If you ask how you can increase your income stability in retirement, there’s a reason why one of the first things we’ll look at is tax planning. Does that surprise you? Most retirees looking to build up a buffer against uncertainties like market volatility, inflation, and healthcare expenses, focus on growing their accounts. They’re looking for ways to generate higher returns, but that usually comes with increased risk, which doesn’t really solve the problem.
In all of the unpredictable retirement costs we just mentioned, we left out the one that is most often overlooked: taxes! Wait a minute–aren’t your taxes supposed to be lower in retirement? This assumption costs retirees thousands every year, a loss that could be prevented with strategic tax planning. Here are the four ways taxes can sneak up on you in your golden years, and what you can do to spend less on the IRS and more on the things that matter to you.
1: Required Minimum Distributions (RMDs)
The thing about RMDs is that, as the name implies, they aren’t optional. Once you turn 73, there’s no escaping mandatory withdrawals from tax-deferred accounts, along with the ordinary income taxes they trigger. That may seem like a fair trade-off for the tax deductions you were able to claim for contributions during your working years, but consider this: if your retirement income will be coming from a traditional IRA, 401(k), AND a pension, you’ll have unescapable, taxable income from each account–pusing you into a higher tax bracket and causing higher taxes for Medicare and Social Securty withdrawals!
If you’d rather not deal with the tax-triggering domino effect of RMDs, there are a few things you can do.
- Opt for a Roth conversion. Roth IRAs have no RMDs, but the tradeoff is that you’ll owe taxes at the time of conversion. By converting after retirement but before RMDs kick in, you can time the taxes for years when you may be in a lower tax bracket, reducing the impact. Keep in mind, you don’t have to convert all at once; you can spread it out over a few years, further reducing the tax implications. Read more about it here.
- Take early withdrawals. As soon as you reach age 59 ½, most people can begin taking withdrawals without a 10% penalty. The earlier you begin taking withdrawals, the more years you’ll have to stretch the income from tax-deferred accounts, minimizing the withdrawal amount and corresponding tax burden.
- Make Qualified Charitable Distributions (QCDs). QCDs can be a great way to satisfy your RMDs while reducing or eliminating taxes. You’ll transfer funds directly from tax-deferred accounts to a 501(c)(3) organization, which counts against your RMD and doesn’t trigger any taxes for you or the charity. QCD limits are indexed annually for inflation, but you can check annual limits as well as deadlines here
2. Medicare Surcharges
Remember that domino effect we mentioned? The higher your taxable income in retirement, the more you’ll pay for Medicare Part B and D (doctors’ visits, outpatient services, preventative care, and prescription drugs). Medicare costs are based on your MAGI–Modified Adjusted Gross Income from two years prior. And if your MAGI is above the annually adjusted threshold, you’ll trigger IRMAA (Income Related Monthly Adjustment Amount). This can increase your Medicare Part B costs by as much as $443.90 per month, and $85 per month for Part D. In summary, you need to plan two years ahead if you want to avoid up to $6,346 in extra Medicare costs per year!
While you can avoid IRMAA by reducing your taxable income through the strategies previously mentioned, you can also supplement your savings to offset higher premiums:
- Save with an HSA. Health Savings Accounts are a favorite among tax-savvy retirees for three reasons: tax-deductible contributions, tax-deferred growth, and tax-free withdrawals. While you can use HSA funds for non-medical expenses without incurring a fee after age 65, withdrawals will count as taxable income. Instead, save your HSA to offset the costs of higher Medicare premiums, which can free up the rest of your retirement income for its intended use.
- Invest in Modern Life Insurance™. With new life insurance products available, specifically Whole Life Insurance, you can take tax-free loans from the cash value of your policy, providing an emergency income source that won’t increase your tax bracket. As with an HSA, these funds can act as a buffer for your nest egg.
3. Social Security Taxes
Medicare isn’t the only thing that costs more the more you have saved for retirement. Social Security benefits aren’t taxed per se, but they do count toward your overall taxable income. For single filers with total annual income above $34,000 or joint filers with a combined annual income above $44,000, you may pay taxes on up to 84% of your Social Security benefits. This is especially important to weigh when deciding whether or not to delay taking Social Security, as the increased benefits can contribute to higher taxable income.
- Reduce taxable income and generate reliable income with a Fixed Indexed Annuity (FIA). While there’s nothing you can do to directly reduce the tax implications of Social Security benefits, you can reduce your taxable retirement income through any of the ways already mentioned, as well as with Modern Annuities®. Just as with a Roth conversion, this is a taxable event, with the tradeoff of converting tax-triggering retirement income to a tax-free asset. New annuity products allow you to benefit from market gains without losing out due to market drops while generating monthly dividends. Win, win, win. When funded from an IRA or 401(k), you’ll reduce the size and tax implications of your retirement account while simultaneously reducing your investment risk and generating reliable income to cover surprise taxes or supplement your income as you see fit.
4. You Outlive Your Spouse
Wait, there’s a tax on losing your spouse? Yes, you read that right, although the IRS doesn’t phrase it that way. Couples who are married and filing jointly enjoy lower tax rates than single filers. And most couples have multiple retirement accounts between them: two IRAs, possibly two 401(k)s, and often a pension as well. Consider that when one passes, the other inherits their partner’s retirement account(s). If the inherited accounts are tax-deferred, that means a steep increase in taxable income with a simultaneous increase in tax rate. Without proper planning, aggressive saving during your working years can leave your grieving partner with a substantial tax liability.
- Convert taxable accounts to tax-free assets. This is one of the most important reasons why we emphasize strategies like Roth conversions and prioritizing after-tax assets like Modern Annuities® and Modern Life Insurance™. With a Whole Life Insurance policy alone, you can leave a tax-free death benefit to your loved one that they will have immediate access to. No lengthy legal proceedings via probate, and no need to sell an asset and trigger capital gains taxes. They’ll have funds available that they don’t have to think about, not only as a financial buffer while they’re grieving, but as income that doesn’t impact their income taxes.
Save Your Nest Egg by UnTaxing Your Retirement
This is just the tip of the iceberg when it comes to minimizing taxes in retirement. We take immense pride in helping retirees convert tax liabilities to income assets, not only because of the impact on their bottom line, but because we’ve seen the intangible results: less stress, more freedom, and increased retirement satisfaction! If you’re ready to untangle your savings from higher tax rates, attend one of our educational events or request your free copy of Greg Parady’s revolutionary retirement book: “UnStress and UnTax Your Retirement™”.
