Retirement Planning October 2023

Benjamin Franklin, once said “Nothing is certain but death and taxes.” When you retire, you will still pay taxes on your investment and retirement accounts. In fact, income taxes along with healthcare expenses will probably be among your largest expenses in retirement. You can't avoid income taxes during retirement. But once you stop working, you stop paying taxes for Social Security and Medicare, which helps reduce taxes.

Company Retirement Plan and Individual Retirement Plan Taxation

When you receive income from your traditional 401(k), 403(b) or 457 salary reduction plans, you'll owe income tax on those amounts. This income is taxed at your regular ordinary rate. Keep in mind that withdrawals of contributions and earnings from Roth 401(k) accounts are not taxed provided the withdrawal meets IRS requirements.

When you start your contributory traditional IRA distributions, you owe tax on the earnings portion of those withdrawals at your regular income tax rate. If you deducted any portion of your contributions, you'll owe tax at the same rate on the full amount of each withdrawal.

If you have a Roth IRA, you'll pay no tax at all on your earnings as they accumulate or when you withdraw following the rules. But you must have the account for at least five years before you qualify for tax-free provisions on earnings and interest.

Pension Taxation

You have to pay income tax on your pension and on withdrawals from any tax-deferred investments—such as traditional IRAs, 401(k)s, 403(b)s and similar retirement plans, and tax-deferred annuities—in the year you take the money. The taxes that are due reduce the amount you have left to cover retirement expenses.
You will owe federal income tax at your regular rate as you receive the money from pension annuities and periodic pension payments. But if you take a direct lump-sum payout from your pension instead, you must pay the total tax due when you file your return for the year you receive the money. Some states do not tax pension payments while others do—and that may influence where a retiree lives when in retirement. If you’ve moved your legal residence to another state that has no state income tax, you don’t owe any income tax on the pension you receive from your former employer. Lastly, if you transfer a lump sum directly to an IRA, taxes will be deferred until you start withdrawing funds.

Social Security Taxation

Many retirees are surprised to learn they might have to pay tax on part of the Social Security income they receive. Whether you have to pay such taxes will depend on how much overall retirement income you and your spouse receive, and whether you file joint or separate tax returns. Generally, the higher that total income amount, the greater the taxable part of your benefits. This can range from 50 to 85 percent depending on your income. There is no tax break at all if you're married and file separate returns.
Ways To Minimize Retirement Taxes.

Reduce your taxable income by delaying distributions from your retirement accounts and using taxable accounts investing in tax-efficient investments to lower your tax rate versus your tax rate on your retirement account distribution. For example, the age you are required to a make a required minimum distribution from your Individual Retirement Account (IRA) is now age 73. The monies left in your IRA or IRA Rollover can grow untaxed for longer now. If possible, use assets in your taxable brokerage accounts such as Trust account, individual, or Joint account.

Interest paid on investments in taxable brokerage accounts is taxed at your regular rate. But other income—from both your capital gains and qualifying dividends—is taxed at the long-term capital gains rate of between 20 percent and 0 percent, depending on your tax bracket. This is true when you have owned the investment for more than one year. You can use capital losses on some investments to offset capital gains on others to even offset taxable income tool. Furthermore, you might be able to invest in triple tax-free municipal bonds (free of federal, state, and local taxes) and or US Treasuries free of state income tax.
You can also invest in investments that produce qualified income. Qualified dividends are a type of dividend that can be reported to the IRS as a capital gain rather than income. This means that for some taxpayers, qualified dividends are taxed at a lower rate than ordinary dividends, which are taxed at income tax rates. The maximum tax rate for qualified dividends is 20%. Ordinary dividends are taxed at income tax rates, which as of the 2023 tax year, maxes out at 37%. US dividend paying stocks and Preferred stocks are two examples.

This lower tax rate on most of your earnings is one of the major advantages of taxable accounts, though it's not the only one. There are no required withdrawals from taxable accounts and no tax penalty for taking income from these accounts before you turn 59½. This means you have greater flexibility in deciding which investments to sell for income and which to hold onto for growth that could help replenish withdrawals.

What Else?

Evaluate the benefits of delaying Social Security and Pension payments. Delaying payments will lower taxable income and increase future payments. Contact Aspetuck to discuss in more detail.

Consider investing in a Roth IRA or converting an IRA to a Roth IRA. Please contact Aspetuck to discuss pro’s and cons.

Source: Taxation of Retirement Income, FINRA. What Are Qualified Dividends, and How Are They Taxed? - Investopedia.

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