Get With The Plan: October 6, 2013

Walter, 64, is a retired teacher. He has concerns about making his money last for him, and he’s worried about taxes.

“I want to keep most of the money I have accumulated after paying off tax obligations,” he said. “I have low risk tolerance, expecting an economic downturn sooner rather than later.”

He also wants to help provide for a sibling who hasn’t been as strategic with savings over the years.

Walter, whose name has been changed, has set aside $412,000 in his 403(b) plan, $26,100 in a brokerage account, $241,000 in a money market and $20,000 in checking.

He also receives a pension of $64,000 a year, and he hasn’t started to take his Social Security benefits yet.

The Star-Ledger asked Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Management in Florham Park, to help Walter plan with taxes in mind.

“His primary concerns are paying taxes on his 403(b) deferred savings account and providing financial support for his younger sibling who is not as financially sound as Walter,” Pallitto says.

Pallitto says Walter lives very modestly — maybe too modestly — because his pension income is almost two times his living expenses.

For that reason, Walter doesn’t plan to take Social Security benefits until age 70.

Pallitto says if he collected Social Security at age 66, he’d receive $2,280 a month. If he waits until age 70, then he would receive $3,000 a month.

“However, waiting until age 70 would increase his overall tax rate for the rest of his life,” Pallitto says.

Walter’s gross income is over $64,000 from his pension, but his taxable income is $53,100, which puts him in the middle of the 25 percent bracket.

If Walter waits until age 70 to collect Social Security, it will also coincide with Required Minimum Distributions from his retirement accounts, Pallitto says. This will push Walter into the 28 percent bracket.

“Based on his pension he will never be in a tax bracket lower than 25 percent, therefore, tax-efficient financial planning would take advantage of the opportunity have his retirement assets taxed at a lower rate,” Pallitto says.

In order to minimize his long-term tax bill, Pallitto
says it would be to Walter’s advantage to pay more taxes now.

Walter has $412,000 in 403(b) retirement accounts. Palitto recommends Walter roll the account to an IRA.

“Over the next six tax years, (he should) convert as much of his IRA to a Roth IRA to `fill-up’ the 25 percent tax bracket,” Pallitto says.

For example, Pallitto says, the 28 percent bracket for single taxpayers starts at $87,850. Therefore Walter can convert about $35,000 of his IRA each year to a Roth IRA.

The Roth IRA assets will growth tax-free to him — or his sibling — and are not subject to Required Minimum Distributions.

“By the time he is age 70, he will have transferred about $210,000 out of his IRA, which will reduce his Required Minimum Distribution amount when he is 70,” he says.

If he starts with $412,000 in his retirement account and assume a 4 percent rate of return with six annual distributions of $35,000, then by the time he is age 70, Walter’s estimated Required Minimum Distribution would be $10,000 per year, Pallitto says.

“His estimated taxable income would be about $93,000, which should be just over the 28 percent bracket threshold in 2019 with inflation adjustments,” he says. “If he does not do any Roth conversions, then using the same 4 percent rate of return, his Required Minimum Distribution would be about $20,000, and his taxable income would be about $103,000, which would be in the 28 percent bracket.”

Another option would be taking Social Security at 66, and using that money to pay the tax bill on larger annual Roth conversions over the next six years.

“In this case he could convert about $65,000 to $75,000 of his IRA to a Roth IRA, which would represent a total conversion by age 70,” Pallitto says. “In this case, he would have no Requirement Minimum Distributions, and his tax bracket will remain in the 25 percent bracket for the rest of his life.”

Pallitto says he favors this strategy because he’s not a proponent of waiting until age 70 to collect Social Security. He says it takes about 11 to 12 years to collect the same total dollars, and no one knows how long they will live.

Looking at other areas, Walter does not need long-term care insurance because his income, excluding RMDs, would cover the cost of care, Pallitto says. However, Pallitto learned, Walter gifts $14,000 a year to his sibling, and that sibling does not have the income, assets or family to assist him in the event of a long-term illness. In essence, Walter says he’d pay for his sibling’s care as long as he’s alive. Pallitto suggests Walter purchase a long-term care policy for his sibling with a portion of the $14,000 that he gifts.

“He could buy excellent coverage for his sibling at a cost of about $4,000 a year and he would never have to worry about spending down his assets for his or his sibling’s care,” he says.

Then, if his and his sibling’s care was covered, and Walter’s income is going to be about three times his annual expenses. That means it’s time for Walter to start enjoying himself more.

“He should splurge and treat himself,” Pallitto says.