Are you thinking about your retirement and how taxes will affect your situation? It is never too early to consider the role of taxes on your retirement, and if you are past age 59 ½ this blog is directed towards you. In fact, if you have someone close to you in this age range I recommend you read this thinking about yourself and them. Not only do people of retirement age need to consider their taxes in retirement but younger people need to be aware of the implications as well. As I tell people all the time it is never too early to save, plan for retirement, and consider the fact that taxes are unlikely to go down in the future. Most people who are retiring today have IRA accounts as well as 401(k) accounts from their employers. The rules for both are very similar and regardless of what else you do or plan for you will be required to make Required Mandatory Distributions (RMD’s) from both accounts at age 70 ½. So here are some tips and techniques to use along the way at different ages between 60 and 70 ½.
Now that you are 60 you can access your IRA with no penalties associated with the withdrawals. But there is more to consider before you should make any of these withdrawals. If you have been saving during your working years, these funds may have been growing tax-deferred for 30-40 years. Another ten years of growth in these funds will increase your account balance like you would not believe. If you need proof go into Excel and use the Future Value (FV) function and run the numbers yourself. The longer the money is left in the account, the higher the value will be and as the program will show the contributions made at the beginning of the account will have the most dramatic effect on its value. Money that is allowed to compound over 40-50 years will increase the bottom line in an IRA’s value.
Also, you will need to consider what assets are held where prior to your retirement and maybe even after you have retired if you did not do this sooner. The reason you have to consider the tax implications is because some assets are taxed at a lower rate than an IRA. Depending on the tax bracket, you will be in after you retire will determine where assets should be held. Taxable bonds and real estate investment trusts should be held in a tax deferred account as they are taxed as ordinary income in the year they earn dividends and interest. Dividend paying stocks and mutual funds along with equities that will appreciate in value should be held in taxable accounts as they are tax advantaged in the year payments are made, or a long term capital gain is achieved. Regardless of what kind of gain is realized in an IRA it will be taxed as ordinary income in the year in which the withdrawal is made. While no one knows what taxes will be like in the future I think, it is a safe assumption that they will most likely be higher than they are today.
At age 60 and in many instances as soon as you change jobs it may be a wise decision to roll old 401(k) accounts into your new 401(k) account. Some people advise rolling old 401(k) accounts into IRA’s and in many instances that does make sense. Regardless of what you do with older accounts a smart move is to consolidate them into one or two accounts to reduce fees and expenses. Also, it makes sense to continue to make contributions to your IRA between the ages of 60 and 70 ½ when RMD is required. And to better prepare for your RMD’s project your future balance in your IRA and calculate what the RMD will be. This is a valuable tool in planning for your retirement and possible tax consequences.
Age 65 and 66 for current retires or those born prior to 1954. For people in this age range now, it may make sense to withdrawal funds from IRA accounts now to live off of and lower your RMD’s at age 70 ½. A strategy that this makes sense for where you will forego the additional 4-5 years of tax-deferred growth is to delay taking one’s Social Security benefits until age 70. By doing this, you are getting a guaranteed 8% return on your money as that is what Social Security will increase your monthly benefit by each year for three years or until you reach age 70. That is automatic 24% raise in Social Security benefits, which you may not see in your IRA for the same period.
Also, there is a need to consider Medicare premiums as well. As most retiree’s will be relying on Medicare in their retirement making withdrawals from an IRA having an adverse impact on the premiums paid by Medicare Part B. If you increase your Modified Adjusted Gross Income too much it could actually affect the premiums you will be forced to pay for Part B. Check with the IRS tables to see what the cutoffs are or consult a tax professional. But this is definitely something that does need to be kept in the back of your mind if you are younger or examined now if you are nearing retirement age.
If you are age 70 ½ there are a few items to discuss as well. One is always trying to avoid making two RMD’s in the same tax year. As you are allowed to make the first RMD by April 1st of the year following your turning 70 ½ it could cause you to actually make two RMD’s in the same tax year with the second being required by December 31st. To avoid this make the first RMD in the year you turn 70 regardless of when that is and make your second RMD in the year you turn 70 ½. That will make your tax base lower and could save you some pretty serious money depending on how big your RMD’s are. And always make your RMD’s avoid a very costly penalty as well. By doing that you will also create a stream of income that you can rely on and count on for your living expenses. And in the chance your living expenses are already covered by other means you can then turn your RMD into a charity gift avoiding the taxes on the RMD and reducing your Adjust Gross Income with the gift to your favorite charity.
Retirement can be a scary time in most people’s lives, but it does not have to be. With a little planning and proper forethoughts it can be the golden and happy years you have dreamed of. If you have any questions or need any additional help, please feel free to contact me.
