Planning for retirement is a key component of maximizing your income. The more income you have the more you can spend it or pass it on to your heirs.
There are many articles on retirement tax planning. Our goal is to give you more than just the “how-to”, so that you don’t rely on others’ words. We’ll explain 6 important things about retirement tax planning.
When I tell people I’m a financial advisor at a social gathering, they are always inquisitive. You can see, I have had many interesting conversations with strangers. These are some of the most frequent questions I receive:
- What tax rate will I have when I retire?
- Are my Social Security Benefits subject to tax?
- What can I do to plan for my retirement?
These and other questions will be answered by the end.
Table of Contents
No matter if you have a financial advisor, the key to a successful plan is you. Only you can decide what your retirement life will look like.
If you are anything like me, then you will want to know how many times you can eat out. You might also want to know how many weeks you are able to live abroad each year. Or ….perhaps you are just looking for a side of guacamole with a $4 price tag and not feeling guilty.
It is important to determine how much money we can spend. This is a unique decision for each person.
Now that you have a rough idea of what you will need for retirement, you can start to plan how you will make it happen. It is important to determine how much you can withdraw each year and where to get it.
The first financial statement that you will require is your balance sheet. This includes a separate column listing your assets and liabilities. Your net worth is the difference between these amounts.
Next, you’ll need to list your annual income as well as expenses on your personal income statements. Your income shortfall is the difference between these amounts.
Your net worth is like your water well. And your income shortfall is the water. Or you will go hungry. In our case, it could lead to you losing your assets.
Inflation is a major obstacle for retirees. Each year, the cost of goods increases. Social Security benefits include a cost-of-living adjustment (COLA), which helps keep up with inflation.
However, if you have a private retirement plan, the COLA may not be included. This means your purchasing power will decrease over time.
The chart shows that inflation has averaged more than 2% in the past 20 years. This is a lower rate than the historical average 3.1% inflation rate since 1913. It still takes a lot out of your purchasing power.
It would be $2,555 to buy the same thing that cost $100 100 years ago! It is important to determine how much money you will need to spend in the future and now.
It’s up to you. It’s up to you, the bad news. In retirement, you have almost complete control over your income decisions. It is important to maximize your income and pay the least tax.
First, you must understand how the tax system works. Social security and retirement account rules will be important. You will also need to be familiar with tax-efficient investing.
That’s why you came here, isn’t that? Let’s begin with the basics of retirement tax planning: how taxes work in retirement.
The federal income tax system in the United States is progressive. This means that income levels increase and tax percentages rise. Wages, salaries, interest, and dividends are all examples of ordinary income. Retirees should be more concerned about taxable Social Security benefits, and IRA withdrawals.
Federal taxes start at 10% for all. Federal marginal tax brackets can go up to 37%. Line 10 of schedule 1040, which is the most recent tax return you have filed, will give you your taxable income. You can see the bracket in which you fall by looking at this table.
Every dollar earned above your marginal tax rate will be subject to tax. Let’s take, for example, a single-filing taxpayer with a taxable income of $40,000. They are within reach of moving from the 12% marginal tax bracket up to the 22% bracket. Their bank account is running out and they need $30,000 to cover their living expenses.
The $30,000 they receive from an IRA account counts as normal income if they take it all. This means that they will pay a marginal income tax of 22% on federal income tax. This does not include state income taxes, depending on where you live.
You could save on taxes if you withdraw $30,000 from a Roth IRA, taxable account, or a Roth IRA. You should think twice about where your income comes from each year.
A key tool for retirement planning is the favorable capital gain tax rate. Capital gains are when you sell a capital asset at a higher price than you paid. Capital assets include stocks, bonds, real estate, precious metals, cryptocurrency, etc.
You can sell the stock for a profit, but keep it for one year. This is called long-term capital gains (LTCG). The table shows the details. These rates are lower than your marginal taxes rates, as you can see.
A capital asset that you have sold for less than one year is subject to ordinary income tax. This is known as short-term capital gains (STCG), and it will be subject to your federal marginal taxes rate.
What would you do if you were to sell a capital asset for a loss? Here’s how to treat the loss in this case:
List all your short-term losses
- quick-term gains offset short term losses
- long term gains can be offset with long term losses
- Compare your net loss/gain to your short-term gain/loss
Here’s how to treat the results:
- A Net LTCG is taxed at long term capital gains rates
- A net STCG – Taxed at your marginal tax rate
What if you have a net loss? You can deduct $3,000 of the loss in your current tax year, regardless of whether it is short-term or long-term. Restricted losses can be carried forward indefinitely. These losses can be used to offset future gains. You can deduct up to $3,000 from your ordinary income if you have no gains in a year.
Withdrawing from your retirement account can help you save a lot of taxes when you retire. All the hard work and saving that you made during your working years is now paying off. You can lose a lot of your savings by not having an income distribution plan. You can’t do that. Your newly acquired skills in retirement tax planning will be used to your advantage.
Any account that is not a retirement account can be considered taxable. As a child, think about your brokerage or bank accounts. Or the stock certificate that your granny gave to you. These accounts are often jointly owned by married couples or in the names of their trust.
Capital gains rates, which we have already discussed, apply to assets held in these accounts. You should pay particular attention to your taxable account’s cost basis and holding period.
Qualified dividends earned from stocks that are held in taxable accounts are also subject to lower capital gains rates. However, interest income in a taxable account is treated as ordinary income along with STCG’s.
You can see that a sale of an asset can be subject to different tax rates. The income, dividends, and interest that an asset generates can all be subject to tax. You can save a lot of money by having capital loss rules. We’ll get to that in a moment.
The most popular type of retirement account is the tax-deferred one. You can think of 401k, 403b, IRA, and pensions. These accounts were exempted from tax for every contribution.
If you’ve invested your money well, compounding should give you a lot of growth. You see the number at your statement’s top that says “Account Value?” It is not yours alone. The IRS is your silent partner and will wait for your distributions.
They are also subject to the highest tax rates when they first open. You should be cautious when withdrawing or rolling over these accounts.
This post was written by All Seasons Wealth. At All Seasons Wealth, we provide expert advice and emphasize the importance of creating in-house portfolios to personalize your strategy for asset management, financial planning, and cash management. We utilize research and perform market analysis to provide you with financial planning in Tampa. No matter your needs, we can work with you to develop a consulting solution tailored to you.
Any opinions are those of All Seasons Wealth and not necessarily those of RJFS or Raymond James. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Every investor’s situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making any investment. Past performance may not be indicative of future results.