Thinking about retirement? Here are 7 tax items to consider…
Many people envision a retirement that’s more carefree than their current circumstances. That vision is more likely to come true when retirees are careful about tax implications.
Questions about taxes and retirement are some of the most common that we receive, so I wanted to take some time and quickly review the following seven things to be aware of:
- How Social Security can impact taxes
- Traditional and Roth IRAs: Both can be helpful
- Don’t forget Required Minimum Distributions
- Self-employment and Medicare
- Carefully consider Roth conversions
- Leverage a down market
- Be cautious about annuities
1. How Social Security can impact taxes
People commonly find work in retirement and bring in some level of income above and beyond their Social Security benefits. The higher the income, the more likely the Social Security received will be taxed. In fact, as much as 85% of Social Security can be taxable. CSH performs and monitors this calculation for our clients to help you avoid any surprises.
2. Traditional and Roth IRAs: Both can be helpful
People with traditional IRAs (which are taxable) should consider adding a Roth IRA (which is tax-free income). A Roth IRA distribution is not considered income for the social security calculation. Over the long term, having both types of IRAs will present strategic tax opportunities. The ideal time to convert a traditional IRA to a Roth is right after retirement but before drawing social security, while you’re still in a low bracket.
3. Don’t forget about Required Minimum Distributions
Traditional IRAs require you to start taking distributions at 72, and the penalties for forgetting to do so are serious. As much as 50% of the amount not distributed may go to Uncle Sam. Many financial custodians never remind their clients of this risk, but CSH monitors distribution requirements throughout the year and in planning for future years.
4. Self-employment and Medicare Part B & D
Retirees with self-employment income can write off Medicare Part B and Part D without itemizing or using the “long-form.” It comes right off the front page of your tax return. The catch is your self-employment must yield a net income — or the revenue profit remaining after accounting for all costs and expenses.
5. Carefully consider Roth conversions
Many brokerage firms encourage their clients to convert their entire traditional IRAs to Roth IRAs to avoid paying higher conversion taxes at some point in the future. But this cautionary tale hasn’t played out in reality. Tax rates are actually lower today than they were 25 years ago.
Also, it doesn’t always make sense to convert. If you’re in a high tax bracket now, then conversion may not make sense at all. If you’re in a low tax bracket, because of business losses or other credits like education, then now might be the time to convert. Or, maybe you only convert a portion of the funds. Moving as little as $5000 can keep you from jumping to the next higher tax bracket.
6. Leverage a down market
When the market is down, retirees don’t have to sit tight and wait for things to get better. A savvy financial advisor will use a down market for tax advantages as well as for upgrading client investment portfolios. (Hint: this is what CSH does.) Harvesting losses in your investment portfolio can not only offset capital gains but also can potentially lower the tax on your social security. When capital losses exceed capital gains, a taxpayer can deduct $3000 from their taxable income that year. Any capital losses beyond that can be carried forward to offset future year gains.
7. Be cautious about annuities
I’m not a huge fan of annuities or pay-in financial products that offer a fixed guaranteed future income stream, but they bring some retirees the comfort of earning a reasonable return with no risk of losing their money. Some of the historical problems with annuities — high fees and high commissions — have recently been improved by commission-free, lower-cost products. Some annuities can lower taxes in retirement, offer protection against market downturns, or access foreign markets where the potential for returns are higher. While fixed annuities are low risk and guarantee against loss of principal, it’s still a case of “let the buyer beware.” In other words, it’s up to you to understand what the annuity costs and how long it takes to get out.
Closing thoughts…
Tax laws change all the time, but at CSH our staff has over 60 years of combined on-the-ground tax experience, and this is something that makes us quite unique. As you approach retirement, it makes sense to ask questions about the tax implications.
For retirees, investments and tax issues work together like a big financial puzzle. And we love helping people put all the pieces together in a way that benefits them and supports their retirement goals!
If you’re an existing CSH client and have questions or concerns about retirement and taxes, we are always here to speak with you.
If you’re not a CSH client but are unsure about your retirement readiness please give us a call at 217-824-4211. We would be more than happy to speak with you about your current situation and analyze ways it could be better. We are a fiduciary, and this means we always act with your best interests in mind!