Consider Strategies To Capitalize On Historically Low Taxes – Before They Increase

By John Vandergriff

Taxes are a necessary part of life, and strategic help with positioning your investments to minimize taxes is rare.

The age-old advice we have all heard asks, “Why pay taxes today when you could defer them to retirement, when your income will be lower?” However, most Americans don’t realize that today our income taxes are at the lowest rates we have seen in decades. That may not be the case for much longer. 

Most of us have heard of the issues with spending programs like Medicare and Social Security, and very recently we have witnessed trillions of dollars being thrown around our nation’s capital like play money. We now face a very real debt problem. How does this translate to taxpayers? A strong likelihood of higher taxes in the future.

In the years immediately following World War II, the government introduced the most progressive tax environment in our nation’s history with income tax rates topping out at 94%. This was not a short-term fix. The top rate stayed at or above 70% until the early 1980s. Today, the top income tax rate for any American is 37% — almost half the post-World War II tax rate.

What should we do? Some say enjoy the low tax rates while you can and don’t do anything that might rock the boat. But unfortunately, that advice could cause you to miss out on what could be the best tax-planning opportunity of your lifetime.

Your retirement savings are likely to become the primary target when tax rates increase in the future. You have yet to realize any taxes on contributions to your IRAs or 401(k)s, and when you take that money out (either voluntarily or at 72 via required minimum distributions), you will pay taxes on these funds at your top rate. While rates are low, why shouldn’t we start taking money out of these accounts, pay the tax while it’s on sale, and then convert those funds into accounts that will offer tax-free growth moving forward?

The good news is, the government gives you two choices for tax-free growth and tax-free withdrawal on money taken out of your IRA or company retirement accounts. Roth IRAs are able to have tax-free growth and tax-free withdrawals after five years of the account being open. The other option comes from Section 7702 of our tax code, which gives tax-free growth ability to life insurance policies that are not modified endowment contracts. This allows you to structure a life insurance policy with a focus on getting tax-free living benefits as a priority over tax-free death benefits.

How can you decide if this will work for you? 

• Project your future income. Look at your income now and where you realistically expect it to be in the future. If you look at the 1980 tax year, the 32% bracket started at $24,600 of income for married filing jointly (approximately $97,300 in today's money adjusted for historical inflation at 3.5%). That same tax bracket of 32% exists today, and it starts at $329,850 of income for a married couple filing jointly. What that means is if you think your income long-term will be $100,000 or more, converting IRAs to tax-free positions at less than a 32% tax rate could save you money in the long run.
• Spread out your conversions. Make a plan to convert over several years instead of all at once to make the most efficient use of your tax brackets. The goal is to convert as much as you can at tax rates that make sense. Since there is no maximum amount for conversion from an IRA to a Roth, you should have the flexibility to make the decisions you need to while we have the opportunity for lower rates. 
• Get started sooner rather than later. Roth accounts need to be open for five years before the growth on your money and contributions are tax-free.
• If possible, use after-tax money to pay for the taxes owed from conversion. This will allow you to keep more money in the Roth to have the most tax-free growth potential on your savings.

Be aware that although the current tax code is set to expire in 2025 and revert back to 2017 brackets, it could change sooner. It is important to pay attention to what happens in Washington, D.C. and adjust your plans accordingly. If tax laws become more aggressive like we saw after World War II, it could make sense to convert more than you planned. 

Also, with recent proposals that could alter the rules on backdoor Roth conversions or Roth conversions phased out above certain income thresholds, moving money into these tax-free accounts is something you want to make sure you do while you still can.

About The Author

John Vandergriff (blueridgewealth.com) is the co-owner of Blue Ridge Wealth Planners.

Blue Ridge Wealth Planners does not offer tax or legal advice. Consult your tax or legal advisor regarding your situation.