Savant - University Wealth Management

Keep Taxes in Mind When Saving for Retirement

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Report Summary

One of the simplest ways to help improve return on your portfolio is to reduce overall taxes on your investments – a decision today that can help lay the foundation for the retirement lifestyle you want tomorrow. Taking the time to review the makeup of your financial assets from a tax standpoint allows you to maximize the unique tools available to you as university faculty.

For many years now, university professionals have enjoyed the benefits of tax-deferred, mandatory retirement plans provided by their employers. As a result, many professors have substantial amounts of their retirement savings in these pre-tax plans. Universities also offer supplemental, voluntary payroll-deduction plans to which an employee can make additional tax-deferred contributions. Evaluate your plans holistically in consideration of the unpredictable future tax environment, in which there are many factors at play. We believe today’s environment, including the political party in office, the health of the economy, and a growing national debt, increases the likelihood of tax hikes in the near term.

Diversify Your Tax Structures

The Tax Cuts and Jobs Act (TCJA) passed at the end of 2017 changed how your taxes are calculated. One of the main benefits was a reduction in federal tax rates, from a top marginal tax rate of 39.6% down to 37%. The Act’s changes are set to expire at the end of 2025, where tax rates will likely revert to the previous, higher rates last used in 2017.

Fluctuating rates make diversification of your tax structures even more important. You can adjust your savings plan now to take advantage of the lower tax rates and potentially put yourself in a stronger position for the future. Your financial advisor can help to split your income into different tax “buckets” that represent different methods of taxation: pre-income tax, capital gains tax, and tax-free or after-tax income.

Different Tax Structures / Different Tax Buckets

  • Pre-Income Tax (Examples: University Retirement Account, 401(k), IRA)
  • Capital Gains Tax (Examples: Stocks, After-tax mutual funds)
  • Tax-Free (Examples: Limited Pay Life Insurance, Municipal Bonds, Roth, 529 College Savings Plans)
Most university retirement assets are pre-income tax.

The Importance of Tax Balance in Retirement

Death, taxes, and unexpected expenses in retirement are all unpleasant certainties we face. You will experience a time in retirement where you will need some extra cash to cover necessary home repairs, pay for additional medical care, or facilitate a move. While you may have a good idea of the level of income you will need in retirement, unforeseen expenses can throw a wrench in your plans. A good tax balance among your assets will help keep your taxes down when events like this occur.

If all your investment assets are in pre-tax accounts, any additional distribution to cover unexpected expenses will be taxed at your marginal tax rate, possibly pushing you into the next tax bracket. In this same scenario, you can access your tax-free assets to cover the additional expenses with minimal, if any, real change to your taxes. Building up your tax-free assets before you reach retirement gives you the flexibility to manage whatever is thrown your way. There are several techniques to build your tax-free assets.

Tax-Free Options

The most popular strategy for accumulating tax-free funds in retirement is the use of Roth accounts. Whether you are contributing to a Roth IRA outside of your employer or a Roth 403(b) through your employer, the concept remains the same: after-tax dollars are contributed and grow tax deferred.

Assuming you meet the requirements, these assets can be distributed in the future without taxation. This can be a powerful tool, especially if you anticipate being in a similar or higher tax bracket in retirement.

There is no income limit for a Roth 403(b) as there is for a Roth IRA. While the only requirement to use a Roth 403(b) is that your employer needs to have the plan available (check with your benefits department), the ability to contribute to a Roth IRA is tied to your income level. As of tax year 2022, the income limits are $144,000 for a single person and $214,000 for a couple. If your income is below these amounts, consider contributing the maximum amount to a Roth IRA each year ($6,000/year if under age 50 and $7,000/year if age 50 and over).

Lesser-known strategies to build tax-free assets in retirement include using permanent life insurance and municipal bonds. Permanent life insurance can be great for estate planning. When properly arranged, it can help provide a tax-free benefit to your beneficiaries. In addition, permanent life insurance builds up cash value on a tax-deferred basis which can be accessed tax-free in the future for any reason. You can take a distribution or a loan from the policy to take a vacation, buy a new car, or simply to supplement your retirement income.

Finally, municipal bonds can also provide tax-free income in retirement. Unlike corporate or U.S. Treasury bonds, the income you receive from a municipal bond is usually exempt from federal taxes. If you live in the issuing state, municipal bond income also avoids state level taxation. This can be a viable option not only in retirement but also in your working years if you are a higher income earner.

Have More Flexibility and Control Over Your Assets

If you are contributing a meaningful amount—preferably the maximum amount—to your employer’s pre-tax retirement account, you have taken the most important step. A formidable retirement nest egg is built by consistently saving money year after year, an action done so often it becomes habit. Strategic planning now, using different “buckets” of tax diversification, helps increase your flexibility to minimize taxation and, ultimately, your likelihood of achieving the retirement lifestyle you desire.

Consider consulting with a CERTIFIED FINANCIAL PLANNERTM professional to be sure you are on the right track for a successful retirement. To learn more about how we can help secure your next steps in life, schedule a no-obligation introductory call today.

This is intended for informational purposes only and should not be construed as personalized financial or investment advice. Please consult your financial and investment professional(s) regarding your unique situation.

Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the U.S., which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Wise Counsel for University Professionals

Our advisors have specific and in-depth knowledge about university employee benefit programs and retirement plans. We work with university faculty, physicians, and other professionals. We are not associated with any university or any retirement vendor, and we have no access to your private retirement or personnel information.

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