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Savvy IRA Planning for Baby Boomers - Strategies

Savvy IRA Planning for Baby Boomers - Strategies

| January 18, 2021
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Thus far in this series on IRA planning I’ve covered a bit of the basics and information on rollovers, withdrawals, and distributions. 

Now I want to focus on savvy strategies you can implement to combat all the twists and turns of IRA planning!

Savvy Strategy #1: Hold Off Taking IRA Distributions

One strategy to minimize the impact of taxes on your retirement savings is to avoid taking distributions from your IRA for as long as possible. This allows your retirement money to enjoy its favorable tax-deferred status for as long as possible.

It also helps to keep income off of your return, which as you’ve already learned not only helps keep your income tax bill lower, but can also help prevent increases in other costs tied to your income.

Savvy Strategy #1: Hold Off Taking IRA Distributions

There are some major downsides to this approach though. Most notably, as your IRA gets bigger, so does your problem! Think about it, if your tax bracket remains about the same over time, then as your IRA grows, so does the amount you’re eventually going to have to pay Uncle Sam. 

This is much different from other things you may be used to.

For instance, imagine you buy a house for $200,000 and have a $50,000 mortgage. If the house doubles in value to $400,000, does your mortgage increase to $100,000? No, of course not! You get to reap all the benefits of that appreciation, but that’s not the way it works with an IRA, 401(k) or similar account. If those accounts double in value, you don’t get to keep all the gains. Uncle Sam is entitled to his share. 

Plus, by waiting to take distributions for as long as possible, your required minimum distributions later on will be larger. This could increase the impact of some of those side effects we’ve talked about.

Thankfully, there’s a way to fix this, so that – to go back to the mortgage analogy for a moment – you can own your IRA free and clear. So that only you benefit from future appreciation. It’s called a Roth IRA conversion and it’s our next savvy IRA planning strategy.

Savvy IRA Strategy #2: Roth IRA Conversions

A Roth IRA conversion is the name given to a special type of transaction where you move money from your pre-tax retirement account, like an IRA, 401(k) or 403(b), to a Roth IRA. When you make a Roth conversion, the amount of money you convert is added to your tax return for the year and is taxable at whatever income tax bracket you happen to be in.

For example, let’s say Jill has $100,000 in a traditional IRA and would like to convert it to a Roth IRA – we’ll talk more about why she might want to do that in a moment. If Jill moves forward with her $100,000 Roth IRA conversion, she’ll have to add $100,000 of income to her tax return for the year, which will be taxable at whatever rate Jill happens to be at. 

Because this is a big decision and can have a significant impact on your taxes, it’s always best to discuss this option with your tax and financial advisors beforehand.

Tax-Free Roth IRA Distributions

So why would you voluntarily choose to make one of these Roth IRA conversions and pay taxes before you have to? Well, there are a lot of reasons, but perhaps the most common reason is one we’ve already discussed... to pay off Uncle Sam now so that you own your retirement account free and clear for life. Remember, with a Roth IRA you have the potential for future tax-free withdrawals of everything in your account.  

If you are over 59 ½ and you’ve had any Roth IRA for more than five years, then all withdrawals from any of your Roth IRAs will be tax and penalty free for life. If you’re over 59 ½ but haven’t had a Roth IRA for five years yet, you can still take out any of your converted amount, tax and penalty free, at any time. If you’re younger than 59 ½, other rules apply.

Who Can Do a Roth IRA Conversion?

Something else to keep in mind is that unlike Roth IRA contributions, there are no restrictions on who can make Roth IRA conversions. You can’t be too old. You can’t be too young. You can be working or you can be retired. There’s no minimum amount of income you need or a maximum amount of income you can have. I think you see what I mean. If you want to convert your IRA to a Roth IRA, there’s nothing in the tax rules that will stop you from doing so. 

Help Reduce The Risk Of Rising Tax Rates

The potential tax-free nature of the Roth IRA may also provide you with additional benefits, such as a hedge against tax rates rising in the future. When it comes to your retirement, there are a lot of unknowns. What will the market do? What will inflation be like? What will your tax rate be? And so on.

That last, one, taxes, is a major concern for many retirees and one we’ve already talked about a bit. A Roth IRA conversion can help manage that risk by paying taxes at today’s known rates. If tax rates rise in the future, tax-free distributions from Roth IRAs will be even more valuable. Of course, if you think your tax rate will be lower in retirement, then that would be an indication that maybe this strategy is not right for you.

Also, since Roth IRA distributions in retirement are generally tax-free, they typically don’t impact the other things tied to your income that we discussed earlier.

Roth IRAs Have No Required Minimum Distributions 

Another big benefit of the Roth IRA, and one that many retirees find attractive, is that Roth IRAs have no required minimum distributions during your lifetime. Remember all those RMD calculations and potential mistakes we talked about earlier? They’re not an issue if you have a Roth IRA. During your lifetime, you can take as much, or as little, as you want. You’re not forced to take anything at 72 if you don’t want to. That means your Roth IRA can continue to grow and compound tax-free for your heirs, which also makes it a very intriguing vehicle from an estate planning perspective.

The Tax Cuts and Jobs Act's Big Change

The Tax Cuts and Job’s Act, however, eliminates this option for conversions made in 2018 and later. If you convert your Roth IRA now or in the future, you are stuck with that decision. 

You're "Stuck" With Your Conversion

Even if your tax bill is higher than you though. Or if the conversion accidentally phased you out of a credit. Or if your investments dropped in value. No matter the reason, you cannot recharacterize that conversion. 

3 Key Questions Before Converting 

So with that in mind, it’s very important that you are sure you want to convert your Roth IRA before doing so. Here are three questions to ask yourself before converting:

1). Do you have a rough idea of the conversion’s impact on your tax bill?

2). Do you have a plan to pay the resulting taxes?

3). DO you have a reasonable expectation that the benefits of “pre-paying” your taxes like this makes sense in your overall plan?

The answer to all of these questions should be yes! 

“Filling Up The Bracket” Roth IRA Conversion Strategy

Here’s a savvy conversion strategy that might be helpful for you called “Filling Up the Bracket Strategy.”

Sometimes you can find yourself in the middle of one of them with room to add more income without pushing yourself into one of the higher tax brackets.

For example, in 2020 the 22% tax bracket for married couples filing a joint return goes from about $80,000 to about $171,000.

Suppose then, that you file a joint return and your taxable income is $100,000. That means that you could add another $71,000 of income without going into the next bracket. Making a Roth IRA conversion of that remaining amount could make sense for you. 

If you plan to convert a sizable portion of your IRA, this approach is often more tax efficient than converting the full amount at one time. Instead, you can make smaller Roth IRA conversions over a number of years, filling up your bracket each time. This can help reduce the average tax rate you’ll pay on your converted money and also spreads the tax bill out over a longer period of time.

Hunt for Low Income Years 

Roth IRA conversions can be especially useful if you had a low income year. For example, are you a business owner with unusually low sales? Or are you paying high, non-recurring medical bills? Or maybe you’re retired but not yet receiving Social Security benefits, pensions, or IRA distributions? 

These are questions to ask to see if a Roth conversion is a good move for you. 

Potential Limitations and Risks of Roth IRA Conversions and the Roth IRA Conversion Strategies Presented Include:

  • There is no guarantee that a Roth IRA conversion will achieve the intended results.
  • There is no guarantee that the Roth IRA distribution rules won’t be changed.
  • The amount converted is generally added to your income.
  • A Roth IRA conversion may also trigger the same “side effects” associated with a “regular” distribution from a traditional IRA.
  • There is no guarantee that investments will appreciate in the Roth account after a conversion.

Of course, these strategies aren’t for everyone, and there’s no guarantee that a Roth conversion will achieve the intended results. 

Savvy IRA Strategy #3: Move Retirement Money Directly 

There’s a good chance that, at some point during your life, you’re going to want to move around some of your retirement money. Maybe it will be done as part of a Roth conversion, maybe it will be to make a new investment, maybe to work with a new advisor. Whatever the reason, you should be aware of how to move retirement money so that you don’t make costly mistakes that could derail your retirement. 

In general, there are two ways you can move retirement money. You can either move it indirectly, in what’s known as a 60-day rollover, or you can move it directly, via a direct rollover or trustee-to-trustee transfer. 

Moving money directly is usually the savvy choice. 

Indirect Rollovers

First, let’s take a look at indirect rollovers. In an indirect rollover, you receive a distribution of your retirement funds, payable to you, or they are sent to a non-retirement account. Then, you have 60 days from the time you receive your distribution to get it back into another retirement account. If you miss the 60-day deadline, the distribution is taxable and, depending on your age, it may be subject to an additional 10% penalty.

Even if you’re on top of things and you complete your rollover within 60 days, there are other problems with indirect rollovers. For instance, if your withdrawal is coming from an employer-sponsored retirement plan, like a 401(k), the plan generally has to withhold 20% of your distribution for income taxes. Congress wants to make sure you don’t take your retirement money, run away, and never pay the taxes you owe.

A separate troublesome rule applies to 60-day rollovers from IRAs. If you’re moving your money to another IRA, only one of these rollovers can be done per year. If you try and make a second 60-day rollover, chances are the entire amount will be taxable. The same rule applies to Roth IRA rollovers.

Direct Rollovers/Trustee-to-Trustee Transfers

As you can see, there are some real problems with indirect rollovers. Thankfully, there’s generally a better way to move your retirement money.

 In a direct rollover or trustee-to-trustee transfer, your money is sent right from your old retirement account to your new retirement account. There’s no 60-day time limit to worry about, there’s no mandatory 20% withholding and there are no one-rollover-per-year rules to be concerned about. 

Typically, this is done by providing you with a check made payable to your new custodian. For example, the check might read “Company X, custodian, [for the benefit of] John Smith IRA.”

If the check is made payable to your new custodian like this, your distribution can still qualify as a direct rollover and get the same favorable tax treatment. There is no 60-day deadline and no mandatory withholding. That’s true even if your plan sends you the check and has you forward it to your new custodian. 

Savvy IRA Strategy #4: Coordinating Your IRA Planning

Another essential component of any savvy IRA plan is making sure that you coordinate your IRA planning with your overall retirement, estate, tax, education and financial plans. Your IRA and other retirement accounts can impact each of these areas and it’s important to factor those things into your planning. 

It’s Not Just What You Own, But Where You Own It

Some of you may have all of your savings in retirement accounts, but many of you probably have some of your savings in IRAs, 401(k)s and the like, with other savings in non-retirement accounts.

If that’s the case for you, one savvy strategy you may want to consider is coordinating your IRA with your overall plan and carefully selecting which of your investments are purchased with IRA money, and which investments are purchased with non-retirement account money. Doing so could help you meaningfully lower your tax bill. 

Strategic Allocation Example – Assumptions 

Here’s an example of what I mean. Let’s imagine that you have $100,000 in an IRA and $100,000 in a non-IRA account. Let’s also imagine that you want to purchase $100,000 of bonds with a hypothetical interest rate of 4% and $100,000 of stocks that will pay hypothetical qualified dividends of 4%. Also assume that you plan to live off the income these investments generate and that you’re in the 24% tax bracket. 

Strategic Allocation Example – Scenario #1

In the first scenario you see, all of the stocks are purchased inside the IRA account and generate $4,000 of qualified dividends. In general, qualified dividends receive special tax treatment and are taxed at long-term capital gains rates. These rates are lower than ordinary income tax rates.

However, because this investment was made inside an IRA and all withdrawals from an IRA are taxed at ordinary income tax rates, if you take a withdrawal of the $4,000 of qualified dividends, they’ll still be taxed at your hypothetical 24% ordinary rate, resulting in a tax bill of $960. In the same scenario, you have $100,000 of bonds that also generate $4,000. Bond interest is taxed as ordinary income too, so that means that you’ll owe another $960 of tax on that income, bringing your total tax bill to $1,920. 

Strategic Allocation Example – Scenario #2

In this second scenario, the bond purchases are made inside an IRA. They generate the same $4,000 of interest as before and, if withdrawn from the IRA, will be taxed at your hypothetical 24% rate. This gives you the same $960 tax bill for your interest as you had before. 

Now, however, you’re purchasing your stocks with non-IRA money and your qualified dividends are taxed at long-term capital gains rates. If your ordinary income tax bracket is 24%, then you have a 15% rate on long-term capital gains. Now, your tax bill on your qualified dividends drops to $600, bringing your total tax bill to $1,560. That’s a $360 difference compared to the first scenario and a tax savings of nearly 25%. In both scenarios you invested exactly the same amount of money in exactly the same investments and you took exactly the same investment risk. However, in scenario 2, you get to spend an extra $360 simply because of your savvy planning. So remember, when it comes to your investments, it’s not just what you own, but where you own it. 

Potential Limitations and Risks of This Strategy Include:

Of course, you should be aware that anytime you’re dealing with investments, there’s no guarantee they’re going to perform as expected. And while I don’t anticipate the special tax rate for long-term capital gains to be eliminated anytime soon, there’s no crystal ball to predict what Congress will do in the future.

Coordinating IRA Planning With Social Security

Another way your IRA planning needs to be coordinated with your overall retirement plan is your Social Security claiming strategy. The decision of when to file for Social Security is one that far too many retirees make without thoroughly evaluating their options first. This is a major mistake and one that, in some cases, can cost you more than $100,000 of income over the course of your retirement!

Now the decision of when to claim Social Security is a very personal decision and one that varies significantly from person to person and couple to couple. That said, many retirement experts today believe that too many people claim Social Security too soon. Remember, Social Security benefits are guaranteed to last your entire lifetime, no matter how long you live, and benefits are generally increased from one year to the next through cost-of-living adjustments. 

Additionally, delaying receiving Social Security benefits past what’s called your full retirement age – 66 for most of you - can allow you to earn an additional 8% increase in payments each year until you turn 70, through what are known as deferred credits. For these reasons and more, it may be beneficial to claim Social Security benefits later than you initially planned for. 

Withdraw From an IRA to Delay Social Security? 

But you have to eat in the meantime, right? That might require you to pull money from your IRA in the interim to help cover your current living expenses. Retirees sometimes opt not to do this because they say, “What if I die early? I’ll have spent my IRA money, which takes away from my heirs, and I’ll have gotten little to nothing for it. While that’s certainly something to consider, here are two reasons you may want to give that approach a second thought.

First, a 2012 report from the Center for Retirement Research at Boston College concluded that Social Security is one of the cheapest, if not the cheapest, annuity available. That might sound a little funny. After all, you don’t buy Social Security, right? In a way, though, you kind of do. If you use IRA money to hold off on claiming Social Security for, say, a year, that’s kind of the price you paid to get the higher benefit. If you compare that “price” and increased benefit to what you can get from commercial annuity providers, it’s almost always cheaper. 

Another reason it can make sense to draw from your IRA in order to help delay claiming Social Security benefits is that Social Security benefits are generally more tax efficient than IRA withdrawals. Remember, when you take an IRA withdrawal, the entire amount is generally added to your income and taxed at whatever rate you happen to be at. In contrast, Social Security benefits may be anywhere from 15% tax free all the way up to 100% tax free. So, the key point for you here is that trading a dollar of IRA income on your tax return for a dollar of Social Security benefits will almost always leave you with a lower tax bill and more money to spend. 

Savvy IRA Strategy #5: Coordinating Your IRA Planning With Estate Planning

Alright, time to move on to our next savvy IRA planning strategy, and that’s coordinating your IRA planning with your estate plan. In most estate plans, there are really two primary goals. First, to make sure that your assets pass to your intended beneficiaries and secondly, that they are passed to them as efficiently as possible. When it comes to IRAs, 401(k)s and other retirement accounts, that’s done with one form in particular... the beneficiary form. 

I really can’t emphasize how important this form is and yet, time and time again, people fail to update these forms after major life events, such as births, deaths, marriages and divorces.

Many times, people think that because they’ve updated their will, everything is taken care of, but that’s not so. For example, if you have your ex-wife or ex-husband named on your IRA beneficiary form, but your will has been updated to say all your assets go to your children upon your death, guess who’s getting your IRA? That’s right. Your ex! And I can’t tell you how often this happens to people! That’s why it’s so important to keep updated copies of your beneficiary forms with all your other important estate planning documents. 

Different Types Of IRA Beneficiaries

Now that you understand the importance of the beneficiary form, let’s talk a little more about IRA beneficiaries. Any person or entity can be an IRA beneficiary, but there are different post-death withdrawal rules depending on the type of beneficiary you select. Broadly speaking, there are three main types of IRA beneficiaries after the SECURE Act. There are, non-designated beneficiaries, designated beneficiaries, and eligible designated beneficiaries. 

As you can probably guess by looking at this slide, non-designated beneficiaries generally have the worst tax treatment, and eligible designated beneficiaries generally have the most favorable tax treatment. 

You might be thinking to yourself, then, “Well, shouldn’t I just make sure all my beneficiaries are eligible designated beneficiaries then?” Unfortunately, in many cases, that’s just not possible… at least if you want to make sure that specific people get your life savings.

For instance, take a look at the different types of eligible designated beneficiaries there. Certainly no one is going to hope that their beneficiaries are disabled or chronically ill. And if you don’t have minor children now, it’s highly unlikely you’re going to have one in the future. The trusts you see there are generally only trusts where the only beneficiary is another type of eligible designated beneficiary, such as a disabled person. So that doesn’t work. Which leaves you with beneficiaries who are not more than 10 years younger than you are, which generally won’t apply unless you’re leaving your IRA to your siblings or friends, and spouses.

If you’re married, chances are that your spouse is your beneficiary, but when the second death occurs, who will your collective retirement funds be left to?

In many cases, it’s going to be your adult children, who fall into that middle, yellow category.

Let’s take a little close look at the rules for post-death distributions for each of these categories of beneficiaries.

Non-Designated Beneficiaries 

Let’s start with the group of beneficiaries that generally has the most unfavorable treatment; Non-designated beneficiaries. This group is composed of beneficiaries that have no life expectancy, and includes beneficiaries such as your estate and charity. As you can see, the rules for how quickly money must be distributed from an inherited account after death depend on how old the owner of the account was when they died. 

In many cases, that means such beneficiaries must distribute the entire inherited account within 5 years. This can lead to big ‘lumps’ of income that get taxed at much higher rates than an owner may have paid during their lifetime. 

Designated Beneficiaries 

Next, we have designated beneficiaries. If you have named children, grandchildren, nieces, nephews, or other, similar close family members – who are not your spouse – as your IRA beneficiary, there’s a good chance that they’re going to fall into this category of IRA beneficiary. 

In the past, this group of beneficiaries was able to take advantage of something commonly known as “The Stretch”, which is where distributions from the inherited account could be spread over the individual’s life expectancy. This allowed the tax benefits of the retirement account to last for as long as possible, and kept taxable income each year to a minimum. 

Unfortunately, the SECURE Act – yes, that same law from last year I keep bringing up – eliminated this tax benefit for ‘regular’ designated beneficiaries. Now, instead, this group of beneficiaries has to distribute the entire inherited IRA by the end of the 10th year after they inherit.

This new 10-Year Rule isn’t as bad as the 5-Year Rule that hits some non-designated beneficiaries, but it’s a far cry from the decades that some children, grandchildren, etc. had to spread out distributions before the SECURE Act was enacted. 

Those of you who expect to pass on large retirement accounts to heirs should be particularly mindful of this change, as it might influence planning decisions during your own lifetime, such as how much, if anything, to convert to Roth IRAs.

The new 10-Year Rule is effective for most IRA beneficiaries and plan beneficiaries, beginning this year (2020). 

Eligible Designated Beneficiaries 

Finally, we get to the brand new type of beneficiary created by the SECURE Act… Eligible Designated Beneficiaries. 

Eligible Designated Beneficiaries are the only beneficiaries left who are… wait for it… eligible to Stretch distributions using the rules that were in place before the SECURE Act was passed. As we discussed before, however, it’s a pretty limited list, and doesn’t help the many of you who plan to eventually leave your retirement assets to your adult children, or other persons who don’t fall into one of the above categories.

The Stretch IRA 

And this is what it means to stretch IRA distributions. Eligible designated beneficiaries– and only eligible designated beneficiaries – are able to take minimum distributions calculated over their IRS-provided life expectancies. The stretch IRA, then, is just the name that practitioners have given the strategy of a beneficiary taking only the minimum amount out of an inherited IRA each year that’s required by law. Doing so helps an eligible designated beneficiary to minimize their income tax and maximize the tax deferral of the inherited account. In contrast, all other beneficiaries typically have to withdraw all inherited IRA money much sooner as we discussed. 

Trusts as IRA Beneficiaries 

One question many boomers ask is whether or not they should leave their IRAs to a trust. Trusts are certainly good at providing post-death control, and if that’s a major concern for you, it’s certainly something to consider. However, naming a trust as your IRA beneficiary adds considerable complexity to your estate plan. If drafted properly, trusts can be treated as designated beneficiaries.

All too often, however, they do not meet the specific requirements outlined by the IRS and end up having to follow the less favorable rules for non-designated beneficiaries. Even if drafted properly, trusts come with certain costs, such as the cost to prepare the trust itself, the cost for filing annual trust income tax returns and accelerated taxation of any IRA withdrawals that are held inside the trust.

Ultimately, naming a trust as your IRA beneficiary is a very complicated matter and is something that should be carefully considered and discussed with your full team of advisors, including your tax advisor, your estate planning attorney and your financial advisor.

Options For Spousal IRA Beneficiaries

Many people name their spouse as the beneficiary of their IRA, so let’s talk about that for a moment. If your spouse is your sole IRA beneficiary, then he or she will generally have several options after inheriting your IRA. They include choosing to remain a beneficiary of your account, as well as making what is known as a spousal rollover. Let’s talk about each of these in a little more detail. 

Spousal Rollovers

As I just mentioned, one option a spouse beneficiary has is completing a spousal rollover. In a spousal rollover, the surviving spouse takes the deceased spouse’s IRA and moves it right into their own IRA. A spousal IRA rollover is an irrevocable decision and once completed, the funds are treated as though they were always in the surviving spouse’s IRA. This is generally the best option for spouses who inherit at 59 ½ or older.

Remain As A Beneficiary

Another option available to spouse beneficiaries is remaining as a beneficiary of the inherited account. This is generally the preferred option if a spouse inherits prior to turning 59 ½ because it allows them to take penalty-free distributions from the inherited account regardless of their age. 

In contrast, if they were to make a spousal rollover, the money would be treated as their own and therefore, any distributions taken prior to age 59 ½ would generally be assessed a 10% early distribution penalty.

If you’re a spouse beneficiary and you inherit prior to reaching age 59 ½, you can remain a beneficiary until you turn 59 ½ and then, at that time, execute a spousal rollover. In fact, more often than not, that’s the best approach. There are other special rules that apply to spouse IRA beneficiaries, so it’s always best to consult with a knowledgeable professional. 

Bonus Strategy #6: Watch Out For Scams!

With that we’ve come to our last savvy IRA planning strategy. It’s one that you should all know but, for whatever reason, people seem to forget. And that’s to always do your homework before making any decisions with your IRA, especially when it comes to investments. IRAs are often the target of schemes and scams because hey, let’s face it, that’s where a lot of people’s savings are. I know it and you know it, but you know who else knows it? 

That’s right, the scammers! 

In recent years the SEC has issued alerts warning certain IRA owner’s that they may be the target of scams and the IRS has even put out a Publication with the title “The IRS Does Not Approve IRA Investments” in response to many fraudulent promoters claiming that their IRA investments were somehow given the green-light by the IRS. At the end of the day, it comes down to the golden rule, if it sounds too good to be true, it probably is. Your IRA may represent a lifetime’s worth of work and savings, Don’t squander it by making a foolish decision. 

We Are Here to Help 

As you’ve probably realized by this point, IRA planning is a lot more complicated than most people realize. Let’s face it, deciding what strategies are best for your IRA crosses into just about every area of planning, from tax planning, to investment planning to estate planning.

Few retirees are aware of just how critical IRA planning is and even fewer have taken the time to truly evaluate all of the issues and develop a comprehensive solution.  Hopefully we’ve helped answer some questions for you today/tonight, but chances are you still have others. But that’s ok…

We are here to help answer your important questions, evaluate your current financial picture and develop a savvy IRA planning strategy that’s best for you and your family. If you need help with any additional questions, don’t hesitate to contact me at!

Advisory services through Capital Advisory Group Advisory Services LLC and securities through United Planners Financial Services of America, a Limited Partnership. Member FINRA and SIPC. The Capital Advisory Group Advisory Services, LLC (CAG) and United Planners Financial Services are not affiliated.

The views expressed are those of the presenter and may not reflect the views of United Planners Financial Services. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Neither United Planners nor its financial professionals render legal or tax advice. Please consult with your accountant or tax advisor for specific guidance.

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