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Avoiding a Government Head Fake on Retirement Savings

A government rule on retirement savings may be tricking retirees into looking at their financial situations all wrong, says a financial advisor who specializes in retirement planning.

The rule says retirees can’t leave money in their IRA or 401k accounts forever. At age 70½ they must begin making minimum withdrawals, even if they prefer to leave the accounts untouched.

“You are forced to take money out whether you want to or not,” says Dave Lopez, a mathematics and computer science major who applies his analytical mind to solving retirement challenges.

And in reality, Lopez says, you should want to take out as much as possible. That’s why he likens the rule to a head fake because it causes retirees to look at the situation from the wrong perspective.

“They get fixated on that minimum amount they must withdraw, so that’s how much they end up withdrawing, leaving the bulk of their savings right there in the 401k or IRA,” he says.

That’s a mistake, he says, especially for people who hope to leave a healthy inheritance to heirs.

“If you keep taking out the minimum amount each year, it will just about guarantee you have a large amount in there at your death,” Lopez says. “Under the current tax law, if you die and your IRA or 401k is left to your heirs, they are taxed on it at a high rate. With state taxes added in, it could be 40 to 45 percent.”

The percentage could end up being even more, depending when you retire and whether tax laws change, he says.

If Congress and the president raise taxes, the government’s share of your retirement savings would go up and the amount left to heirs would go down.

That’s where it would be good for the middle class to take a lesson from wealthy retirees, who are less likely to fall for that head fake, Lopez says. They understand that they need to withdraw greater chunks from their IRA and 401k accounts, placing the money in tax-friendlier accounts.

“While people in the middle class take out the minimum-required amount, the rich do the exact opposite,” he says.

Lopez says a few strategies exist that retirees can take advantage of to make sure taxes don’t deplete their legacy to their children. “You have to put these strategies into place early, though,” Lopez says. “The later you wait, the less effective they are and the less your savings will be.”

  Explore tax-free options. Move the money into a tax-free vehicle, such as a Roth IRA or a specially designed life insurance plan that would allow the dollars to flow tax free to heirs. Lopez says one additional advantage with the life insurance option is that, historically, when laws are changed related to life insurance the old policies are grandfathered in and not affected. “It’s a top estate planning trick for the rich,” he says. “The challenge is the middle class doesn’t know it exists.”


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