How to Minimize Your Taxes When Retiring

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How do you minimize your taxes when retiring?  One must consider Social Security, taxable and tax-favored holdings, and, if applicable, a pension. It is crucial to have a  well thought out financial plan prepared many years in advance of retirement and updated annually as a person approaches their planned retirement date.  We utilize what we call a “Capital Sufficiency Analysis” to help project things like income from investments, retirement plan withdrawals, spending during retirement, etc. to provide the investor with an idea whether or not they can comfortably retire.  Obviously, these are just projection and are not intended to be precise but rather to provide a framework (think road map) for their retirement.  We can make adjustments in these projections like the assumption that perhaps in their late 70’s or early 80’s they perhaps move to a smaller home or increase costs for potential increased medical costs or for caregivers.  We find that by having this roadmap, all investors benefit.  Those with sufficient assets can feel good that they can comfortably retire.  For those who obviously need to save more (or spend less), those years leading up to retirement can also be enlightening.

What are the important things an investor with substantial gains can do to minimize annual taxes on withdrawals?

All gains that are eventually withdrawn from retirement plans are considered ordinary income and taxed at the investor’s highest marginal tax bracket.  As such, it can make sense to plan to take higher withdrawals from retirement plans in years where other income might be lower than normal.  It might even make sense to convert an ordinary IRA to a ROTH IRA in a year where income is particularly low or even negative.  Taking funds out of a Retirement account (even before the annual Required Minimum Distribution (“RMD”) kicks in) might make sense.  One thing that we advise clients is to make sure they have not “painted themselves into a corner” regarding having all of their retirement savings in pre-tax accounts.  By having too much of their wealth being tied up in retirement accounts, any amounts needed to pay for retirement needs have to be “grossed -up” to include the amount needed to pay the taxes on the amount withdrawn.  Then, in the following year, taxes have to be paid on those taxes withdrawn that can easily snowball into a vicious cycle of taking out money to pay tax and then needing to take out even more money to pay those taxes.  We would always recommend that clients balance spending down assets between after tax and pre-tax funds to hopefully avoid this type of situation.  Again, planning is paramount to help ensure that the investor does not create this type of situation.

Investors should never allow taxes to dictate how they invest money.  Rather, they should fully understand how taxes impact their investments.  For example, perhaps an investor is really more income focused (because that income is needed to be spent each year for retirement expenses) then yes, most income investments are not going to be very tax efficient (i.e. they would generally generate ordinary income assuming these are not retirement plan assets).  By investing in high dividend paying stocks, the Federal tax rate on qualifying dividends is lower than ordinary income from taxable bonds or CDs, etc.  That said, of course stocks, even high dividend paying stocks, can be more volatile and the investor needs to be able to withstand the inevitable downturn of stock prices.  Municipal bonds can make sense for those taxpayers in a high bracket, particularly for those living in states with very high state income taxes like California and New York.  Remember, all bonds have an inverse relationship to interest rates.  With rates for the ten-year treasury now just slightly above 2% ,should interest rates increase dramatically, the value of those bonds can drop significantly.  Asset allocation, particularly to non-correlated assets such as real estate equity investments or lending against real estate, will help investors lower their overall portfolio volatility and hopefully help them stay on course to and through their retirement.

Generally, most retirees relish the idea of being debt free during their golden years of retirement.  Of course, this is not always possible for many investors.  For those who will need funds from their residence, it is important to plan ahead and obtain a new mortgage while they are still working and can show income.  Unfortunately, most banks will be much more difficult to deal with in obtaining a mortgage when you cannot show a W-2 or income from a business.  The idea of a reserve mortgage would only be utilized as a “worse case scenario” as most reverse mortgages have lots of fees and characteristics that one generally wants to avoid.

Year-by-year planning is very important and should be reviewed with the investor’s CPA to determine when best to take money out of retirement accounts, make charitable donations, pay down or obtain mortgage.  These all can have far reaching impact on what is typically the investor’s biggest expense – income taxes.

Again, planning well ahead of retirement is critical.  Obtain projections from Social Security of your projected benefits at full retirement age and what the benefits might be if you delayed taking benefits until say age 70.  The same thing goes for any other defined benefit plan that pays a monthly retirement benefit.  Think ahead if you are in your 50s or perhaps early 60s about long term care insurance if you are worried that should care be needed later in life that this would be a “time bomb” for your retirement planning and deplete the assets you so carefully accumulated prior to retirement.  Also think about making sure you have a balance of both retirement (pre-taxed) and non-retirement assets so as to not be in the situation where you find yourself only having pre-tax funds available potentially causing a higher tax burden.

Gregory Kushner

These comments are for informational purposes only and should not be considered tax advice. Please consult a tax professional if you feel these services are necessary for your situation.”


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