Federal Employees – Avoid a Potential Tax-Bomb

10.18.24: Audio automatically transcribed by Sonix

10.18.24: this mp3 audio file was automatically transcribed by Sonix with the best speech-to-text algorithms. This transcript may contain errors.

Speaker1:
Welcome back to the federal retirement Show. I'm your host, Val Majewski with American Benefits Exchange. And as always, really appreciative of you tuning in and listening to what we have to say, the information that we provide to you, the federal employee who's looking for accurate and honest information when it comes to your benefit and retirement situations. And that's what our goal is to provide that information to you so you can be knowledgeable, you can be educated on all it is that we believe you need to know, so you can make the best decisions for you and your family, both as you're going through your career and as you enter retirement. Now, today's conversation comes from there's a lot of these episodes. Do a lot of these sessions that we have revolve around conversations that I've had or representatives of our company have had with federal employees, just like you. So I know that these topics are relevant because others are going through it, and this is one that we get a lot of. But it came from a recent conversation that I had with a federal government employee when it comes to retirement and when it comes to having income in retirement, and then when it comes to also utilizing or setting up their TSP properly. And what do I mean, and where am I getting at here, or where are we going to go. And it talks about taxes and you know, are you creating a tax bomb for yourself when it comes to leaving money to your family? And what are your options? And this conversation, again, that I had with a federal government employee revolved around, uh, meeting enough when it comes to their income in retirement.

Speaker1:
But then what to do with the remaining money? Let me. I'll paint the picture here. Say you're going to retire and during the retirement scenario, during your retirement review. And by the way, that's one of the ways in which we can go over these things with you is by doing a full benefits and retirement review. If that's something you're interested in, go to our website WW dot Federal Retirement Show.com. Fill out the form and we'll be in touch. And we can do a full benefits and retirement review for you. But just saying and talking about this particular person, we were going over that review, doing all that was needed to be done to outline what their pension is going to look like, what their future Social Security income is going to look like, what their TSP is going to be doing for them both now and in the future, what their family look like going over the survivor benefit options and everything, and what we got to the retirement income scenario. Uh, we went over the pension, we went over Social Security, and this person was going to need to utilize a little bit of their TSP to generate another guaranteed lifetime income for themselves to get to a level that they're going to be comfortable with.

Speaker1:
And you've heard us talk about this before, that if you need income in retirement or to back up a second, what we would normally recommend and look at is making sure you have at least a base level of guaranteed lifetime income to cover all of your expenses and then some. But to make sure that everything is going to be paid for your bills, your living expenses, all of that with guaranteed lifetime income. That way there's no worry, there's no stress. There's that peace of mind. Well, that's what we're talking about with this person. But they're going to have a significant amount of TSP and other investments available, or just sitting there even after generating all the income that they need. They were not going to utilize all of the assets that they had to generate the lifetime income that's needed. This is a good position to be in, as you might think, hey, I've got too much money. I've got enough money left over. I'm not sure what to do with it. What do I do? Well, they did say that they wanted to leave a legacy. They want to leave their their TSB and other investments, other retirement savings accounts that they had to their loved ones, spouse, kids, grandkids, etc. and we start looking at this and all of those assets, all of the monies that they've been saving up have been in pre-tax accounts, basically the like the traditional portion of your TSB.

Speaker1:
The money has not been taxed yet. So all the money that you've put in and if this was you in this scenario, all the money you put in has not yet been taxed, has accumulated interest or earned your interest based on the performance of whatever the investment vehicle is. And in the end, every dollar when it comes out is going to be taxable or taxed as ordinary income. But if the design if the thought for this federal employee was, look, I'm going to have all the income I need and then some, I'm going to have a good problem, which is too much money in retirement. Am I creating a tax bomb for myself or my loved ones. If all that money is in a traditional type account, write a pre-tax account and depends on the way you think of it, I would say yes, you're going to create kind of a tax problem for either yourself or somebody down the road if you need to access that money. Why? Because everything's going to be taxed. It's going to be taxed as ordinary income. Now there's two things we can't avoid right. Death and taxes. Somebody's going to pay that tax. So the idea here was this federal employee is going to have more than enough money. They're going to have some left over in their TSP and other investments. And they want to create and leave a legacy. There's a couple of things I want to discuss here with you now.

Speaker1:
Number one, what do I mean by the tax problem? Well, again, all this is pre-tax dollars is our interest. Accumulated interest has had earnings. Whatever whatever the investment vehicle is. If it's TSB, let's say the funds went up. They earned interest over time. Well, when they want to take money out every dollar is going to be taxed as ordinary income. So depending on your tax bracket, you're going to have to pay tax on whatever type of withdrawals you make from the account while you're alive. Let's say you're the retiree. You take a withdraw withdrawal out, you're going to owe tax on that entire amount. It's taxed as ordinary income. Same is true if you leave it to your spouse. If they start taking withdrawals, they're going to pay taxes on it. We can't avoid the taxes. What if it passed on to your beneficiaries, say your kids? Well, they're also going to owe tax on this. But if your traditional account got passed to them, it's now going to be considered an inherited IRA and a non-spouse inherited IRA requires now by new law tax code, that they need to withdraw that entire account within a ten year period. So if you have a significant balance in your TSB, yes, they will, um, inherit that money, But they'll now be required to take all that money out within a ten year period. And even if they took out incrementally, you know, one tenth every single year for ten years, they're going to pay tax on that entire amount on top of any money that they've earned.

Speaker1:
As far as income that can bump them up into a higher tax bracket, they can end up paying more tax on all the money that they earn, not just the amount that they had to take out from the inherited IRA. So there could be a problem not just for you, but if you want to leave a legacy to somebody else, you can be creating a problem for them. So that was the discussion we had. It's like, well, you know, how do I do this? How do I set my family up? Right? If I want to leave a real legacy? How can I set my family up right? What are some of the things that I can do? What are my options. And we talked about that with this federal employee. Again first we're making sure they're securing enough guaranteed lifetime income to support them, meaning the retiree and the spouse in perpetuity. Guaranteed lifetime income, making sure the expenses and then some are covered with a guaranteed amount, something that they cannot outlive. It's guaranteed for lifetime. But the remaining funds, especially the ones since they're all traditional funds that were pre-tax, there's a couple of things that this person can do to avoid their loved ones having to pay tax or creating a tax bomb for them. The first thing which you know, may or may not like, my favorite thing will be the second one.

Speaker1:
But the first thing that we would discuss is doing Roth conversions. You've heard about us talk, uh, this topic before on the federal retirement show. We're saying you can prepay the tax. You can get Uncle Sam out of your pocket and all of your loved ones pockets by prepaying the tax on your taxable portion. On the traditional portion. How do we do this? You can do incremental Roth conversions. You can certainly do a single Roth conversion. I don't normally recommend that. If it's a it's a big balance that you have, but you can do partial Roth conversions over time. Now, what is a Roth conversion do? A Roth conversion takes traditional money pre-tax dollars and instantly, like Abracadabra, turns it into tax free dollars. So it's a conversion. It converts from traditional to Roth. Now, you do have to pay the tax on whatever portion that you convert. But now that note, that new money that was converted to a Roth can grow, can earn interest and going forward without needing to owe future taxes on that account, it's been converted to Roth. It is now a tax free account. So that means if your spouse or your loved ones, children, grandchildren, whatever inherit that money, it is now tax free. Going forward, they will not have to withdraw that money within a ten year period because taxes have already been paid.

Speaker1:
It is now in a tax free account. That's one way you can do it, and I'd recommend doing it incrementally over time. That way you spread out that tax liability and hopefully get it all done before something happened and you pass that money on. But that money will go to your beneficiary beneficiaries on a tax free basis. The only negative is that you need to pay the taxes today. So if you convert money, you have to pay the tax on whatever you convert. And that way now going forward that money is tax free will earn interest on a tax free basis. This can avoid that tax bomb or that the potential big tax liability for your loved ones going forward. Like I said we can't avoid paying tax. Somebody's going to pay the tax. Might as well be you now while you're alive. And you can lessen that burden for your loved ones. Now I'm a value guy. You may have seen this. You may have heard me talk about it. You want to get the best bang for your dollar. You want to set yourself up, right? If you want to leave a legacy, if those words come out of your mouth and I've heard a lot of federal employees tell me, I don't want to touch my, let's say, TSP money, I want to leave a legacy. I want to leave it for my loved ones. I think that is awesome, right? I still say, I want you to spend your money.

Speaker1:
You spend your money. You spend whatever you want to spend. Use it for your retirement. You've saved it up. You've done a good job. Splurge. Use it. But if you want to leave a legacy, don't leave them assets. Leave your loved ones life insurance. Now, the disclaimer at the beginning here, right? The asterisk is you have to be healthy enough to get life insurance in order to secure it. But why would I say, hey, I'm a value guy instead of leaving assets to your loved ones? Leave them life insurance because you can get a tax free benefit paid to your loved ones for pennies on the dollar, pennies on the dollar instead of just giving them the asset. So in this scenario, talking to this veteran employee, we've secured the lifetime income. My recommendation, my option to get better value. Would you say with that remaining TSP money do yourself a favor. Take we're going to take some of it out incrementally over time to pay your life insurance premiums and your life insurance premiums. Now, why would we do that? Because, again, you can leave a significant amount of legacy in the form of a death benefit for pennies on the dollar. So if you had, let's say, $1 million in your TSB, you have $1 million set aside, and maybe all of that is taxable, let's say. Okay. And you can convert it. Sure. But that money is an asset.

Speaker1:
It's sitting there. In order to give somebody $1 million, you have to give them $1 million. Right. Where am I going with this? Well, if you wanted to give them that same $1 million on a tax free basis, it will not cost you $1 million to do that for life insurance. It may cost you several hundred thousand, but you're not going to have to pay $1 million to leave them $1 million tax free. As far as a life insurance death benefit is concerned. Now again, the caveat is you need to be healthy enough for that. But if you are, you will pay pennies on the dollar compared to setting aside an asset to leave that to your loved ones. If you are convinced 100% that you want to leave a legacy. Use a portion of that TSP money to pay for life insurance. Spend your money. Enjoy it. Utilize the money, but take a portion of it and set that aside. If you want to leave them a significant amount, you can leave them a significant amount of life insurance. Now, how does life insurance work? The death benefit is a lump sum that is tax free. Tax free. It doesn't have to be converted. It's already tax free. And as I mentioned, if you want to leave $1 million worth of death benefit, you do not have to spend $1 million to provide that. So just understand the way that works. If the word legacy comes out of your mouth, if you said, I want to leave a legacy for my loved ones, I want to make sure that they're taken care of in the event something happens to you.

Speaker1:
Yes, you may have a significant balance in your investments in your TSP and anything that you've set up outside, but use a portion of that if you're a value person, which if you set up that much money, if you saved that much money, I bet you are a value person. You want to get the best bang for your dollar. Do yourself a favor and look at. I'm not saying it's a guarantee for everybody that you're going to be able to set this up, but I would at least look at the option of setting up a life insurance policy to leave that tax free legacy that you're looking to leave, and it will also allow you to spend and utilize more of your money in retirement and enjoy it. Now, granted, I'm not saying you won't enjoy your retirement all these things, but I would tell you, I wouldn't want you to hold on to your money so tightly in retirement and never spend it and think you need to leave it to everybody else. No. Spend your money. Use your money. You saved it up for your retirement. But take a portion of that and you can leave the same legacy without letting that money sit there for pennies on the dollar by securing yourself a tax free life insurance death benefit that you can leave to your loved ones, and they're not going to be set up with a tax bomb.

Speaker1:
You're going to pay some of the tax over time using those life, uh, those dollars you take out to pay the life insurance premiums and you can convert the rest, whatever you don't use. So we can get rid of that tax bomb entirely. We can give your your loved ones a greater legacy for pennies on the dollar. And you can spend more of your money, utilize more of your money for your retirement. So to wrap this up, when I'm talking to this federal employee and what we want to set up, when they said, hey, I want to make sure I'm taken care of. Great. We're going to use a portion of their TSP to set up a lifetime income stream to complement the pension and Social Security, so they have enough guaranteed income going forward. And we can even set it up where that TSP income increases, just like pension and Social Security will get cost of living adjustments, we can set it up where it increases as well. And that way it tries to keep up with inflation. So that's set their income level. Set there. They can count on that on every every month that money is coming in. Mailbox money. Awesome. But then on the back end, if that weren't legacy with the remaining funds, you want to leave it to your loved ones.

Speaker1:
Do not leave them the asset again. Leave them life insurance. That's my recommendation. You can do it the other way. They said step one or part one was doing Roth conversions. That way you eliminate the tax liability on your funds and when they're passed to your loved ones, they're passed tax free. Or if you're a value person, like I said, I am, you can secure that legacy for pennies on the dollar, assuming you're healthy enough to get it by using life insurance. And it would be a permanent form of life insurance. So that way, you know it's never going to run out. It's not going to expire. As long as you keep paying for it, it's going to be there, and you can actually set it up where you only pay for a limited amount of time and it's locked in and set for life. So pretty awesome things that we can do to make sure you're leaving a legacy, if that's what you desire or desire to do, and leave a tax free legacy. Not a tax burden. So that the information that we're talking about here, the thing that I wanted to avoid with this federal employee, was leaving their loved ones with a tax liability or a future tax bomb because we didn't properly prepare going forward. Right. Why would we not want to leave them taxes to pay? Because we don't know which way taxes are going.

Speaker1:
And most people I talk to, if I give them three options, are taxes going up, down or staying the same? Most of them are going to tell me that those taxes are going up in their opinion. Very few have said stay the same, and nobody has told me that they think taxes are going down. So do yourself a favor. If again, you want to leave a legacy, I'm beating a dead horse here. But if you want to leave a legacy to your loved ones with any of your retirement savings, including your TSP that are in taxable accounts, look at ways in which you can leave them a significant amount of money on a tax free basis without creating some sort of tax burden or tax bomb for them also, by the way, by doing that, if you convert money and if you set up your legacy, yeah, you're going to have more that you can spend, get better value, pay pennies on the dollar to leave that that tax free death benefit or legacy for your loved ones. So I hope you found this information helpful. I hope you, uh, are in a similar situation where you do have too much money that you don't know what to do with in retirement, but you want to think about ways and be creative that you can send or leave money to your loved ones in case something happened to you. Um, I encourage everybody utilize that money. Um, make sure that you're, you're not, uh, shorting yourself when it comes to retirement.

Speaker1:
You've worked a long time. You've earned this. So you want to make sure that you're taking care of yourself and your spouse, but with the funds that are left over, let's be smart. Let's plan ahead. And let's not leave that tax burden to our loved ones. So as I mentioned before, if you're interested in this information, you want a full benefits review. You want to see of doing some of these things or these strategies are right for you. Go to Federal Retirement Show.com fill out the form. One of our, uh, professionals, one of our experts in federal benefits. If it's not me personally, we'll be reaching out to schedule your review. Create a few different reports for you. Go over your entire situation, answer your questions, and make sure you're pointed in the right direction. I really appreciate you taking the time out of your schedule, as always, to view our content to join us on the Federal Retirement Show. Tell others about it if you find it helpful. If you like the 100 plus episodes that we have here and all of the different information that we're giving, share it with your friends. Don't keep us a secret. We want more federal employees to hear this. We want more federal employees to be aware of what it is they need to know when it comes to their benefits and retirement information. Thank you again and look forward to seeing you on a future episode.

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