others. But this high income leads to an interesting retirement “trap.” High income people usually contribute to a traditional retirement account to lower their taxes now. After many years of this, they often end up with a “monster” traditional retirement account.

A large tax-deferred investment account is a great asset to have when planning your retirement. But it does come with a catch: you have to pay taxes when you pull the money out. If you don’t pull your money out fast enough, you will be forced to take required minimum distributions (RMDs) at age 73, and they will be large. Those large required minimum distributions can kick you into a high tax bracket, and you have no choice but to accept this.

Since a traditional retirement account doesn’t create taxable income unless funds are withdrawn, a person with no employment income, and a large traditional retirement account they are not withdrawing from, could potentially be in a very low tax bracket. This provides the opportunity to withdraw funds from a traditional retirement account at a temporarily low tax rate before RMDs kick in and drive up taxable income each year. 

There are a couple ways to do this. First, you can simply accelerate withdrawals from a traditional retirement account. Take out as much as possible now, up to a tax rate you are comfortable with. For example, if a person saw RMDs were going to kick them into the 35% tax bracket later, they could save on taxes by distributing enough to “fill up” the 24% bracket. 

Another option is to do Roth conversions and convert traditional retirement account funds into a Roth account, after which they will never be taxed again provided you follow all the rules. This can be a very powerful option for people with a long time horizon, and works best when people have other assets to pay the taxes on the conversion.

If you have a monster retirement account, you may want to think about how you are going to withdraw from that account in the most tax-efficient manner. It will also be important to be mindful of how different levels of taxable income impact IRMAA surcharges or ACA subsidies. If you need help with that, you may want to talk to a retirement planner. 

Paul R. Ruedi is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.