Gabe Fransen | June 3, 2022

As you move from your working years to your post working years, the transition can be complicated. Instead of income coming into the household and investments being added to, it’s now time to take distributions from those retirement accounts for your income needs.

With the lifestyle and financial changes that occur when going from working years to post working years, there are plenty of taxation questions that may arise. We’ll cover some of the most common concerns and strategies that we see in our office as we collaborate with our clients and their tax professionals to confirm and proceed with recommended strategies to reduce tax liabilities during retirement years.

What are we seeing

• Social Security income tax questions
• Planning for annual taxable income needs
• Roth Conversion Planning needs

Social Security Tax

Provisional Income, 1/2 Social Security + other income sources is how most of your Social Security will be taxed.

Social Security benefits are taxed at one of three rates (tax year 2022):

• 0% for provisional incomes $32,000 for those married filing jointly
• 50% for provisional incomes $32,001 to $44,000 for those married filing jointly
• 85% for provisional incomes greater than $44,001 for those married filing jointly

These are percentages of your Social Security income that will be taxable – not the tax rate on the Social Security income.

If you chose to, you can essentially prepay your taxes by doing a withholding, this is federal withholding only, not state.  

Without proper planning, you might create a “tax bomb”. This happens when retirees have additional realized income that increases the percentage of Social Security income that is taxable. This sometimes happens when:

• You are required to take your RMD (required minimum distributions)
• Your Non-Qualified accounts have realized capital gains
• Unexpected expenses arise and need to be funded from retirement/taxable accounts

Annual planning with a financial adviser in partnership with your tax professional can help determine and plan for how much of your Social Security income will be taxable each year.

Annual Taxable Income

There are basically two types of Income:

• fixed (Social Security, pensions, and annuities)
• variable (investment accounts, traditional and Roth IRAs, 401(k) accounts).

The nice thing about fixed income is that it is a consistent income source; however, it limits options for creative tax strategies.

Variable income allows for income timing and tax planning opportunities such as: 

• Roth conversions
• Qualified charitable distributions (QCDs)
• Tax gain or tax-loss harvesting 

Working with your financial adviser and tax professional can help you find the best strategy or strategies for your situation on an annual basis. It is important to plan for these things before the end of the year, we like to talk to our clients about these topics in late Q3 or early Q4, this allows them to then have conversations with their tax professional and collaborate on the plan for implementation. If you wait until tax time to have these conversations, you won’t be able to benefit for the current filing year because it will be too late.

Business owners have the ability to time income and expenses into their plan to help mitigate tax liability and/or plan for sales of the business to be distributed over time to eliminate the “tax bomb” scenario.

Benefits of Roth Conversions

We often see clients or prospective clients with the majority of their retirement assets in tax-deferred accounts like 401k, 403b, traditional/rollover IRA with the remaining and typically smaller amount of assets in Roth accounts. The story that is often told to young and old investors alike is that, you are doing yourself a favor by taking a tax break during your working years where your income is higher, you are in a higher tax bracket, deferring that taxable income to when you are in a lower tax bracket (in your post working years). That is a good theory unless you want to maintain your working years lifestyle in your post working years and with the current low tax rate environment, it might actually be more beneficial to pay your taxes now if tax rates and tax bracket go the other direction in the future – see Tax Cuts and Jobs Act below. This problem becomes compounded once folks hit age 72 (current RMD age) and they are forced to take distributions from their tax-deferred accounts.

With a proper spending/expense plan and income plan in place, Roth conversions can maximize retirement assets by reducing long-term tax liability with a strategic Roth conversion plan.

Roth conversion 101: Transfer assets from a tax-deferred retirement account (ie: Traditional IRA, 401K) into a Roth IRA. The amount converted will be counted as income and taxed as such for the tax year the conversion takes place because it is considered a distribution from the tax-deferred account. Now that the assets are in the Roth IRA:

• They will never be taxed again
• They grow tax free
• They are no longer part of the RMDs

Because the amount converted will be counted as income in the year converted, it is important to know about the fixed income and variable income of the current tax year so that you know how much room you have in your current tax bracket that you can convert and not bump yourself into the next tax bracket. This is where coordination between the financial adviser and the tax professional is very important.

Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act of 2017 (TCJA) was a law passed by Congress that drastically overhauled how our taxes are calculated.  One of the more notable changes is that almost every tax bracket dropped by 1-3%, so the vast majority of middle class Americans are paying lower taxes.

Those beneficial changes in tax brackets implemented as a result of the TCJA are set to expire at the end of 2025. These lower and larger brackets could sunset as scheduled, they could change with other legislation, or Congress could decide to make them permanent. Assuming the TCJA-related tax cuts sunset in 2025 without Congressional action, the timing is right for Roth conversions. In doing a Roth conversion, taxpayers could leverage today’s lower tax rates while allowing the converted amount to continue to grow tax-free until and into retirement.

What About State Taxes?

One last thing to keep in mind is that while state taxes matter, they are almost always lower than federal taxes. In most circumstances, it’s best to plan around federal taxes and let the state taxes fall where they may.

Work with a Financial Adviser and Tax Professional

Knowing your future tax liability and the strategies to mitigate or lower the liability could save you 10’s of thousands or maybe even 100’s of thousands of dollars throughout retirement years. Working with a Financial Adviser in conjunction with a Tax Professional that will identify and help navigate the implementation of advanced tax strategies is a very important component of a retirement plan.