Retirement Tax Planning: What are your options?
When considering one’s retirement, people tend to have different lines of thought. Most people think about what they want to do in retirement. They are excited to have the freedom to travel, see the world, and enjoy new experiences. Some will think about where their cash flow is coming from. Other people might project their retirement income to evaluate if it is enough to support their lifestyle. Even fewer will think about the net tax effect of their retirement income taxation. Who really thinks about this? Well, as a financial planner I am consistently looking at the long game on behalf of my clients. The following retirement tax-saving commentary is strategically relevant for people who have or will have saved over a million dollars in their retirement accounts and/or who have a pension.
Consider Sources of Retirement Income
Lately, I have been working with several couples who are retiring early. These couples could be paying more in taxes later in retirement than they paid while working. It is hard to imagine that one would owe more taxes in retirement than during their working years. However, when you start combining multiple income sources, you might be surprised at what you end up owing in taxes. The key to retirement tax planning is knowing your income need, when to elect social security benefits, and what future RMD’s (Required Minimum Distributions) distributions amount could look like.
An example of this is a hypothetical married couple with a combined working income that places them in the 22% marginal tax bracket during their working years. When they retire and start receiving their pension, that pension income could start them in the 12% marginal tax bracket. Next, adding on the social security benefits could move them back into the 22% marginal tax bracket. Then wait a few years and start taking RMDs which could push them into the 24% marginal tax bracket.
The Roth Conversion
One way to help lower this future tax bill is by completing consistent Roth conversions. This is the process of reallocating your assets from a qualified retirement plan to a Roth IRA. Managing the Roth conversion is a way to keep income within a targeted tax bracket and could help lower the overall tax bill during retirement.
The Roth conversion is a tax strategy that came out of the Pension Protection Act of 2006. It is worth mentioning that there is a clause in President Biden’s Build Back Better (BBB) to remove or cap this strategy. Currently, the BBB is stalled and may not get passed in 2022. Just be aware that the government is thinking of changing this. If you decide that a Roth Conversion is an effective strategy, tax rates will increase in the years ahead. Therefore starting sooner rather than later makes the strategy even more effective. A key part of this strategy is allowing those converted dollars more time in the Roth account to grow tax-free. Of course, you must follow the Roth guidelines to have the distributions considered tax-free.
Consult with a Professional
Remember that any tax strategy requires a yearly review and a review by your tax professional to make sure this strategy will work in your specific situation. I am not a tax professional so when I work with a client on implementing a Roth conversion strategy, we consult with their tax professional to understand how it will impact their tax return. If the strategy is of interest to you or if you have questions, please let me know. You can reach me by calling our office at (717) 492-4787 or by email at jsimkins@mystewardshipadvisor.com.
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