For high net worth individuals, the perspective around retirement tends to shift from concerns about whether you’ll be financially secure in your golden years to how you can manage your investments, taxes, cash flow, and charitable affairs in the best possible way. High net worth retirement planning can be complex for reasons we’ll dig into shortly, but the good news is that the process can be smooth with the right guidance.
In this article, we’ll walk through 4 steps to consider in the high net worth financial planning process for your retirement years, so you can achieve your objectives and minimize your tax bill at the same time.
Do you have tax-related questions about retirement planning? Bay Point Wealth’s team of experts can help. Schedule a call with us today.
Complexities Of High Net Worth Retirement Planning
A high net worth is defined as having $1 million or more in liquid assets. High net worth financial planning for retirement can be complicated, because many individuals have amassed numerous accounts, including individual retirement accounts (IRAs), Roth IRAs, brokerage accounts, and a pension, by the time they retire. It’s essential to understand when to withdraw money and from which accounts to reduce your tax burden, which we’ll explore in the steps below.
In addition, high net worth individuals often have a net worth that exceeds their local and federal estate tax exemption amounts, which can make legacy planning tricky. It’s important to be aware of this potential complication, and consult a professional if you have questions. Now, let’s dive in.
Retirement Planning For High Net Worth Individuals: 4 Steps
1. Organize your investments in a tax-efficient way.
Where you invest your money matters, for example, if you hold stocks, such as some exchange traded funds, it’s best to keep those investments in a brokerage account or a Roth IRA, so you can benefit from tax-deferred growth as well as tax savings when you withdraw the money. You can also leave taxable accounts to your children as part of your legacy plan. As a result, your children (or other beneficiaries) will receive a step-up in basis upon the account holder’s death, which minimizes the tax they’ll be required to pay on these assets if and when they sell them.
Tax planning in retirement is even more critical for high net worth individuals who hold mutual funds because those investments often have capital gains distributions, which means you could be taxed up to 25 cents per share on your investments, depending on the fund. Where possible, you should hold funds that have these capital gains distributions in tax-deferred accounts. In contrast, if you hold bonds, keep them in a regular IRA. This defers the ordinary income that these investments generate.
2. Plan your cash flow.
In retirement, you have to replace a steady paycheck that you’ve relied on during your working years. It’s crucial to know what your cash needs will be, so you can plan when to withdraw money and from which accounts.
For example, there is often a sweet spot between retirement and the date you must start taking Social Security benefits (age 70, if you choose to delay after you become eligible), during which time your family could be in a low tax bracket. This period applies to high net worth individuals, too.
Depending on what you think your future tax bracket will be, you may want to take a large amount out of your IRA during this time through a Roth conversion (a transfer of assets), enabling you to access this money while you won’t have to pay as much tax on your withdrawals.
Real-World Case Study On Roth Conversions
Here’s an example of one instance where a Roth conversion strategy benefited our clients—a senior couple who had approximately $7 million in investable assets.
This particular couple’s goal was to pass down wealth to their heirs and reach their charitable objectives in a tax-efficient way. As such, we were doing some cash flow planning for them, beginning with the wife’s Social Security benefits, which kicked in at age 70. The husband was earning some income from his work as a doctor, but planned to start reducing his work hours shortly.
The couple had most of their assets in pre-tax accounts like workplace savings plans and traditional IRAs, which meant that they anticipated making some large required minimum distribution (RMD) withdrawals at age 72.
The strategy we put into play:
We saw a brief window of opportunity between age 70 and 72 in which this couple could leverage Roth conversions while their income was within the 22% tax bracket. They ended up carrying out a $250,000 Roth conversion. They also funded a Donor Advised Fund (DAF) in the same year to move more money out of their pre-tax accounts and remain within a low tax bracket for the time being.
The idea behind this strategy was not only to reduce the couple’s RMDs, but also to enhance their legacy (by using Roth conversions as a tool so they could pass down wealth to their children, tax-free) and achieve their charitable objectives. To do so, we organized their investments in a tax-efficient way and loaded up their Roth IRA account with equities to drive the highest possible growth for their investments.
Considering the $250,000 value of this couple’s Roth conversion, over the course of 20 years, the money will be worth more to their heirs than the pre-tax amount by almost $100,000. This is nearly a 40% increase after tax (assuming a conservative annual portfolio growth rate of 6%).
The additional piece of good news in this story is that after we completed the Roth conversion, the SECURE Act 2.0 passed. Now, the husband has an extra year before he needs to begin taking RMDs. So, we’re gearing up for round two of the Roth conversion strategy with this couple. (This development highlights why it’s imperative to work with a financial advisor who can help you stay on top of tax law!)
Why this strategy works:
First, many of our high net worth clients who are leveraging Roth conversions don’t plan to spend those funds in their lifetime. Second, since the standard deduction is so high nowadays, passing down cash gifts or appreciated securities to heirs is usually not an appropriate strategy for most people, because you’d need to gift a large sum to itemize it on your tax return. In contrast, opening a DAF is like funding your own private foundation and gives you more flexibility to make charitable donations as you wish.
3. Consider your gifting objectives.
Gifting—whether to your heirs or charity—and leaving a legacy are important actions to take in the eyes of many high net worth individuals. This encompasses both gifting during their lifetime and passing down their wealth in the event of their death.
If the ideas of gifting and leaving a legacy also resonate with you, the key is to work closely with your financial advisor on a year-to-year gifting plan. This way, you can see your money put to work during your lifetime.
Your advisor will help you establish a financial ceiling regarding how much of your wealth you can gift each year. In some years, you can gift more money than in other years, depending on your tax situation and changes in your investments. For example, if in a particular year, some of your investments increased significantly in value, and you need to rebalance your portfolio, it could be an opportunity to gift appreciated shares of your investments to accomplish both rebalancing and charitable gifting. This will enable you to receive the best tax benefits possible.
For example, when you reach age 70 ½, qualified charitable distributions allow you to gift money straight from your IRA to a charitable organization. The benefit of this is that your charitable distributions are not taxable income, and can reduce the taxable amount of your RMD.
Donor Advised Funds are also powerful tools for high net worth individuals who plan to have a charitable focus in retirement. These funds offer the flexibility to transfer large sums of money to a charitable savings account without choosing a charity to donate to right away.
If you’re currently taking the standard deduction on your tax return, and you hold investments with significant amounts of capital gains, using a DAF to combine several years’ worth of charitable donations at once is an excellent way to eliminate these gains and minimize your taxes during high-income years. The best part? DAFs enable you to donate your appreciated investment(s) to numerous charities over time during your retirement.
4. Make a legacy plan.
Married couples with high net worth can gift $17,000 per spouse to each of their children annually to reduce the potential total sum of their federal estate over their lifetimes. The current limit, which will likely change in the future, is $11 million per spouse, but it has been as low as $1 million as recently as 2006.
High net worth individuals need to focus on withdrawing money from IRA accounts most efficiently and cost-effectively as part of their legacy planning. The goal is to withdraw funds at a lower tax bracket than you believe your beneficiaries will be when they need access to the funds themselves.
Create A Solid Retirement Plan With Bay Point Wealth
Just like overall financial planning, there is no one-size-fits-all approach to retirement planning for high net worth individuals. The most important point is to put a plan in place before retirement, ideally during your highest income years when you’ll have greater opportunities for personalized, impactful planning.
At Bay Point Wealth, we stay up to date with changing tax legislation, and we have a wealth of knowledge (pun intended) about minimizing your tax bill in retirement while maximizing your investments to pass down to future generations.