Retirement Is About Income and Taxes

Courtney Jones, CFP®
Posted on 
September 30, 2021

Retirement Is About Income and Taxes

Have you considered the taxes that you will pay in retirement? Before making the transition to living on “income from savings” instead of “income from work” make sure you review the tax implications. Some of our clients jump to conclusions as it is very common to assume that you will be in a lower tax bracket and that your social security payments will not be fully taxed. However, failing to consider taxes can be an expensive mistake, and it has implications for other retirement benefits.

What to expect

Depending on your income from other sources, up to 85% of your Social Security benefits may incur Federal income taxes as per the Social Security Administration. Additionally, withdrawals from a 401(k) and traditional IRAs are taxable since the money you funded them with was tax-deferred. Pension payments are also considered taxable income. If you have taxable investment accounts you should be aware that dividends, interest income and capital gains from stock sales will all create tax liabilities.

Your new retirement tax bracket is derived from your combined income, which is your adjustable gross income, nontaxable interest income and some portion of your Social Security. If your income is high enough, you may also have to pay a premium over regular rates for Medicare Part B, as outlined in the Part B costs chart in Medicare.gov

How to Lower Your Tax Bill

The first step to reducing your potential tax bill is to lower your income needs. You may consider several strategies to do this. Many people try to pay off or pay down as much as possible on mortgage and other debts before retirement. This means you will not have to withdraw as much income, which will lower your tax liability. This may require a new budget plan or putting off discretionary expenses during the last years of working, but the advantage over the course of your retirement may be worth it.

If you are planning to move in retirement, consider moving somewhere with lower taxes. This can include lower state income taxes or states that do not tax retirement income.

If you are set for income needs and had planned to make a charitable contribution, consider doing it directly from a traditional IRA. Once you reach the age of 72, Required Minimum Distributions (RMDs) will kick in. The lower your balance, the lower the amount of the RMD.

Other tactical moves

Another strategy to consider is Asset location, a strategy for placing investments in accounts where they have the potential to lower your tax liability. Not to confuse with Asset allocation, a strategy for diversifying your accounts across investment types.

When you invest you can do so in tax-advantaged, tax-free, or taxable accounts. Carefully think investments to hold in each account. Taxable accounts, such as brokerage accounts, should hold tax-efficient investments. These include stocks you will hold for more than a year; tax-exempt municipal bonds; and index funds. Tax-deferred accounts are good homes for tax-inefficient investments. These include fixed income, commodities, some alternatives, and other actively managed strategies.

If you have a Roth IRA from which you can withdraw tax-free, along with a traditional IRA, you may want to be thoughtful about your total income picture when determining which account to withdraw from. Taking from the appropriate account based on whether your income is likely to be higher or lower each year can lower taxes.

Converting to a Roth IRA may also be a good strategy. You will need to think through when and how much you will convert, or your upfront tax bill will be quite large. Staggering the conversion over several years can make it more manageable. Some financial planning tools, like the one we use in our practice, Money Guide Pro can provide you with useful information and quantify the taxes that can be saved over a lifetime by converting your IRA to a Roth IRA.

As you can see, retirement planning does not stop with creating an investment strategy to generate the income you want. Carefully thinking through the tax implications and making tactical moves to keep income as tax advantageous as possible can have a lasting impact.

Retirement Is About Income and Taxes

Courtney Jones, CFP®
Posted on 
September 30, 2021
Retirement Is About Income and Taxes

Retirement Is About Income and Taxes

Have you considered the taxes that you will pay in retirement? Before making the transition to living on “income from savings” instead of “income from work” make sure you review the tax implications. Some of our clients jump to conclusions as it is very common to assume that you will be in a lower tax bracket and that your social security payments will not be fully taxed. However, failing to consider taxes can be an expensive mistake, and it has implications for other retirement benefits.

What to expect

Depending on your income from other sources, up to 85% of your Social Security benefits may incur Federal income taxes as per the Social Security Administration. Additionally, withdrawals from a 401(k) and traditional IRAs are taxable since the money you funded them with was tax-deferred. Pension payments are also considered taxable income. If you have taxable investment accounts you should be aware that dividends, interest income and capital gains from stock sales will all create tax liabilities.

Your new retirement tax bracket is derived from your combined income, which is your adjustable gross income, nontaxable interest income and some portion of your Social Security. If your income is high enough, you may also have to pay a premium over regular rates for Medicare Part B, as outlined in the Part B costs chart in Medicare.gov

How to Lower Your Tax Bill

The first step to reducing your potential tax bill is to lower your income needs. You may consider several strategies to do this. Many people try to pay off or pay down as much as possible on mortgage and other debts before retirement. This means you will not have to withdraw as much income, which will lower your tax liability. This may require a new budget plan or putting off discretionary expenses during the last years of working, but the advantage over the course of your retirement may be worth it.

If you are planning to move in retirement, consider moving somewhere with lower taxes. This can include lower state income taxes or states that do not tax retirement income.

If you are set for income needs and had planned to make a charitable contribution, consider doing it directly from a traditional IRA. Once you reach the age of 72, Required Minimum Distributions (RMDs) will kick in. The lower your balance, the lower the amount of the RMD.

Other tactical moves

Another strategy to consider is Asset location, a strategy for placing investments in accounts where they have the potential to lower your tax liability. Not to confuse with Asset allocation, a strategy for diversifying your accounts across investment types.

When you invest you can do so in tax-advantaged, tax-free, or taxable accounts. Carefully think investments to hold in each account. Taxable accounts, such as brokerage accounts, should hold tax-efficient investments. These include stocks you will hold for more than a year; tax-exempt municipal bonds; and index funds. Tax-deferred accounts are good homes for tax-inefficient investments. These include fixed income, commodities, some alternatives, and other actively managed strategies.

If you have a Roth IRA from which you can withdraw tax-free, along with a traditional IRA, you may want to be thoughtful about your total income picture when determining which account to withdraw from. Taking from the appropriate account based on whether your income is likely to be higher or lower each year can lower taxes.

Converting to a Roth IRA may also be a good strategy. You will need to think through when and how much you will convert, or your upfront tax bill will be quite large. Staggering the conversion over several years can make it more manageable. Some financial planning tools, like the one we use in our practice, Money Guide Pro can provide you with useful information and quantify the taxes that can be saved over a lifetime by converting your IRA to a Roth IRA.

As you can see, retirement planning does not stop with creating an investment strategy to generate the income you want. Carefully thinking through the tax implications and making tactical moves to keep income as tax advantageous as possible can have a lasting impact.

Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC. Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC.  Advisory services offered through Sanctuary Advisors, LLC., an SEC Registered Investment Advisor. Credo Wealth Management is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC. This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. This communication has not been reviewed for completeness or accuracy, does not necessarily reflect the views of Sanctuary Securities, Inc. or Sanctuary Advisors, LLC., and is not a recommendation or endorsement of any product, service, or issuer. For additional information, please refer to one of the following consumer websites: www.FINRA.org, www.SIPC.org.

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