Rosalind Evans
Many retirees don’t think about taxes until it’s time to withdraw funds from a pretax account, which financial experts say can be a costly mistake. Proper tax planning can significantly impact the longevity and value of your retirement savings. This article explores how the “bucket strategy” can help reduce your tax burden during retirement.
Understanding the Bucket Strategy
The “bucket strategy” is a tax planning method that helps retirees minimize their tax burden by strategically managing their income. According to certified financial planner Sean Lovison, founder of Purpose Built Financial Services, this strategy involves filling your “buckets” or federal tax brackets by receiving more income in lower-earning years.
“You can reduce your lifetime tax burden by strategically receiving more income in lower-earning years to fill your ‘buckets’ or federal tax brackets,” said Lovison, a certified public accountant.
The Role of Roth Conversions
Roth conversions are a crucial component of the bucket strategy. These conversions transfer pretax or nondeductible IRA money to a Roth IRA, where future withdrawals are tax-free. The trade-off is paying upfront taxes on the converted balance.
“For example, if you’re in the 12% tax bracket before collecting Social Security, that could be a chance for Roth individual retirement account conversions to save on taxes later,” Lovison explained.
By converting enough to place yourself in the 22% or 24% tax bracket, you can avoid higher tax brackets of 32%, 35%, or 37% when Social Security and required minimum distributions (RMDs) begin. Secure 2.0 has pushed the beginning date for RMDs to age 73, starting in 2023, and it will rise to 75 in 2033, allowing more time for strategic conversions.
The Importance of Tax Planning During Accumulation
Judy Brown, a certified financial planner at SC&H Group in Washington, D.C., and Baltimore emphasizes the importance of tax planning during the “accumulation phase” or when you build your retirement savings.
“Often, investors don’t think about taxes until they start making withdrawals from pretax retirement accounts,” Brown noted. “They thought they had $1 million in their 401(k), but it’s only $700,000 after taxes.”
Adding to pretax, Roth and brokerage accounts can provide tax diversification, offering various “levers to pull” to manage adjusted gross income in retirement. This proactive approach can make a significant difference in effectively managing retirement funds.
Making the Most of Your Retirement
Proper tax planning can enhance the longevity and value of your retirement savings. By employing the bucket strategy and considering Roth conversions, retirees can strategically manage their tax brackets and reduce their lifetime tax burden.
“This is a real issue right now that people don’t think about,” Lovison pointed out, highlighting the importance of early and effective tax planning.
Understanding and implementing the bucket strategy can be a game-changer for retirees looking to maximize their savings and minimize taxes. It’s crucial to start tax planning early, consider Roth conversions, and diversify your retirement accounts for a more secure and financially stable retirement.
