Life is a series of conundrums. Families move from wondering how to make ends meet today, and save for the future. They accumulate and preserve and one day realize they have no idea how they accumulated so much in their retirement accounts. Next, the third stage of your financial life – distribution. The emotions and stress truly begin. The big three unplanned distribution periods: job loss or interruption, death and divorce.
Losing a job is taxing emotionally but can be incredibly destructive financially. We know to an emergency fund to continue to sustain, but that’s sometimes easier said than done. Our job is to help turn lemons into lemonade, and in that context, please pay attention to your household taxable income.
We had a business owner that came to see us early this year, with a six-figure 401k. Their standard tax rate is above 30%, but last year their taxable income was negative. Income variability can happen when you run a business and needs examining for issues and opportunities alike. They are under 59 ½ so taking money out of their 401k would create a 10% penalty for early withdraw. It never dawned on them that 10% is far less than 30% and it might have made sense in their financial and tax situation to take the money out early.
The death of a spouse is never easy but especially true financially. Please keep in mind that the year you lose your spouse is the last year (unless you remarry) where you will file a tax return as married filing jointly. That term allows you twice the standard deduction and also more income taxed at a lower rate. Our job is to help families make the most out of all situations pleasant or not. Numerous times over the years we have assisted surviving spouses at the very end of a tax year take advantage of lower taxation than they will experience the following year. Distribution may not feel natural but taking money out of your accounts at the right time is critical.
Divorce is the other big unplanned distribution that can take people by surprise. This is the only time where when living your IRA or 401k can be transferred to your spouse’s name. Please keep in mind that a tax-deferred dollar is not worth an after-tax dollar. How the assets are divided needs to be based on the fairness of course but also need for immediate income or support. Who gets what should also look at future presumed tax rates. The high-income earner would do better to receive less tax-deferred dollars for instance.
Distribution brings on many emotional issues. Most families where unplanned or even planned distributions occur have invested 30-40 years in the process of accumulation. Now they are being forced or encouraged to take money out of their accounts simply isn’t natural. Our objective and your objective should be to get your assets in the best taxable situation possible. When income varies, and the frustration of life gets in the way don’t forget to make lemonade out of lemons.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see our Disclosure page for the full disclaimer.