How you position and withdraw your money before retirement and in the early years of retirement can extend how long your assets last by years, or add greatly to the amount that your beneficiaries inherit.
Some financial planners call this the “Tax Planning Window”, because this is the period when people often stop one or more sources of income and replace them with new sources. When and how those new sources are used has both immediate and long-term tax consequences. Since most people retire in their 60s, the 60s and early 70s are a critical time for financial planning, and specifically tax planning.
The effects of smart tax minimization strategies can be significant. In his book, Income Strategies: How to create a tax-efficient withdrawal strategy to generate retirement income, Dr. William Reichenstein, a leading retirement researcher details over 50 different scenarios that: Extend portfolio lifetimes by 1 to 13 years and Save $10,000 to over $100,000 in total taxes over the client’s lifetime.
The Income Sources that need to be correctly planned in your 60s and early 70s:
Work vs. Retirement: People typically decide to retire or reduce their work hours when they are in their 60s.
Social Security Benefits can be started as early as age 62, but there are incentives for waiting until as late as 70 years old to start taking Social Security.
Pensions: Often the lifetime income from a pension (if you are fortunate enough to have one) is determined by choices you make when you first start receiving it.
Withdrawals from your Tax-deferred accounts (such as IRAs, 401(k)’s, 403(b)’s etc).: Money in these accounts can be withdrawn after age 59 1/2 without a 10% penalty, but since any money withdrawn is taxed as regular income, when and how much you withdraw will have tax consequences.
Withdrawals from your Tax-Free Roth IRA or Roth 401(k) accounts: The conventional wisdom recommends delaying withdrawals from your Roth accounts until last (to allow the greatest amount of tax free growth), but this often will not be the optimal tax minimization strategy.
New Tax Issues to Deal with in your 60s and 70s:
Taxes on your Social Security benefits: Your Social Security benefits may or may not be taxed depending on your other income each year and when you start taking Social Security benefits. This causes some surprisingly high marginal tax rates that aren’t published in the IRS’s tax rate tables.
Required Minimum Distributions (RMDs): An increasing percentage of the money in a Tax deferred account must be withdrawn each year starting at age 72 (except in 2020 because of the CARES/Corona-virus legislation). It makes sense to plan while you are in your 60s for the impact of these RMDs to minimize the overall tax effects.
Medicare Income-Related Monthly Adjustment Amount (IRMAA): The Affordable Care Act instituted higher Medicare premiums for retirees as their income levels rise. This is effectively an additional income-related tax. Unlike other taxes, these premium increases are step-increases, so if your income is $1 above the five thresholds, your premiums can increase up to $1,200 per year, effectively a 120,000% marginal tax rate on that additional $1.
Bottom Line:
The Tax Planning Window created by a person’s transition from work to retirement has multiple opportunities to minimize taxes. Unfortunately, there are a lot of “moving parts” between the timing of income and specific taxes that will require a specific, personal plan to achieve all the tax minimization possible.
John Krehbiel is an independent, fee-for-advice, financial planner who specializes in helping busy couples and tech professionals in Brevard County, Florida. Krehbiel Financial LLC is a Registered Investment Advisor in the State of Florida. The information in this article should not be relied upon for the purposes of transacting securities or other investments. You should consult with a financial advisor or other professional to determine what may be best for your individual needs.