Does the Rapid Market Recovery Signal a Missed Opportunity to Save Taxes in Retirement?

The Market Drop May Have Been a Huge Opportunity for a Tax-Free Retirement

Tax-free retirement income opportunity - McBeath Financial Group, McLean County Financial Planner

Sheltering in place didn't shelter retirement accounts last quarter.  Most people opened quarterly investment statements with dread. I'm betting many people chose to ignore their damage report and stuck their heads in the sand.

But what was the secret for the few that had no anxiety? Could it be that they were prepared for the worst because they took a proactive approach, beforehand? It's one of the reasons why people invest in financial planning. But beyond surviving the market drop, many were even able to take advantage of the circumstances and improve their retirement vision. They found the prime opportunity to control their long-term tax burden.

“You never let a serious crisis go to waste. And what I mean by that is it's an opportunity to do things you think you could not do before.” Love him or hate him, these words of politician Rahm Emanuel certainly apply to this situation.

See, while many were afraid to look at their retirement account statements from the first quarter, others were taking action. They saw an advantage in ‘pre-paying' taxes at an extreme ‘discount.' This maneuver may position them to pay substantially less taxes in retirement! It's an effective tax strategy that entails looking at the tax burden throughout your lifetime and also over your beneficiaries' lifetimes. By settling future tax liability now, a tax-free retirement means more predictable income later.

Why now is a great time to pay taxes on retirement accounts?

Currently, taxes are low. A quick side by side comparison of our current tax structure compared with the increased rates effective for 2026 will prove this. Then, with the feds pumping money into the economy and increasing the national debt at alarming rates, do you think taxes will stay the same? Or do you feel somehow this debt will have to be paid?

I repeat, the current US tax code is currently approved for just five more years: through the year 2025.

Due in no small part to the effects of the Coronavirus as well as the federal response, some projections indicate the debt will surpass the national GDP as early as 2023! [1]

There are only two ways for lawmakers to address this issue:

  1. Cut expenses (which means lowering the federal budget) or
  2. Increase revenue (which means raising taxes)

The good news is, currently, we are in a relatively low-tax environment. While plotting and charting future income and expenses, it makes sense to consider that tax rates are likely to be higher in the future. Unfortunately, this may coincide with retirement, which is when we may need the income most. So, shouldn't a solid retirement plan include tax planning?

How can we have tax free money in retirement?

Strategic tax planning is a holistic approach to reducing the long-term tax burden and allows a more predictable cash-flow in retirement. One example would be opting to pay taxes on qualified retirement accounts now – while tax rates are lower.

Earned income will be taxed, either now or later. Choosing when and how it is taxed will determine how much of your assets will end up going to the IRS. What's left over is how much you'll have to pursue your dreams, or pass on to your loved ones. With the current tax code, there is a small window of opportunity that may allow you to maneuver accounts to your advantage in retirement.

The most common process for protecting retirement accounts from future taxation is as simple as converting tax-deferred retirement accounts, such as 401Ks, 403b and IRAs into a different financial vehicle, such as a Roth IRA. Another option involves a tactical use of tax code that allows use of specific life-insurance vehicles for generating tax-free income and wealth transfers.

Why was it advantageous to convert when the market dropped?

If you are considering a full conversion of your IRA to a Roth, account values are lower, so there is less to tax. Whether a full Roth conversion or partial conversion, the growth that occurs in the Roth account will be tax-free.

Why are opportunistic investors reviewing their financial plans and using this strategy to save significant money on taxes in retirement?

When the market was peaking, conversions often did not make sense. The immediate tax liability, often equating to less assets available for future growth, might have out-weighed the long-range benefit. However, when investment accounts are lower, the conversion can be done at a ‘discount’ as a smaller portfolio would incur a more modest tax liability. This is a considerable advantage when assets appreciate to their former value and beyond. And as we’ve seen, the S&P 500 did bounce back considerably with an incredible April recovery of 12.68%! [2]

For those that missed a prime opportunity, I have some good news.

First, with the markets still below their peak, it’s highly recommended to analyze retirement accounts to calculate the benefits of converting retirement accounts.

Finally, there's always another crisis around the corner. And while no one wishes for a disaster, many will seize the opportunities available. Some even predict we're headed toward a w-shaped recovery and can expect another market drop. [3] Markets move fast, so will you be ready?

The best way to be prepared is to have a financial plan in place. While it may not make sense to rack up a substantial immediate tax liability while market values are high, it's great to capture an opportunity to transfer funds when sharp dips happen.

So, whether the market is up or down, there are often advantageous options available with proper planning. The key is incorporating a long-term strategy to survive and thrive throughout all market cycles.

A financial advisor with tax expertise may help you take full advantage of the current low-tax environment. In a best-case scenario, seek an advisor that provides holistic and stress-tested investment advice that incorporates a long-term macro-tax strategy to make your money go even further.

Bloomington Normal Retirement Planner Krista McBeathKrista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance.

She utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help their clients avoid a future tax time-bomb.  Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones, with less tax burden, planning makes the difference.

click to schedule an appointment with financial planner Krista McBeath of Normal IL

Related Article: Is a Roth Ira Conversion Really a Good Idea?