Setting up a plan that will provide the income you need for the entirety of your retired life is usually the top concern for people around retirement. We look at it a little differently. Our focus isn’t just on making your assets work to provide income; it’s on ensuring that you keep as much of that income as possible.
Planning to minimize taxes is even more important in retirement than it is when you are working, because your income stream is limited by your existing assets. Another dimension is that up to 85% of your Social Security benefits are taxable, and you may also be subject to a Medicare Part B premium surcharge if your income exceeds certain levels.
Maximizing income while minimizing the taxes you pay comes down to planning. It’s not about saving money in any one year – it’s about creating a strategy that lowers your lifetime bill.
1. Maximizing Social Security
Maximizing your social security benefits means delaying taking them for as long as possible. For every year that you delay benefits after the age that you meet full retirement age (FRA), which is usually age 65-67 for most people, you get an 8% per year raise, up to what the SSA calls “Late Retirement” at age 70. This can have a dramatic impact on the amount of your benefits. If you take early benefits between ages 62 and FRA, you pay a penalty.
For a married couple filing jointly, up to 50% of your benefits is taxable if your income is from $32,000 to $44,000, and up to 85% of your benefits is taxable if your income is more than $44,000. Maximizing how much you get keep more in your pocket – so a strategy where the higher-earning spouse waits longer to claim can pay off.
The strategy for funding retirement while you are delaying can also create more tax-efficiency later in retirement. By withdrawing from a traditional IRA or 401(k) account to fund early retirement, you reduce your invested capital, which reduces the amount of your required minimum distributions when they kick in at age 72. There will be tax consequence, but we’ll get into that in a later step.
2. Avoiding the IRMAA Medicare Tax
Medicare is a great solution for healthcare in retirement, but just like social security, it is means-tested. For social security, this amounts to taxes on up to 85% of your benefits. For Medicare, this translates into a surcharge on the Part B and Part D premiums. The surcharge can be hundreds of dollars per month. For a married couple, the surcharge applies to each Medicare recipient – so it adds up quick.
Your income level triggers the surcharge, but there’s another wrinkle. Whether or not you have to pay a surcharge, and the amount of the surcharge, are calculated from your modified adjusted gross income (MAGI) from two years prior. Taking additional income in any given year – from selling a property, part-time work, going on a dream vacation, or purchasing a second home – all may have expensive impacts down the line.
RMDs will also impact the IRMAA, and they are structured to increase with age – so this isn’t something that will go away.
3. Fill Up Those Buckets!
There’s a big jump in tax brackets from the lowest rates to the next lowest, and then incremental increases after that. If you’re withdrawing from a traditional IRA or 401(k), those funds will be taxed as ordinary income. In the early years of retirement, before social security kicks in, withdrawing as much as possible can keep your taxes lower. This also reduces the size of your account – which lowers RMDs later.
|Tax Rate||Married Filing Jointly|
|12%||$20,550 – $83,550|
|22%||$83,550 – $178,150|
|24%||$178,150 – $340,100|
The same strategy applies to your taxable accounts. Tax-loss harvesting can lower your taxes, but it also makes sense to look at highly-appreciated assets. Selling them in years when your income puts you in the 0% capital gains rate bracket is a good strategy.
|Filing Status||0% Rate||15% Rate||20% Rate|
|Married Filing Jointly||<$83,350||$83,350-$517,200||>$517,2000|
Step 4: The Roth Conversion Years
Lowering the value of your traditional IRA accounts by using them to delay claiming social security benefits is one strategy for reducing RMDs later in retirement. Another is to avoid RMDs entirely by converting to a Roth account. You’ll pay taxes on the amounts converted, so spreading them out in the early years of retirement when you don’t have other sources of income will reduce the tax burden by keeping total income in lower tax brackets.
You’ll want to pay attention to the capital gains tax here, so selling assets that haven’t appreciated substantially – like bonds – will help. But you’ll need to watch your asset allocation, as you don’t want the resulting portfolio to be overweighted to riskier assets.
The optimum years are before you begin claiming social security, and you’ll want to be careful about the IRMAA surcharges, too.
5. Give Generously and Strategically
One of the themes we see with clients is the desire to share the results of their hard work and good fortune with others. Gifting to charitable organizations that express your values is a valuable way to leave a legacy. Creating a gifting strategy that maximizes the gift can at the same time be tax-advantageous to the giver.
Qualified Charitable Distributions (QCDs) – These are direct transfers of funds from your IRA to a qualified charity. The amount distributed as a QCD counts towards your RMD for the year, up to $100,000 – but it’s excluded from your taxable income. Setting up an ongoing strategy can reduce your taxable income while fulfilling your desire to make a difference to causes you care about.
Gifting Appreciated Assets – Holding assets that have appreciated can create a tax liability when they are sold. By transferring ownership directly to a charitable organization, the charity gets the full, before tax value of the asset, and the donor can deduct the appreciated value from their taxes. This can create a valuable offset to other income in retirement.
Retirement income planning isn’t just about creating a paycheck – it’s about keeping that paycheck in your pocket. The retirement puzzle requires some thought and strategy, but when you put it together correctly you can create the retirement you want.