Historically, portfolio construction for many retirees sat on a “three-legged stool,” in which guaranteed income flowed from a pension and Social Security and personal savings served as a supplement.

Pensions are growing scarce these days, but Joseph A. Clark, co-founder and managing partner of Financial Enhancement Group in Anderson, Ind., still has some clients with lifelong streams of cash. Nevertheless, Clark doesn’t talk about stools for retirees’ portfolios.

“We prefer to think of trees,” Clark says. “Retirees can pick the fruit from different ones, to best deal with the critical component of taxation. Not knowing the source or the timing for income can lead to inefficient taxation and ultimately a failed plan.”


To Clark, pension income falls from the “mailbox check” tree. “That’s forced income,” he says, “coming from Social Security and required minimum distributions from traditional IRAs in addition to any pensions.”

Late-year meetings with clients can reveal the extent of the mailbox checks that they’ll report as taxable income. “From there,” Clark says, “we determine the amount of money a client can report inside that same marginal bracket. Retirees should intentionally recognize that level of income from a taxable source and then use tax-free or pretax money to fund the rest of their income needs.”

A married couple filing jointly can have up to $73,800 of taxable income (after deductions) and remain in the 15% tax bracket in 2014. Thus, a couple with a projected $50,000 in taxable income could take up to $23,800 from their traditional IRAs and owe only $3,570 in tax, at 15%. If they want to spend more, they can take untaxed withdrawals from taxable accounts (perhaps from a money market fund) or tax-free distributions from a Roth IRA.


“Having money in different places allows clients to choose where to pick the fruit,” Clark says. Retirees who don’t need more spending money can use the bracket-filling traditional IRA withdrawals to fund Roth IRA conversions. Moreover, preretirement clients are urged to make annual partial Roth IRA conversions in this manner. Not only will this create a sizable pool of tax-free cash, after five years and after age 59 and a half, it also will reduce future required minimum distributions from traditional IRAs.

“RMDs can become a huge problem,” Clark says. “After the first spouse passes away and the surviving spouse inherits, the survivor no longer will be filing jointly. Therefore, the RMDs will be taxed at the single taxpayer’s rate, and the tax bill can be much higher.” Wives typically outlive husbands, so the added RMD taxation might be termed the “widow’s penalty.”

To make the most of their Roth accounts, Clark’s clients undertake multiple Roth IRA conversions. If the goal is to convert $20,000 worth of IRA money at year-end, for example, a client might execute four $20,000 conversions into four Roth IRAs, with a different type of investment in each one. “By Oct. 15 of the following year,” Clark says, “we can leave the best performer in place and recharacterize the other three.” The client ends up with $20,000 in the one Roth IRA left standing, on the way to tax-free growth there.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

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