What steps can I take to avoid a tax time bomb in retirement?

[00:00:00] Ralph Estep, Jr.: Have you ever wondered if your retirement savings could turn into a ticking time bomb? And what if I told you that the very nest egg you've been carefully building could explode in a tax nightmare just when you least expect it? Well, stick around today as we uncover the hidden dangers lurking in your retirement plans, and we're going to learn how to defuse that potential tax time bomb before it's too late.

[00:00:27] Ralph Estep, Jr.: So today, we're diving deep into the question: What steps can I take to avoid a tax time bomb in retirement? Well, let's take a quick look back at yesterday's show. Yesterday, we tackled the delicate topic of discussing pension income during the dating process. If you missed that one, I'm going to encourage you to go back and listen to it. I gave you some practical tips on how to navigate those tricky financial conversations when you have those new relationships without coming across, as what somebody said, being a gold digger or a miser. So trust me, it's a must-listen-to if you're single and have a pension or if you're dating someone who does. Now, let's get to today's hot topic.

[00:01:10] Ralph Estep, Jr.: I received this message from Sophia. Now, Sophia actually mentioned she's from Tulsa, Oklahoma. So, shout out to our Oklahoma listeners. This is what Sophia wrote. She said, "Dear Ralph, I've been diligently saving for retirement for years. I've been maxing out my 401k and I'm feeling pretty good about my financial future. But recently a friend mentioned something about a tax time bomb in retirement. And now I'm worried. I thought it was doing everything right, but am I setting myself up for a big tax hit down the road? What can I do to make sure I'm not blindsided by taxes when I should be enjoying my golden years?”

[00:01:47] Ralph Estep, Jr.: Well, Sophia, that is a wonderful and perfect question. I'm so glad you asked that because that's something most people and I dare to say many people overlook. And it can have some significant and serious consequences if you don't address it. So, that concern is very valid, and it's a perfect example of why we need to think beyond saving money. But we need to consider how that money's going to be taxed when we retire in the future.

[00:02:15] Ralph Estep, Jr.: So Sophia, your question reminds me perfectly of Proverbs 21:5. And it says this. "The plans of the diligent lead to profit as surely as haste leads to poverty." That's a tough verse, but it reminds us of the importance of careful planning in our lives, especially our financial lives. Just as we plan for our retirement savings, we also need to plan for those tax implications of those savings. So, as you say, you don't get blindsided.

[00:02:45] Ralph Estep, Jr.: Well, now, let me tell you about my client, Robert. Robert's situation is a perfect illustration of how good intentions can sometimes lead to unexpected challenges in retirement. So picture this. Robert, a client of mine. He's a hardworking small business owner.

[00:03:00] Ralph Estep, Jr.: And Robert was this guy; he always prided himself on being financially responsible. For decades, I'm talking about decades; he maxed out that traditional 401(k) plan, and he was thinking the whole time he was setting himself up for a comfortable sit-back and relaxed retirement. He'd watched the account balance grow year after year, and every year, when he got that year-end statement, he felt more and more secure with each of those statements. Well, fast forward to Robert's retirement age of 65. At that point, Robert had done great.

[00:03:29] Ralph Estep, Jr.: He had amassed over $2 million in his 401(k), and he felt on top of the world. He would share this with me every year when he came in and got his taxes done. Look, Ralph, look how much I've gotten now. Look, I got how much I've gotten now. But we never really had that conversation about what would happen.

[00:03:44] Ralph Estep, Jr.: So he's enjoying the fruits of his labor. But there was a problem lurking beneath the surface. And it's a problem that would rear its ugly head when Robert turned 72. You see, here's the problem. Robert had forgotten about one crucial detail, which is the required minimum distributions or what we call RMDs. So, at age 72, this age is changing. Right now, it's 73. It's going to go up to 74. These RMDs make it so that the IRS requires you to withdraw a certain percentage from those IRA or 401(k) accounts each year, and here's the problem. You've got to take those withdrawals whether you need the money or not. And here is the kicker. This is the one that kicks you in the mouth. That money is taxed as ordinary income.

[00:04:31] Ralph Estep, Jr.: So for Robert, my client, this suddenly meant that he had to withdraw about $80,000 in his first year of that RMD. I guess what that did that added to his social security benefits, and he had some, he had some small rental income. He had a place at the shore that he rented out, and all of a sudden, Robert found himself catapulted into a much higher tax bracket than he'd ever anticipated. Now, when he came in and sat down to get his taxes on, the shock on Robert's face and the fact that we ran the numbers are things that I'm never going to forget.

[00:05:04] Ralph Estep, Jr.: He looked at me and said, “Ralph, I thought I was being smart by deferring all these taxes while I was working. How did I end up paying more in retirement?” He then said to me, “Ralph, why did I even bother to save all those years when the government is going to take almost half of my money now that I'm retired?” He was devastated. He was so angry and disappointed. And listen. It was a tough moment for me. But it was also an opportunity for transformation. I felt for him. I saw his frustration. But more importantly, I saw his fear of running out of money in retirement and having to pay those taxes. So, what do we do?

[00:05:43] Ralph Estep, Jr.: We sat down and started strategizing ways to mitigate the damage and prevent it from getting worse in future years. The good news for Robert is this is what I do. This is my passion. So here's what we did. First thing we did. We looked to see if we could do Roth conversions. So, what we did when he was only 65 was start systematically converting portions of Robert's traditional IRA to a Roth IRA.

[00:06:09] Ralph Estep, Jr.: We did that in the years before he turned 72. Yes. He had to pay taxes on those conversions, which was ordinary income, but we did it in a controlled manner. We did it so that we could keep him in those lower tax brackets each year. The goal was to reduce the size of a traditional IRA so that when he hit 72 or 73, he would take smaller RMDs, which would add to his income. And I did a show on this before, and I'll put a link in the show notes.

[00:06:37] Ralph Estep, Jr.: I would encourage you to go look at that. The second thing we did. Number 2, we explore what's called qualified charitable distributions. You may have heard me say the word QCDs. So once Robert turned 70 and a half, he started making donations directly from his IRA to those charities he cared about.

[00:06:55] Ralph Estep, Jr.: And here's the best part. Those QCDs are counted towards his RMD, and I know we're throwing a lot of initials out there, but stay with me here. But it didn't increase his taxable income because that money shows as an RMD, checks the box, and he made the RMD. But because the money went right to the charity through that QCD, it didn't affect his income.

[00:07:14] Ralph Estep, Jr.: So that was a win-win. And you might ask, why is that? Because Robert was able to support causes he believed in. He was giving them a hundred percent of the money. He didn't have to worry about tax consequences, and it helped him manage his tax liability. It was truly a win-win. What's the third thing we did?

[00:07:31] Ralph Estep, Jr.: We diversified as retirement income sources. And what do we do there? We started focusing on building up some after-tax investments. So Robert was heavy in that 401(k). But I knew we needed to give him some flexibility so that, you know, when he got to retirement, he could draw from different things each year.

[00:07:48] Ralph Estep, Jr.: He didn't have to take all that IRA money. And see, a lot of people miss this step. And this is a strategy that you can focus on because most people think about, well, just like Robert, I'm going to put as much as I can Ralph into that pre-tax 401(k) because you're saving that money right now, but you're not thinking about that step.

[00:08:05] Ralph Estep, Jr.: That's going to happen down the road when you got to take that money out. And the last thing we did was we got strategic about social security. We carefully planned when he should start taking those benefits. And by doing that, we were able to better manage his overall tax situation and retirement. Now listen, the transformation wasn't instant.

[00:08:25] Ralph Estep, Jr.: It took time. But over time, Robert's retirement situation became much more manageable, and the truth is I could see it as we would meet. He went from feeling blindsided and frustrated to feeling like he was back in control of his financial future. So, you might be asking, what can we learn from Robert's story? Well, here are some things that I came up with.

[00:08:45] Ralph Estep, Jr.: These are some action items that you can take to avoid that tax time bomb in your own retirement. Number one thing. Diversify your retirement savings. That's just what we worked on with Robert. Don't put all your eggs into a traditional 401(k) or IRA basket. Consider those Roth options. The reason you want to look at Roth options is that they offer tax-free withdrawals in retirement.

[00:09:04] Ralph Estep, Jr.: The second thing you could do, you've got to plan for your RMDs before they're required. You got to start thinking about those strategies to manage his RMDs. When you're in your sixties or in your mid-sixties, you can't wait until you're 72 or 73. To all of a sudden say, Hey Ralph, what do I do now?

[00:09:21] Ralph Estep, Jr.: Because the truth is, there's not much I can do at that point. And I've dealt with clients that found themselves in that position. They already were at that point where there really wasn't anything we could do except, like my grandmother used to say, suck it up, buttercup, because you had no other choice. You had to take that money out, and there was nothing we could do.

[00:09:38] Ralph Estep, Jr.: Now, there are some little nuance things you could still do: the QCD, charitable contributions, and all that sort of thing, but big picture stuff you can't, which leads me to the next thing. And that's considered those Roth conversions in lower income years. So you have to do that before you get to that RMD state.

[00:09:53] Ralph Estep, Jr.: And this is a very specific area of expertise, but you basically can take those Roth conversions and make them happen in years where your income might be lower. Maybe you've retired, and you've only got that social security earning and you're going to live off some savings. That's the kind of thing that you could schedule a call with me to talk about.

[00:10:11] Ralph Estep, Jr.: So I'll talk about how to do that at the end. Another thing we discussed is that you could explore those queue CDs. And if you're charitably inclined, some people aren't, but they can be a powerful tool for managing your tax liability and, at the same time, supporting those costs as you care about. Listen, we all have those causes that make an impact on us.

[00:10:29] Ralph Estep, Jr.: And if you can, if you can help them and at the same time, help yourself. It's really a no-brainer, and last but not least, I've alluded to this many times already. This is a time to get professional help; retirement tax planning is complex. And there are rules that are always changing. It seems like every day, I'm getting a new publication about it. We'll consider this, consider this the secure act list, and all these; it will make your head spin. And I don't expect my clients to know those things.

[00:10:58] Ralph Estep, Jr.: That's what you pay me for. So, working with a financial advisor who understands both retirement planning and net tax strategy can be invaluable. So, you know, and I'm going to talk about how you can get in touch with me in a minute. Remember. It's not just about how much you save for retirement. That's great, and it's a good thing to do, but it's also about how you save. And how you plan to withdraw those savings.

[00:11:23] Ralph Estep, Jr.: And if you can be proactive and strategic, you can set yourself up for retirement that's not only well-funded, but it's also tax efficient. You don't have that tax time bomb because it really is a time bomb. If you don't plan for it, you're going to find yourself all of a sudden, bam, you're going to come in and meet with someone like, man, let us say you owe X number of dollars, and you're going to fall out of your chair.

[00:11:44] Ralph Estep, Jr.: Now I want to remind you that the whole point of the ask graph show is to ask and answer your questions. So, just like that question we've got today, I want you to keep them coming in. Now, you can submit your questions by going to justaskralph.com. Remember those questions and drive the show. It's what I use to come up with the topics for every day because I know I'm here to help you navigate your financial journey.

[00:12:04] Ralph Estep, Jr.: And I want to do it from that Christian perspective. We'll speak in and help. You might be saying, Ralph, I am lost. I'm worried about the bomb's going to go off in my retirement. Maybe you're feeling overwhelmed by all this talk of retirement planning and tax strategy. It's all been a big blur to you. But I want you to know that you don't have to figure it out on your own. I love working with people just like you one-on-one.

[00:12:26] Ralph Estep, Jr.: We can create a personalized plan. That aligns with your financial goals and your faith. That's what I bring to the table. I'm going to marry both of those worlds together. Now, you can schedule a point with me by going to askralph.com and clicking on the banner at the top. You'll see what it says. It says to book a call with Ralph. Click it, fill in the blanks, and you'll be set up with me.

[00:12:44] Ralph Estep, Jr.: Now. You might be thinking, Ralph, is this going to cost me an arm and a leg? Well, listen, I believe in being upfront about things. I do charge a $150 consultation fee. That's what I do. I can't work for free. But you kind of think of it as an investment in your financial future. Now, during our session, we'll dive deep into your personal finances.

[00:13:02] Ralph Estep, Jr.: Maybe you want to talk about business finances. If you're a business owner. But what we're going to do is we're going to work together to create a moat roadmap for you to achieve all of your financial goals. Now, you might be saying, Ralph, I don't want to give you $150. What if I don't get anything from it? Well, here's the deal. I will personally guarantee.

[00:13:19] Ralph Estep, Jr.: If you don't get at least $150 in value from our meeting, I will refund your consultation fee 100%. So why don't you schedule today? And let me help you create a plan that will set you up for success. Well, let's recap a minute. That's just about what we talked about today. Number one, we learned about the potential tax time bomb. That can be lurking in traditional retirement accounts. We talked about my client Robert's story and how he was caught off guard by those required minimum distributions. The third thing we do.

[00:13:46] Ralph Estep, Jr.: We discuss strategies to mitigate this risk. We figured out ways to diffuse that time bomb. Those things included Roth conversion and qualified charitable contributions. Car charitable distributions, just Q CDs. And also, we talked about how to diversify your retirement income sources. Finally, we have outlined some steps you can take to avoid a similar situation.

[00:14:06] Ralph Estep, Jr.: If you're in your own time, if you find yourself in that same place. Remember this. Uh, being a good steward of your finances. Like I said, it isn't just about saving money. It's about being wise in how you save and how you plan for the future. Remember what Proverbs 21:5 reminds us. The plans of the diligent lead to profit, surely as haste. Leads to prop leads, leads to poverty.

[00:14:31] Ralph Estep, Jr.: It just does. That's what it leads to. Now get ready for tomorrow's show. We'll be tackling another important question. And I may have my son come on the show. We're certainly going to talk about his dog. His dog's name is Firefly, but we're going to talk about how do I budget for my pet care expenses. Now, you might be a dog person, a cat person, or maybe you have a more exotic pet.

[00:14:50] Ralph Estep, Jr.: You don't want to miss this one. We're going to be exploring how to factor in those furry or, dare I say, scaly, I don't like snakes. But maybe you have a scaly friend in your budget. The whole point is that I want to do that without breaking the bank. So don't forget to tune in tomorrow. And I'm going to close with this.

[00:15:05] Ralph Estep, Jr.: Remember this? My passion is to help you achieve financial success. I want to see you live out your dreams. That's what fuels me. And I want to see you do that while you grow in your faith. Because I knew this, together, we can master your finances from that Christian perspective. We can do it. You just have to take the first step and reach out to me. Well, as I always close the show, stay financially savvy, and God bless you.