There are two main ways your retirement assets can help you reduce your “tax drag” in order to harness the full potential power of compounding growth:


#1 Defer taxes. When you make a deductible contribution to your Traditional IRA or 401(k) account, this reduces your taxable income for the tax year that you make the contribution. These pre-tax dollars will grow in your account untaxed until you withdraw them (and the investment growth they created) in retirement, at which point they will be taxed as income. Thus, deductible contributions can help you reduce your taxable income today, but they will also increase your taxable income in the future.


#2 Reduce your tax rate. Deferring taxes does not, on its own, enhance your after-tax wealth potential. Deductible contributions will only help you to save on taxes over the long run if your tax rate today is higher than it will be in the future when you make a distribution or a Roth conversion. The federal income taxes are calculated using a progressive marginal income tax system, applying a higher tax rate for more taxable income in a given tax year. Therefore, when it comes to managing contributions to your retirement accounts, the strategy for managing taxes is straightforward: Spread your taxable income over as many years as possible.


There are several breakpoints in the marginal income tax rates. You can use these breakpoints to your advantage by timing deductible contributions to stay out of higher tax brackets and timing taxable distributions/conversions to “fill up” lower tax brackets in years when you have lower taxable income.


Strategies to discuss with your financial advisor

Generally speaking, the longer your assets can remain in tax-deferred accounts, the greater their after-tax growth potential. However, this doesn't mean that deferring your taxes for as long as possible will be the key to maximizing the after-tax growth of your investment portfolio.


There's a danger in deferring your taxes too long—at some point, too much tax-deferred growth can result in higher required minimum distributions (RMDs) and thus a higher tax cost than if you had paid taxes at an earlier point in time. This is why we recommend that you find the right balance between deferring taxes into the future and paying them today.


With this in mind, here are some strategies that you should discuss with your financial advisor:


1. Accelerate IRA distributions to “fill up” your tax bracket in lower-than-normal tax years. This can help you to increase the after-tax distributions from your retirement assets versus an “RMD-only” approach.


2. Use Roth conversions and Irrevocable Life Insurance Trusts (ILITs) to boost the after-tax wealth you can leave to your heirs. Roth IRA assets can grow income tax-free and if a life insurance policy is purchased and owned by an ILIT, then the policy’s death benefit will not be included in the insured’s gross taxable estate at death.


3. Make Qualified Charitable Distributions (QCDs) to meet your philanthropic objectives and maximize the value of your charitable contributions, while simultaneously satisfying all or a portion of your RMD.


If you are unsure of where RMDs fit into your financial plan, your financial advisor can help you to view these decisions through the lens of the UBS Wealth Way, which is a blueprint to create a purpose-built investment strategy that's designed to allocate your resources to help meet your family's unique objectives.


When it comes to determining how these distributions will be taken and where the funds will be used, there are many factors you'll need to consider with your financial advisor. For instance, upcoming cash flow needs, current and future projected tax rates, and the beneficiaries who are currently designated for the account can all affect whether a particular strategy will lead to better outcomes for your particular situation.


Read the full report Beyond RMDs: 3 strategies to improve your after-tax wealth potential 29 July 2022.


Main contributors: Ainsley Carbone, Justin Waring, and Daniel J. Scansaroli


This content is a product of the UBS Chief Investment Office.


UBS Wealth Way is an approach incorporating Liquidity. Longevity. Legacy. strategies that UBS Financial Services Inc. and our Financial Advisors can use to assist clients in exploring and pursuing their wealth management needs and goals over different timeframes. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved. All investments involve the risk of loss, including the risk of loss of the entire investment. Timeframes may vary. Strategies are subject to individual client goals, objectives and suitability.