Tax planning shouldn’t be an afterthought
There are so many elements of a comprehensive retirement plan, such as applying for Social Security, investing, planning for long-term care costs, and estate planning. The one thing they all have income for is taxes. Tax planning touches on all elements of a person’s financial plan, which is why it should never be an afterthought.
The first thing to realize when planning for retirement is that taxes don’t stop when you stop getting a paycheck. Taxes could still be one of your biggest expenses, which is why you need to incorporate tax planning into your overall financial plan.
How will your retirement income be taxed?
Although you paid into Social Security during your working years, you may still have to pay taxes on your Social Security benefits. If your provisional income as an individual is between $25,000 and $34,000 or between $32,000 and $44,000 as a married couple filing jointly, up to 50% of your benefit may be taxable. If your provisional income as an individual is over $34,000 or over $44,000 as a married couple filing jointly, up to 85% of your benefit may be taxable. Note that these income thresholds have not increased since they were first instituted in 1984, and there are currently no plans to adjust them for inflation. If you are close to this threshold, consider that inflation could push you over and trigger this tax.
If you have a private pension, your pension payments may be taxed at ordinary income rates. If you’re like most retirees these days, you don’t have a pension, but you might just have a 401(k) or an IRA. These are tax-deferred accounts, meaning what you withdraw will be taxed as ordinary income, plus a 10% federal penalty if you withdraw before age 59½. Keep in mind that at age 72, you will most likely need to make minimal withdrawals from your tax-deferred retirement accounts. These amounts are set by the IRS and may require you to withdraw more than you normally would in a year, increasing your tax liability.
You may also have other sources of taxable income in retirement, such as investment gains and dividends, rental income from property, or the sale of your home. There are potential tax reduction strategies available for all of these with the right amount of planning and knowledge. For example, at any age, you can take $250,000 tax-free from a home sale if you meet the conditions, including living there two out of the last five years – that doubles to $500,000 for married couples. The two years do not have to be consecutive. This does not apply to other real estate sales, only primary residences.
Will taxes increase in the future?
We may be living in a time of historically low income tax rates, but that may soon change. Government programs such as Social Security and Medicare are under strain and government spending has increased during COVID. We recently saw President Biden propose a new billionaire minimum income tax, which could also affect many people who are not billionaires. Although this is only a tax proposal, it could be indicative of the direction that tax policy will take over the next 10 years.
At the end of 2025, we will likely see the Tax Cuts and Jobs Act expire, and no one knows what will replace it. That’s why it’s important to plan for tomorrow’s tax rates, not just today’s.
Foresight is 20/20
Many of the most effective tax strategies require foresight and advanced planning – sometimes years in advance. For example, a Roth conversion is a strategy that could potentially pay off for many years. In exchange for paying tax on the retirement savings you convert from a traditional IRA to a Roth IRA at today’s known tax rates, you can enjoy tax-free income five years from now. or older (after the account has been open for at least five5 years and you are age 59½ or older).
Ask yourself if you think taxes will go up, down or stay the same over the next five years. Depending on your answer, a Roth conversion could be a viable long-term tax minimization strategy.
A Roth conversion could be especially helpful if you’re retired and under age 72, the age at which you should start receiving required minimum distributions (RMDs) from a traditional IRA or 401(k). Once you reach this “magic” age of RMD, you cannot convert any dollars that are part of your RMD – only dollars beyond your RMD. Many times this severely limits the ability to continue performing Roth conversions. Additionally, with tax rates expected to rise in the near future, there is no better time than the present to essentially “buy out the government” at today’s historically low tax rates.
If you have a charitable bent and are at least 70.5 years old, using a Qualified Charitable Distribution (QCD) might be for you. Simply put, you can send contributions to qualifying charities directly from your IRA and avoid paying taxes on the amount contributed. If you were otherwise taking the standard deduction, using this strategy essentially allows you to take the standard deduction AND a charitable deduction without having to report the QCD as income.
It’s not what you earn, it’s what you keep
As the saying goes, it’s not what you earn, it’s what you keep. When we think about our biggest expenses, we often overlook taxes because we assume there’s nothing we can do to change the amount we owe. However, this is often not the case. Tax planning and developing tax strategies is one of the five main areas we address in our process of developing financial plans for our clients. Seeing tax planning as an integral part of an overall financial plan rather than a separate afterthought could make a big difference in retirement.
We are an independent financial services company that helps individuals create retirement strategies using a variety of investment and insurance products tailored to their needs and goals. We do not provide tax, estate planning or legal advice or services. Always consult qualified tax/legal advisors regarding your own situation. We are not affiliated with Medicare or any other government agency.
Harlow Wealth Management Inc. is an SEC-registered investment adviser and a registered insurance agency in Washington State and other states.
Investing involves risk, including possible loss of principal. Insurance and annuity guarantees are backed by the financial strength and claims-paying ability of the issuing company.
CEO, Harlow Wealth Management
Chris Harlow is a CPA and CEO of Harlow Wealth Management, serving Metro Portland and Southwest Washington to help clients develop their financial strategies for retirement. Chris’ past experiences have instilled in him a dedication to guiding clients through tax and retirement strategies. He has passed the FINRA Series 65 Securities Examination; holds life insurance licenses in Washington, Oregon and Arizona; and has his CPA license.