Investing is great. Not losing money on your investments is even better. Making a mountain of money from those investments is awesome. Developing and executing a strong investment strategy is difficult and takes a great deal of knowledge. If you’ve gotten to the point where your investments are dialed in and you’re accumulating capital, preferably in tax-deferred savings accounts, take a moment to congratulate yourself. But don’t get too comfortable because the tax man cometh.
Previously, we outlined our Multi-Pillar Tax Strategy to help protect your investment income. The first pillar, which will be of paramount importance in retirement, is to use Required Minimum Distributions (RMDs) to your advantage. Just to reiterate: when you turn 70 ½, the IRS requires that you begin taking yearly disbursements from your retirement accounts. When any of your tax-deferred savings is distributed to you, it’s counted (and taxed) as income. The idea is that Uncle Sam depends on that tax revenue, so you can’t keep it locked up forever.
You need to use these RMDs as wisely and tax-efficiently as possible. Once you reach retirement, you’ll likely have a clearly-defined budget that provides you with the lifestyle you want. Since you’ll be required to take a certain amount out of your retirement account annually, you need to make sure that amount is calculated as part of your budgeted annual income. That way, you can draw from your other sources of income only what you need with the goal of staying in the lowest tax bracket possible to avoid any unnecessary taxation.
Let’s say you’re not keeping tabs on your yearly income streams during retirement (we know you’re too smart for that but just indulge us here). You draw and pay tax on enough money from various income streams to cover your annual budget then at the end of the year, you remember “oh, right. I have to take my RMD also!” Then you’re paying unnecessary taxes for the year. What’s even worse is if this additional income bumps you up into the next tax bracket. Then you’re really paying more than your fair share to Uncle Sam.
So while wise investments are a critical part of your wealth-building strategy, they’re only one piece. If you’re smart (and we already know you are), you’ll look a little further down the road and consider how and when those returns will be used. Timing is everything. We always recommend that you work closely with a financial advisor because wealth management strategies are dynamic. They need to be reviewed and adjusted on a regular basis to make sure any changes in the regulatory environment, along with a wealth of other factors, don’t change the outcome of your strategy.
If you’d like to learn more, join Noble Capital at our quarterly State of the Company event where we’ll take a deeper dive into our Multi-Pillar Tax Strategy.