Lower Taxes in Retirement? By Katherine S. Newton, CFP®, CeFT®
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t is a long-held assumption that when you retire, your taxes are lower and as a result, you have more expendable income. While this may be true for some, it can be a dangerous and costly assumption to make. Without proper planning, the opposite can actually be true. Let’s consider Sarah who is single and 57 years old with most of her retirement savings in her 401-k plan and in her traditional IRA. She also has an account invested in dividend-paying stocks and bonds, inherited from her parents. None of the 401-k or IRA money has ever been taxed, but she knows it will be taxed when she withdraws it in retirement. Without any fancy footwork or investing prowess, her 401-k easily doubles by the time she retires at age 67. She then consolidates the 401-k balance into her IRA account. She decides to wait until she is 70 1/2 to take her first withdrawal, the year in which she is required to take her first RMD (required minimum distribution), working part-time as a consultant and using Social Security plus interest and dividends to live on until then.* But when she files her taxes the next year, she has an unpleasant surprise. The RMD along with her Social Security income plus the income from her stock and bond portfolio puts her in the next highest tax bracket, a higher bracket than the one she was in when she was working full time! And the amount of her Social Security income on which she must pay taxes has increased from 50% to 85% so that after taxes, her social security income is almost halved! Thirdly, her Medicare premium (which is based on her income from two years earlier when she was still working) increases as a result of “means testing.” Her MAGI, or modified adjusted
114 — Summer 2019 CAROLINA MOUNTAIN LIFE
gross income, which includes tax-free interest she earns on her municipal bonds, puts her over the next higher threshold for paying Part B Medicare premiums. So her income after taxes and Medicare premiums is actually lower as a percentage of her total income than it was when she was working! What could she have done to avoid the scenario where her income in retirement requires her to pay more in taxes, more taxes on her Social Security, and higher Medicare premiums, a scenario in which she seems to have been unfairly penalized simply for having saved so well while she was working? Here’s what the 57-year-old Sarah does instead as a result of working with her long-time Financial Advisor who shows her the best way to increase her after-tax retirement income: Since her 401-k plan offers her the choice of either saving into the pretax traditional bucket or into the aftertax, or Roth, bucket, she begins to put all of her current and future retirement savings to work in the Roth. This means that the money she saves is currently taxed before it goes into the plan. But she chooses to pay the taxes now while she is working, knowing that after the money is in that account, there are no more taxes along the way or during retirement. She also decides to “convert” part of her pre-tax IRA to an after-tax Roth IRA during the early years of her retirement when her taxable income is low. She knows that while taxes must be paid on the amount that is converted, there are no more taxes for her to pay during retirement on that money. Thirdly, she sells some of her appreciated stock during early lowincome retirement years so that her capital gains taxes are lower than if sold in a high-income year.
Working closely with her CPA and Financial Advisor, she takes advantage of other strategies to increase her after-tax retirement income and also to lower her Medicare premium. And she continues to revisit the plan with her advisor annually as tax and retirement plan laws change. For you, any one or a combination of these strategies may help you avoid the “Stealth Tax” surprise, so that you have more retirement income available to spend and less going to taxes or Medicare surcharges. As a result of careful planning, your increased after-tax retirement income can help you to more fully realize your dreams. *At story submission time, there is legislation before Congress to extend the beginning date for required minimum distributions to age 72. The views are those of Katherine Newton and should not be considered investment advice or to predict future performance.Past performance does not guarantee future results.All information is believed to be from reliable sources.However, we make no representations as to its completeness or accuracy. Please note that neither Waite Financial, LLC, Cetera Advisor Networks, LLC, Carroll Financial Associates or any of their agents or representatives give legal or tax advice. For complete details, consult with your tax advisor or attorney. Investors should consider their investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing. Before investing, the investor should consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. Registered Representative offering Securities through Cetera Advisor Networks LLC, a broker dealer and Registered Investment Advisor, Member FINRA/ SIPC. Advisory services offered through Carroll Financial Associates Inc., a Registered Investment Advisor. Waite Financial, Cetera Advisor Networks, and Carroll Financial Associates are unaffiliated.