Retirement doesn't mean no tax planning

Retirement and tax planning


You are over 62 and no longer earning big dollars - drawing SS.  So you no longer need to spend time tax planning - do you? If you answered yes then you may be right if SS is your main source of income and you have little or no money in retirement plans (IRAs or 401Ks) or a future company pension that will activate in 2-3 years. If you have sources of income (now or later) that are taxable - tax planning may be as important or more so than at any point in your life.

Let's say you are married and your spouse still works (that darn taxable income!!!). Maybe you are due a pension. So do you want to activate your pension now or wait? If you have investment or savings where taxes are already paid (or will be taxed at low rates) you may want to use part of that savings and wait to activate sources of taxable income.

Why is that? One reason is SS benefits are not taxable in all or part depending on other taxable income. For a single person the line in the sand is $25,000. Above that line SS income starts to be taxes (up to 85% of your SS income - talk about double taxation because you paid taxes on SS deposits as you worked). You take 50% of your SS benefits and other taxable income. If you are single and that is over $25,000 then part of your SS benefits become taxed. For example if you get $18,000 a year in SS benefits and have less than $16,000 of other income then SS benefits are not taxable. If you are married - the line is $32,000 (not 2 X $25,000).

So if your spouse still works almost surely some of your SS benefits will be taxed. The more money you receive from a pension or take out of your IRA/401K the more of those benefits get taxed. Hence, you may want to postpone taking money out of a 401K or IRA until a later date. If you are below the line ($25,000 single, $32,000 Married) you may want to take enough money out of your 401K or IRA to reach that line. If you don't need the extra money to meet current expenses set up a Roth IRA and do a transfer from your regular IRA (or 401k) in an amount to reach the limit.

　The 70 1/2 tax trap

At 70 1/2 you have no choice except to take money out of your IRA (401k). You will need to refer to the appropriate IRS publication to compute the amount. In general thou it is around 5% of your total IRA/401K account value. So if you have a substantial amount in these retirement accounts you have to figure out - do I pay more if I wait to do the required amounts or is it better to draw down the accounts over the next few years until you are 70 1/2. If you feel incapable of figuring this out you may need the help of a capable financial advisor (just avoid those that want to manage your money for a fee unless you need help in that capacity also).

The point is - if you have substantial amounts - at age 70 1/2 you could face some hefty tax bills unless you plan to minimize that bite. Suppose you have $500,000 of retirement assets and have to withdraw $25,000 at age 70 1/2. If single then probably 85% of your SS benefits will become taxable. If you are married you have to consider combined incomes. Say each of you have $500,000 in retirement assets and each have to take a 5% distribution at 70 1/2. That is a total of $50,000. So surely most of your SS benefits will be taxes.

If possible you want to avoid this tax trap. One way is to die and leave the assets to a beneficiary. Then it becomes their problem. Of course it is probably not the preferred solution.

What should you do?

Without knowing your individual situation I cannot answer that question. If Married you could always get divorced and just live together (that way each of you get a $25,000 line in the sand). Not recommending that - just commenting on it.

My personal situation is such that (I am single) that I am under the $25,000 line. So I am able to transfer some funds to a Roth IRA (I don't need it for current living expense) each year and pay taxes at a 10% Federal Income Tax Rate. I doubt I will totally avoid the 70 1/2 tax trap, but I will have minimized the effect.

But as you should see by now - just because you are retired it does not mean you can quit staying on top of your personal financial situation (and tax planning). Good luck in your efforts. A session with a capable financial planner may be necessary to come up with a personal plan.