Tax-Wise Planning for Retirement, Part I

As an amateur pilot, I’ve noticed several similarities between flight and finances.

Once you’ve reached cruising altitude at 10,000 feet in the clear, blue skies, you think about these sorts of things:

Whether we’re talking about personal wealth or a cross-country flight, proper planning matters.

So does making adjustments necessary (and only adjustments necessary) to stay on

course in the face of unpredictable variables beyond your control.

In other words, with both your wealth and your wings, if you ever hope to reach your intended destination, it’s best to base your decisions on your desired goals.

Sure, you may not notice on a short trip, but try flying two degrees off-course from San Francisco to New York. You’ll end up landing in either Boston or Washington, DC.

Even sticking to the West Coast, a slightly miscalculated flight plan between San Francisco and Seattle would result in some costly swimming lessons.

When it comes to investing, taxes represent among the strongest of headwinds.

Collectively and over time, the drag on an otherwise sound financial plan is noticeable — and can be dramatic.

Fortunately, there are a number of tax-wise actions you can take as you navigate your financial journey.

In this two-part series on tax-wise personal investing, we’ll begin with some strategies that apply particularly well to dental professionals as they plan for optimized retirement saving — and cover how a little planning can go a long way toward enhancing expected outcomes.

In part two, we’ll cover additional tax-wise strategies you or your professional advisor can apply to your investment activities in general, including asset location, tax-efficient investing and tax-loss harvesting techniques.

Retirement Saving — In the Office and at Home

Are you funding the maximum allowable amount to in your practice’s retirement plan each year?

Good for you! But have you evaluated whether that will be enough to fund your anticipated retirement?

Unless you plan to lead a particularly frugal lifestyle, tax-sheltered retirement saving probably won’t be enough by itself.

While you can be applauded for enjoying the tax benefits of funding your formal retirement plan each year, it is prudent — often necessary — to also establish a personal investment account to prepare for a comfortable retirement.

Combining your dental practice’s formal retirement savings plans with an after-tax, personal investment account enables improved planning, robust wealth accumulation, and enhanced overall portfolio strength, during and after retirement.

Your personal investment account doesn’t need to be complicated. It’s simply a self-guided savings program that you coordinate, invested in alliance with your retirement account.

Together, all of your assets should be:

  1. Globally diversified in accordance with an overall wealth accumulation plan you’ve devised (often with the assistance of a wealth manager or investment advisor).
  2. Invested in low-cost mutual funds that aggressively minimize expenses and maximize your ability to capture long-term market returns in accordance with that reflect your tolerance for market risk. In industry jargon, these are referred to as passively managed, asset class funds. In your personal investment account, the funds you select should also be tax-managed whenever possible, to control the impact of taxes.

Consider some of the benefits of a well-structured personal investment account to supplement your office retirement plan:

  • It’s your money, so you don’t have to balance your needs with employees’ best interests.
  • There are no administrative costs like with your pension plan.
  • There will be no future taxes on the amounts you contribute, and capital gains and dividends are currently taxed at less than half the rate of profit sharing plan distributions.
  • You can allocate assets for greater tax efficiency. (More on that in the sections that follow.)
  • It’s a good hedge for the uncertainty of Social Security benefits.

By having an additional account that is earmarked for retirement, you (or your wealth manager) can also more effectively plan your retirement spending with an eye toward maximum tax benefits.

For example, other than the relatively new Roth 401(k) portion of your retirement plan (if you made that election), you must begin withdrawals from your retirement plan assets at age 70 ½.

You may begin withdrawing from those assets at age 59 ½. This is an 11-year period

during which your retirement assets can continue to grow if you instead have a personal investment account to draw from.

To illustrate the difference this can make in your life, consider the following scenarios:

  1. Good, age 35, funds his retirement plan with $49,000 per year (the maximum allowed contributions to his 401(k) & profit sharing plans) and no personal savings account. He invests in a portfolio of 60% stocks and 40% bonds, retires at age 65 and begins withdrawing $150,000 per year.
  2. Better mimics Dr. Smith’s strategy, except she additionally establishes a personal investment account into which she saves $6,000 per year from age 35–65, invested moderately.
  3. Best follows suit, but saves $12,000 per year in his personal savings account, invested moderately.

Using Monte Carlo* to run 3,000 simulations, Dr. Good’s retirement account stands a good chance of being depleted by the time he’s 83.

The odds become dicey on whether Dr. Better’s account will last beyond her 89th birthday.

Dr. Best’s account is likely to be going strong when he turns 90, with surplus funds remaining.

The message is clear: If you have the discipline to set aside additional assets when you’re younger, you can expect to reap higher rewards later and longer – particularly if you work with an advisor to help you manage your assets in tax-wise manners.

In our next Wealth Extractions article, we’ll cover some of these additional strategies that you or your advisor can apply.

Photo by 401(K) 2013

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