By Cristina Wiebelt-Smith, CPA, Associate Wealth Advisor
You’ve probably spent a good portion of your working years saving for retirement, and now it’s time to start checking things off your bucket list! Part of financial planning is guiding you in making decisions that will allow you to take the trips, make improvements to the house, play as much golf as you want or give more to charities. Focusing solely on investments might get you there, but you don’t want to leave anything on the table.
You worked hard to build these assets, and we want to help you make the most out of them. One big way to do that is through tax planning.
What’s happening in the market is important to your finances, but we also know that tax planning can have a huge impact. In fact, we ask every client to bring in a copy of their tax return and we use tax planning software during most client meetings.
Common Questions about Taxes in Retirement
When you think about your federal tax rate plus your state tax rate, tax savings could range from 15% up to more than 40%. That’s a pretty good return on your investment, especially when it doesn’t depend on the market. With tax season upon us, now is a good time to look at some common tax questions for the retirement years.
Will my tax rate be higher or lower during retirement?
It depends on what types of retirement income you have and what your deductions are during retirement. The current tax rates and standard deductions are set to sunset after 2025. Starting in 2026, the tax rates are set to increase and the standard deduction is set to decrease – this has a big impact on our planning ideas.
What kind of retirement income is taxable?
- IRA distributions
- Annuities – may be fully or partially taxable
- Social Security – see below
Is there any tax-free retirement income?
- Social Security, depending on your other income – see below
- Tax-exempt interest and dividends
- Distributions from Roth IRAs
- Distributions from Health Savings Accounts if used to pay medical bills
Is my Social Security taxable?
It depends on how much other income you have. The IRS uses a number called provisional income to determine how much of your Social Security is taxable. Provisional income is equal to half of your Social Security plus all tax-exempt interest plus all other income.
Most states do not tax Social Security, including Missouri.
Can I still contribute to an IRA?
Yes! Thanks to the SECURE Act of 2019, all retirees can now contribute to a traditional IRA if they have earned income. If you or your spouse aren’t covered by a retirement plan at work, you can deduct the contribution on your tax return no matter how much you earn. If you are covered by an employer’s plan, the deduction is limited based on your income.
Can I contribute to a Roth IRA?
Yes, if your income is under $144,000 for a single filer and $214,000 for married filing jointly. These contributions aren’t tax-deductible, but they can be an integral part of managing your taxable income in retirement because the distributions are tax-free, unlike the traditional IRA. Contributions you make can be withdrawn at any time without penalty or tax. The earnings can be withdrawn tax-free and without penalty once you’ve owned the account for five years and are at least age 59½.
Do I have to take money out of my IRA?
Yes, once you turn 72, the government requires that you take Required Minimum Distributions (RMDs) out of your traditional IRAs each year. The amount is based on the balance in your traditional IRAs and an IRS factor. RMDs are taxable and they tend to increase as you get older, so this can have a big impact on your taxable income. There are planning ideas to help decrease your RMDs, especially between now and 2025 before the current tax rates sunset.
How can I decrease my RMD?
The short answer is by decreasing the balance in your traditional IRAs. Here are three ways to do that:
- Qualified Charitable Distributions, or QCDs – If you send money directly from your IRA to a qualified charitable organization, the distribution is not taxable, it counts toward your RMD and there is no effect on the amount given to the charity! This is one of the easiest planning tools at your disposal. You can actually start making QCDs at age 70 and start decreasing that IRA balance before the RMDs start at age 72. For more details, see The Benefits and Rules of Using Qualified Charitable Distributions.
- Roth Conversions – You can transfer money from your traditional IRA to your Roth IRA. We take money out of the traditional IRA, tax it and move it to a Roth IRA. The Roth IRA grows tax-free and the distributions are tax-free. Roth IRAs are not subject to RMDs, which offers more flexibility in tax planning. Maybe Social Security and pension income cover your living expenses – you can let your Roth account continue to grow without taking distributions until you need them.
- Take a distribution out of the IRA before age 72 and use it to build your savings account, put in that new patio or take the family on a vacation. Consult your advisor to determine if this makes sense with your current tax situation.
Should I roll my 401(k) over to an IRA?
Once you leave an employer, it is usually beneficial to roll your 401(k) into an IRA for several reasons.
- The ability to take advantage of the strategies listed above.
- You’ll have more control over how the assets are invested.
- 401(k)s are subject to RMDs.
- It is tax-free to roll a 401(k) directly from an employer into an IRA. If the money goes through your hands first, it must be deposited into an IRA within 60 days to be tax-free and there are withholding requirements. This also applies to 403(b) plans.
Are life insurance proceeds taxable?
No, life insurance proceeds are not taxable.
Will I have to pay estate tax?
Only if your estate is more than $12.06 million ($24.12 million for a married couple), which is the federal estate tax exemption for 2022. If the value of your estate is less than this exemption amount, no federal estate tax is due. This exemption is set to sunset after 2025 back down to $5 million.
Remember to check if your state has an estate tax. The state exemption could be different than the federal amount. Some states have an inheritance tax, which is paid by your heirs. Missouri does not have an estate tax or an inheritance tax.
Should I start gifting some of my assets?
If you have assets valued close to that $12 million exemption, you may want to start a gifting plan now. Or if you have the funds and want to see your family enjoy the money now, go for it!
- You can gift up to $16,000 per person in 2022 before you’re required to file a gift tax return (Form 709). If you gift over $16,000, you’ll file a gift tax return, but that doesn’t mean the gift is taxable. You can use part of that $12.06 million estate tax exemption to offset the gift and not pay any gift tax. The next few years may be the time to make some gifts before that exemption sunsets in 2026.
- Gifts to a spouse are not subject to the gift tax.
- Tuition or medical expenses you pay for someone else do not count toward the $16,000 as long as the money is paid directly to the school or medical organization.
- Gifts are not taxable income to the recipient no matter what the amount is.
- If you are thinking of gifting anything other than cash, talk to your CPA or advisor.
Don’t put all your eggs in one basket.
This doesn’t just refer to investments – it also refers to the location of your assets. It’s good to have a mix of accounts to pull from during retirement. This allows you to control your taxable income on paper while still pulling enough distributions to fund your lifestyle. Think about setting up an IRA, Roth IRA and joint account.
Lastly, and most importantly, start planning now! If you wait until you are 72, there may be some missed opportunities. We want to collaborate with you and bring tax planning into your financial plan no matter what your age or stage in life.