Editor's Note: This article is part of the Financial Advisor series "How I Solved It." Advisors describe a client with a problem and what they did to help.

When an accountant reached out to this financial advisor to discuss a tax oversight made by a mutual client, the news was grim. The retired couple had under-withheld almost $50,000 in taxes for the first 11 months of the year and was facing interest and penalties.

The accountant mistakenly assumed, based on conversations she’d had with the couple, that they had been withholding enough of their IRA distributions and Social Security benefits when they did their quarterly tax estimates. To correct the oversight and eliminate the interest and penalties associated with the underpayment, she thought the couple should take an additional $50,000 IRA distribution with 100% tax withholding.

Bradley Newman, a CFP with Harrisburg-based Roof Advisory Group, a division of Fort Pitt Capital, thought there had to be a better strategy than raiding their IRA.

He calculated the couple would actually have to withdraw more than $65,000 from the IRA to cover the net $50,000 in taxes due because the additional distribution would be taxed at 24%. The cost of avoiding the tax penalty and interest would have exceeded $15,000 ($65,000 x 24%), he said.

He asked the accountant if she knew how much the penalty and interest would be if the couple wrote a check from their after-tax investments. She replied 8%, which translated into $4,000 ($50,000 x 8%). That would save the couple more than $11,000 and give their IRA assets the potential opportunity of continuing to appreciate.

Taking the additional $65,000 distribution to pay the penalty and interest “kind of becomes like a dog chasing its tail,” said Newman. “The cure is worse than the disease and the solution hurts more than the problem.”

The additional distribution also would’ve pushed his clients into a higher marginal tax bracket, he said.

Upon sharing his analysis with the accountant, she “basically said, ‘I kind of had my accountant blinders on,’” said Newman. The clients were ecstatic about the more cost-effective strategy, he said, and the accountant told them it was Roof Advisory Group’s idea.

To satisfy the $50,000 withholding shortfall, the couple tapped into funds in a joint investment account. The couple was still subject to the penalty because the IRS wants taxpayers to pay taxes as money is earned, said Newman.

He isn’t critical of the accountant. He noted that professionals tend to focus on their own area of expertise. The lesson learned, he said, is there is a benefit to taking a broader view of how a decision affects a client overall.

Collaborating with other trusted professionals (such as CPAs, estate planning attorneys and business valuation experts) provides more opportunities to collect multiple viewpoints on an issue, figure out how to help clients more efficiently reach their goals and ultimately get clients to where they want to go, he said.

“At the end of the day, it doesn’t matter if we’re orchestrating it or someone else is orchestrating it, as long as we’re being collaborative,” said Newman. “I’ve never seen anything bad come out of collaborating on behalf of a client.”

According to Newman, Roof Advisory Group communicates with the CPAs of about 90% of its clients.

Split Decisions

Newman also suggests that clients who are retired take a mix of distributions from their qualified investments (pretax IRAs and 401(k) retirement savings plans) and nonqualified investments (after-tax savings accounts, brokerage accounts and mutual fund accounts). This helps preserve some after-tax money for down the road, he said. He collaborates with clients’ accountants to determine the best blend of distributions.

If 100% of a client’s annual distribution comes from an IRA, it could be taxed at about 30%. If the distribution is split 50-50 between an IRA and an after-tax joint account, the client’s earned income is halved and the tax rate would theoretically be about half that or 15%, he said, “although the math won’t work out exactly.”

The key is to start communicating with clients many years in advance of retirement to help them determine how much money they should be saving in pre-tax versus post-tax accounts, said Newman. This involves financial planning work and modeling, he said.

“We’ve been conditioned all of our lives to defer, defer, defer, defer,” he said, “so you’re not paying taxes on the earnings that year.” After-tax income “gets a little bit of a bad rap,” he said, because people want to get a tax deduction today and they want deferred growth and income.

Clients with “a more blended ratio of qualified versus nonqualified dollars will ultimately have to save less money because it’s going to be taxed more gently,” said Newman. “I don’t think people really think about that until they get to the doorstep of retirement.”