May 20, 2024

The retirement risks your client may not have considered

Clients who are approaching retirement may already fear the risks of a market downturn, of outliving their assets or of incurring high health care costs. But there are two retirement risks they may not have considered: taxes and legislation.

The CEO of Stonewood Financial gave a rundown on the risks that taxes may pose to a client’s retirement and how to get clients to consider those risks during the National Association of Insurance and Financial Advisors Congressional Conference on Monday.

Advisors must communicate to clients “in a non-scary way” the tax and legislative risks that could impact their retirement, said Becky Ruby Swansburg, CEO of Stonewood Financial. Tax risk, she said, is the risk that your client’s tax burden in retirement will be greater than what they had planned while legislative risk is the risk that Congress changes the rules surrounding taxation and retirement savings, and those rules negatively impact your client’s retirement approach.

Three things, she said, can happen to a client’s taxes in retirement: increase, decrease or remain the same. The average saver hasn’t taken the time to determine which will happen to their taxes. Situational tax changes, such as a change in income or marital status, is why most people believe they will have lower taxes in retirement. Clients also believe that because they are putting their retirement savings in tax-deferred accounts, they will pay taxes during their working years but not as much in their retirement years.

Swansburg said “the Great American Savings Myth” is that somehow, based on situational changes, clients will be in a lower tax bracket in retirement. However, the reality is that everyone who saves money in a tax-deferred retirement account has a tax bill coming due in the future.

She gave the example of a 60-year-old client with $1.5 million in an individual retirement account, growing at 5% annually with a 20% effective tax rate. That client will pay about $190,000 in taxes when he takes his required minimum distribution, will pay about $60,000 on the growth of reallocated assets and his beneficiaries will pay about $183,000 in taxes on the remaining IRA value at his death at 90. Total tax bill – nearly $435,000.

Converting that IRA to a Roth IRA would generate a $145,000 tax bill, with no taxes owed when funds are taken out of the account and no taxes owed by beneficiaries after the account owner’s death.

“It’s up to us to give clients this information so they can make informed decisions,” Swansburg said.

The legislative risk is tricky

The legislative risk is more difficult to predict, Swansburg said.

With the national debt standing at $33 trillion and Congress unlikely to reduce discretionary spending, the only way of increasing revenue is to increase individual income taxes. What most people don’t realize, she said, is that Americans earning $100,000 or more annually contribute 90% of the income tax revenue in the U.S. “We don’t have enough rich people in this country to fix our tax situation,” she said.

U.S. taxpayers “are in an artificially low tax bracket rate environment rate right now,” Swansburg said, noting that the individual tax cuts passed by Congress in 2017 will sunset in 2025 unless Congress passes a new package of tax cuts. “Clients can do something to reduce taxes right now, but that window is closing soon,” she said.

A different approach

Advisors must take a different approach to protecting a client’s retirement savings, Swansburg said, by “getting some of their assets out of the line of fire.” Diversification is the way to accomplish this.

Roth accounts are one way to address tax risk, she said, but cash value life insurance also has a role to play in protecting against legislative risk. That’s because cash value life insurance is not an account; it’s a contract. “When Congress changes the rules on a contract, it changes the rules going forward and not for the contracts already in place,” she said.

Tax diversification is the most important thing retirement advisors can do for their clients this year, Swansburg said. “Make sure some of their funds are in something tax free,” she said. “Having some contracted funds in your retirement approach can help protect against some changes that could come from Congress.”

Clients have a choice this year, she said. “They can either buy out the IRS today or they can stay on the path they’re on and risk paying higher taxes.

“The highest gift we can give to our clients is the confidence that no matter what happens in Washington, their retirement will be OK.”

Susan Rupe is managing editor for InsuranceNewsNet. She formerly served as communications director for an insurance agents’ association and was an award-winning newspaper reporter and editor. Contact her at Susan.Rupe@innfeedback.com. Follow her on X @INNsusan.

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