Tax Talk – Taking money from your IRAs tax-free

Tax Talk – Taking money from your IRAs tax-free

In our last Power Hour, we talked about using money from IRAs to pay for long term care costs and in doing so, not pay taxes.

Here’s why, if your medical expenses are more than seven and a half percent of your adjusted gross income, then you can deduct your medical expenses. If you’re paying for long term care, whether that be home care, assisted living care nursing here, more than likely, you’re going to surpass 7.5% of your income going towards medical care.

So, you take it out of your IRAs, which would be a taxable event, but then deduct it because you’re spending it on medical costs, in essence cancelling out the taxes due.
I want to go into a little bit deeper, why that might be important when looking at the big picture. We want to think about how everything is connected and what we do in one area affects another area: cash flow, investment positionings, estate preservation and tax planning.

How IRAs, ROTHs, Non-Qualified and Life Insurance is Taxed to Beneficiaries

Money we don’t use in our lifetime is passed on to our beneficiaries. Now, most people I talk to would rather their family be their main beneficiary and they would prefer that Uncle Sam is not included, but if we don’t plan accordingly, many times Uncle Sam becomes the first and main beneficiary.

If we have money that we have in IRAs, or Roth, or non-qualified accounts, how that money is then passed to the beneficiaries all works a little bit differently.

If you have money in Roth or Life Insurance, it goes to your beneficiaries tax free. So, these would be the last accounts we would want to use for long-term care costs.

Money in non-qualified accounts, you’re already paying tax on it through dividends and realized capital gains when you trade. There could be long term capital gains as well depending on what is in the account and how long you have owned it, however, beneficiaries receive a get a stepped up in cost basis canceling out any capital gains taxes owed at the time they receive the accounts.

Now let’s look at your IRAs. I’ve had brilliant clients who did not realize that their IRA money that would go to their kids would be taxable. But it is! Not only that, but if your IRA money goes to your beneficiaries, your kids, your grandkids it’s added to their income and could put them in a higher tax bracket.

The distribution rules are ever changing, they used to be able to always spread it out over a lifetime, but that is limited now based on the size of the account. They can currently spread it over 10 years which in either case spreads the taxes out over a longer period. However, not all beneficiaries choose to do that and often 40% or more of an IRA is lost to taxes.

Without proper planning, when you give your family an inheritance from your IRA, you’re actually giving them a tax burden with it.

Therefore, you would want to use your IRAs first for long-term care costs.

Long Term Care and Hybrid Policies

There are hybrid long term care policies that would have a life insurance benefit well and this is a great planning tool for money that you are not using or needing for retirement income. (Remember, it is important to have a retirement income plan in place first before you look at any type of long-term care insurance.)

Most people I talked to want to pay the least amount of tax possible. Your IRA is taxable but using your IRA for long term care costs means you pay less taxes, or no taxes, because you’re deducting the medical expenses.

Your life insurance (even that with a long-term care benefit), your Roth, or even your non-qualified counts that aren’t taxed near the same when it goes to the beneficiaries so those are the accounts you want to leave to your kids and your grandkids, then they are actually getting more of the assets who worked for instead of Uncle Sam grabbing his share first.

Whether it’s taking money out for long term care, or anything else, that all areas of your financial life are coordinated, because we’ll be doing one area affects another.

Long-term care is about estate preservation and covering for additional cash flow, but how our assets are held (aka investment positioning) very much affects not just your tax plan but your estate plan as well.

If you have questions, make sure you just give us a call because we’re happy to talk through your situation and what makes most sense for you.

In our power hour in October Power Hour, we talked about health insurance and where your income is coming from could end up making you pay more for health insurance coverage. Each situation is different.

If you have any questions, if you need to take withdrawals out, if you’re trying to figure out the best way to do it, make sure you give us a call and let’s just walk through the options, so you do it in the most tax efficient way, both for now, and for the legacy that you pass to your family.


We serve clients in Mineral Point WI, Dodgeville WI, Platteville WI, Lancaster WI, Fennimore WI, Boscobel WI, Richland Center WI, Muscoda WI, Spring Green WI, Mazomanie WI, Sauk City WI, Middleton WI, Madison WI, Fitchburg WI, Verona WI, Mount Horeb WI, Barneveld WI, New Glarus WI, Monroe WI, Belleville WI, Oregon WI, Stoughton WI, Darlington WI, Cuba City WI, Hazel Green WI, Belmont WI, Dubuque IA, Freeport IL

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