The Changing Tax Environment & Today’s Opportunities

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  • 19 mins 26 secs
Better planning and ideas can help investors navigate the uncertain tax landscape and motivate them to make the most of their financial futures. Prudential's Brett Berg and Karen Hoffman discuss legislative developments, important tax considerations, and annuities as a funding vehicle for IRAs and Roth IRAs. Prudential is a founding member of the Alliance for Lifetime Income, whose mission is to help address the retirement income situation in America through education efforts, reaching millions of people in or approaching retirement.
Channel: Alliance for Lifetime Income

Jenna Dagenhart: The current tax environment can be confusing for investors, presenting them with new risks and challenges. That's where better planning and ideas come in. They can help investors navigate this uncertain landscape, and motivate them to make the most of their financial futures. We'll cover all these topics and more today with the Alliance for Lifetime Income in partnership with Prudential, which is a founding member of the Alliance.

Jenna Dagenhart: The mission of the Alliance is to help address the retirement income situation in America through education efforts, reaching millions of people in, or approaching retirement. And one of the unique ways the Alliance is reaching retirees right now is by sponsoring the multiple, Grammy award-winning legend, Elton John on his 2022 Farewell Yellow Brick Road Tour in North America. Elton John is taking on the Alliance for Lifetime Income as his first and only nonprofit sponsor as part of his farewell tour. I'm afraid he couldn't be with us today, but we do have two great speakers lined up for you from Prudential, Brett Berg, Vice President, Advanced Planning, Individual Solutions Group. And Karen Hoffman, Vice President, Advanced Planning for Prudential's Retirement and Life Distribution.

Jenna Dagenhart: Together, they have more than five decades of experience in the financial services industry, and too many degrees and certifications to count. They both also specialize in estate planning, and charitable giving. Brett, Karen, thank you both for joining us. Brett, you and Karen are both members of Prudential's Advanced Planning team, one thing that your team does is monitor legislative developments. Now, that we're a year plus into the current administration, would you mind sharing your high-level views of what legislation has happened? What may or may not happen that had been proposed? And share if there's any residual legislation from the previous administration that is creating challenges, or opportunities?

Brett Berg: Well, the tax environment is uncertain. And that's important from a retirement income perspective because taxes represent a significant cost. So, financial professionals need to keep that uncertainty in mind, and help their clients take steps to manage the risks that they face as they plan for their retirement, and their retirement income.

Brett Berg: In the United States, of course, we've seen increases in spending this leads to rising debt, which all leads to conversations about potentially increasing taxes. The most recent bill that was discussed in this administration was the Build Back Better Act. Now, the Build Back Better Act has not passed, it may not pass. And if it ever does pass, it may look significantly different from what was originally proposed. And the ultimate impact, of course, of any such legislation would depend upon if it's passed, and what it includes. Nevertheless, it's still important because it really shows us and reminds us that we may have increases in future taxes.

Brett Berg: And if we look at the bill, both what was ultimately included in the bill and what was not included in the bill, we see several areas where retirees, or near retirees, or people planning for their retirement income would be concerned. Increases in income taxes, now that wasn't in the final bill, but it was discussed. Increases in capital gains taxes, that wasn't in the final bill, but it was discussed. [Slide 4 around 3:44] And there were many items that were included in the final bill that would've significantly impacted retiree planning for retirement income, and sources of those retirement income in the future.

Brett Berg: And let's start with the targeting of the Roth IRA conversions. In the final bill they basically, and when I say they, I mean, Congress, said that beginning in the year 2032, they would not permit people earning over $400,000 single, or $450,000 married, filing jointly to convert to Roth IRAs. That's very significant because, as we know, if we have a Roth IRA and are eligible for distributions, we can take those distributions out on a tax free basis during retirement. Also included in that bill beginning in 2022, they would not allow non-deductible contributions to IRAs or 401(k)s to be converted to Roth IRAs. So we see the targeting of that area, or at least the consideration of that area as a potential source of concern.

Brett Berg: You also asked me Jenna, about any residual legislation from the previous administration that we need to be concerned about. Of course, we do. We know that the Tax Cuts and Jobs Act, for example, sunsets many of its provisions after December 31 in 2025. So, beginning in 2026, we're going to see a rise in marginal income tax rates, just because that bill sunsets the provisions that allowed for temporary decreases in marginal income tax rates.

Brett Berg: Also, importantly from the previous administration, is the so-called Secure Act. Now, the Secure Act is important because for most beneficiaries it eliminated the so-called stretch IRA. Now, what was the stretch IRA? The stretch IRA allowed people to stretch out their distributions of an IRA, thereby minimizing the impact of taxes on those current distributions, and maximizing what was allowed to stay tax deferred. For most beneficiaries, including most non-spouse beneficiaries in particular, the stretch IRA is no longer available. Instead, they have to force out distributions, forcing income into their hands, forcing taxation to occur within 10 years. So, at a minimum, people need to review their portfolios, their entire financial plans with their financial professionals, review their beneficiary designations, and make certain that what they have in place matches what they intend, what their intent is.

Jenna Dagenhart: Karen turning to you, Brett mentioned the uncertain tax environment, and the risk of higher taxes. Could you address broadly how Prudential views the opportunities for financial professionals to help their clients in this kind of environment?

Karen Hofmann: Yes, Jenna, great question. It's really about reviewing their portfolios for tax efficiencies. It's really going to be more about importance of tax diversification. And what do I mean by that? [Slide 5 around 7:10] Buckets of monies are in different tax vehicles. For example, taxable accounts, mutual funds, bonds, stocks, cash tax deferred accounts, IRAs, SEPs, 401(k)s, annuities. And then, of course, tax advantaged accounts are things such as Munis, Roths, HSAs even, cash value, life insurance. So it's really about looking at where, in retirement, those monies are going to be coming out of.

Karen Hofmann: And, of course, you can manage tax deferred vehicles easier than taxable accounts. You can delay distributions from those vehicles. And so, what we're thinking is... What we're saying is annuities may be a much important element for many people to consider incorporating them into their overall financial picture to really compliment that tax diversification.

Karen Hofmann: In addition, today's annuities include more innovations, or important innovations to provide a wide range of features and benefits to help protect the customers, the outcomes for those customers. We are in a historically low tax rate environment right now, as Brett says, while at the same time seeing rising inflation. So the time really is now. The time to plan is now. As Brett says, taking advantage of Roth conversions is really an important consideration for a lot of the clients that we work with. This is one of the areas Congress, as Brett said, is potentially targeting and we believe they will eventually for potential change, as we saw in the Build Back Better Act.

Karen Hofmann: Taking advantage of Roth conversions is one important consideration. This is one of the areas Congress is potentially targeting for potential change, as we saw in the Build Back Better Act that Brett mentioned. Financial professionals and their clients should consider taking advantage of the opportunity for after tax savings in Roth conversions while they can.

Karen Hofmann: Now, one other thing I want to mention that Brett didn't mention is although they are targeting doing away with Roth conversions, they are also targeting any mega backdoor Roth conversions, which I know many of your clients are probably taking advantage of. And also the backdoor IRA Roth conversion, so they're targeting those as well. So, having those conversations will definitely put them in a better position to manage the risk of higher taxes. For example, they can access monies from a Roth in retirement on a tax free basis. If the client is in a much higher tax bracket, which we expect, this will be a much greater help to the retiree's income tax bracket.

Jenna Dagenhart: Brett, Karen gave us some planning implications and ideas. What are some other ideas or areas that are important for financial professionals to think about?

Brett Berg: I think the Secure Act, going back to my original comments, let me just expand on that. I think that that's one area where financial professionals really need to focus. That really was lost in a lot of what we were talking about in terms of Build Back Better, what would or would not happen? We know the Secure Act has happened. We know that most non-spouse beneficiaries will not be able to stretch out the IRA. And this can have tremendous financial impacts in terms of tax consequences, and tax costs, and tax drag on assets that people thought would otherwise be maximized in terms of their legacy, be maximized for the next generation.

Brett Berg: Some people still do not have enough education on how the Secure Act can impact their plan. Let me just give you an example, Jenna. [Slide 6 around 11:11] For example, let's say we have Don and Kathy both aged 65. One daughter, Barbara, she's 30 years old right now. $1.5 million in an IRA that's what Don and Kathy have, $1 million of investible assets. They have income from a defined benefit pension plan, and sufficient income from other assets to meet current and future income needs. $500,000 of the IRA assets are earmarked as legacy money for Barbara.

Brett Berg:  Now let's just assume if Don, age 65, allocated that $500,000 of his IRA assets to an account naming his wife, also age 65, remember that's Kathy, as beneficiary followed by his daughter, Barbara, age 30, as successor beneficiary. And assuming Don took appropriate RMDs from the account, starting at age 72, Don would leave an account worth $730,000 to his wife, Kathy, at his death, if we assume that Don dies at age 80. Until her death, Kathy takes the appropriate required minimum distributions. During their lives, Don and Kathy, would've taken over $397,000 in required minimum distributions. And at Cathy's passing, Barbara would receive $723,000. Now, under the old stretch rules, Barbara, who in this example is 48 in the year her mother Kathy dies could have stretched out the account over 37 years, and potentially taken $1,993,977 of pre-tax distributions during that period.

Brett Berg: Well, today under the Secure Act, things are different. If, in fact, the beneficiary takes $723,000 and liquidates the entire sum, assuming an income effective tax rate of 31% net to the beneficiary Barbara, we would show $497,694. [Slide 9 around 13:41] Now, of course, I said that the beneficiary has 10 years to take that sum of $723,584, plus the growth out. Let's assume a 5% return on the $723,000 number total distribution over 10 years, we would project in our modeling, $910,116. Total taxes paid, assuming a rate of 31% of 283,956 for an after tax total distribution in 10 years totalling $626,160. [flip through slide 10/11 with disclosures and then close PPT]

Brett Berg:  So you can see that the difference between the old rules and the new rules is quite significant in terms of the tax impacts. And what we want to make sure of is that clients understand that, financial professionals are reviewing that with them, reviewing their beneficiary designations, and asking the questions, is this what the clients still want? Do they want something different? Do they want to plan differently? Do they want to take additional steps to mitigate these risks to change their plans? They need to do so in the context of an overall comprehensive plan that takes into account a lot of different considerations with their financial professionals, and their other advisors, such as CPAs and attorneys.

Jenna Dagenhart: Karen, Brett mentioned Roth IRAs and IRAs in his comments. You talked about the features and benefits of annuities. Often, there's a question about using annuities as a funding vehicle for IRAs and Roth IRAs. What are your thoughts?

Karen Hofmann: Yes, we get that question a lot. It really depends on the customer. We do see annuities funding Roth IRAs, and traditional IRAs, where customers just want the features, and the benefits of the annuity products versus the tax benefits. They already get tax deferral because of the qualified status of the IRA, or the Roth IRA. So, that's not really the reason for the annuity. Rather, they need to evaluate whether they want the features, and the benefits of the annuities.

Karen Hofmann: And so, let me expand a little bit. Some of the key features of annuities are, and you may know this, upside potential growth to help combat inflation. A measure of downside protection for those clients that are risk averse. Death benefit of an annuity that, I think, is a huge feature of an annuity versus some other investment that is invested in.

Karen Hofmann: Each of those customers needs are different. And there are many different types of annuities on the market. There have been tremendous innovations in the past few years. That's why continuing education, and awareness about annuities is what really can help them accomplish this. And it's so important whether it's in connection with an IRA, a Roth IRA, or just non-qualified annuity and a... Let me do that.

Karen Hofmann: Or a non-qualified annuity purchased without [de-taxed 00:16:58] monies. You've really just got to look at the features, and what you get from annuities versus perhaps, say, just a mutual fund account, or some other investment account.

Jenna Dagenhart: And finally, Brett, many of our financial professionals who are watching this might ask, "How do we get our clients motivated?" What would you say to that?

Brett Berg: Well, the time for planning is now. What we saw with the Build Back Better Act, and with respect to potential tax increases, and potential tax changes was that there was a whole wave of planning that happened. And now, that we have a lull in the legislation, or at least a pause in the legislation, we don't know whether it will or will not pass. Sometimes it's just human nature to say, "We'll take a break from that." But we really encourage people to have a sense of urgency, to review their plans, to review their goals, to really take into account the potential for the increases in taxes, the sunset that will happen, which will lead to an increase in taxes, if nothing happens legislatively.

Brett Berg: And review their plans in light of those risks, both real and potential, and take advantage of the opportunities that they have to diversify their portfolio, to diversify their products among the different tax classifications that Karen talked about. To take advantage of the product innovations that allow them to help protect their outcomes in a way that matches up with their goals, with their desires, with their dreams, and their plans. And to really do so now take advantage of the opportunities we have to plan now. We're really shouting from the proverbial rooftops, the time to plan is right now. Thanks Jenna.

Jenna Dagenhart: Well, Brett, Karen, thank you both so much for sharing your thoughts, and insights into tax efficient strategies with our viewers.

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