What's The 'Taxes-On-Sale' Concept And How Can You Take Advantage?
Personal finance tends to feel like a basic calculation of incoming earnings and outgoing payments. You work for a paycheck and then spend that money on the burdens of modern living. From utility bills to savings goals and splurge purchases, every month you take in a certain amount of money and almost immediately turn around to pay out your obligations. You might be among the 78% of Americans living paycheck to paycheck, making each incoming salary deposit feel like a huge relief that another month will be funded.
But for savers eying up retirement (and other savings goals, like a down payment on your first home), building up a war chest of cash places your financial concern in another bucket. Instead of thinking about making ends meet, you'll start to consider how best to liquidize your saved assets to make them work in your favor. You're likely to have opened a 401(k) account if you're saving for retirement, or deposit funds into a stock brokerage account to save for a new car, home, or dream vacation. Withdrawing these funds can come with a potentially steep tax burden, so planning out your exit from accounts like this carefully is crucial. Here's where a unique financial concept known as "taxes-on-sale" comes into play. More importantly, this is how to capitalize on the contemporary tax landscape.
As a retiree, your biggest debt is likely the totality of your tax burden
This fiscal line of thinking is primarily useful for retirees, but it can be applied across the financial spectrum. For retirees, financial life is a little different: Retirees have the greatest level of control over their "income" figure that will be reported to the IRS each year. At this stage, you may have started drawing Social Security checks, and you're potentially taking distributions from tax-advantaged retirement accounts.
Your income and expenses are likely much lower than at any other time in your adult life. Even so, your nest egg, unless held entirely within a Roth IRA, will be subject to taxes when it's distributed into your bank account. Estimates places a $1 million Traditional IRA value at a tax burden of as much as $300,000. Therefore, you'll want to withdraw these funds at opportune moments that give you the largest discount on that tax bill — hence, the "taxes-on-sale" line of thinking. You owe taxes on this money (there's no legal way around that, unfortunately), but reducing the amount you'll have to pay gives you more money in your pocket.
Utilizing a conversion to a Roth IRA or taking distributions when tax rates are lower allows you to pay a reduced rate for the same thing. It's like when you want to buy a new pair of shoes but wait until the ones you want go on sale during a Black Friday event. You will get the same product either way, the only difference is the price you pay. The "taxes-on-sale" concept reframes your tax bill as a sort of "purchase" of your saved capital, seeking to pay for liquidity or movement into a Roth IRA at a discount.
The calculation may be changing, or not
As is the case with any financial decision, investment or otherwise, there's always a bit of "what if" to be considered. When purchasing a new home, you'll be exploring mortgage options and have to deploy your best reasoning skills to determine if a variable, fixed, or adjustable rate mortgage will leave you in the best position over the long life of the loan's repayment term. The same can be said for investments in which tomorrow is never a certainty and yesterday's performance often means very little.
In the world of complex tax law and political posturing, the only thing that's certain is the stability of the overarching taxation system until it sunsets at the end of 2025. And even then, small changes may work their way into its application in the meantime. With the reelection of Donald Trump, it's possible that a new round of tax-focused legislation will pass through the federal government, providing a similar outcome to the current system that was passed during his first term in office. However, tax rates are often set with the help of sophisticated economic modeling and sometimes visualization tools like the Laffer curve (although this certainly isn't the best way to think about economic policy). It's also quite possible that a second Trump administration will renew tax law at its current rates or even increase certain bracket figures or thresholds out of necessity. The future remains unclear, but the present offers a great opportunity for IRA conversions and distributions at a historically friendly rate.