Help Me Retire Podcast - Episode 17
- Mike Brown
- Mar 27
- 9 min read
Reducing taxes in retirement
Show notes:
This is the Help Me Retire Podcast… with your host… Mike Brown… Senior Wealth Advisor with Raymond James Financial Services… and head of Brown Family Wealth Advisors…
Mike is the best-selling author of Your Way to True Wealth: How to Make It Happen, Make It Last, and Make It Matter…
He and his team have been helping clients pursue their dreams of financial independence for the past 30 years… and in the Help Me Retire Podcast… he’ll share his best ideas with you…
And now… here’s Mike…
Every dollar you pay in income taxes... is a dollar you can’t spend when you retire... so it makes sense to look for ways... legitimate ways... to pay less in taxes... that’s got to be part of your retirement strategy...
It’s unlikely you’ll be able to avoid taxes entirely when you retire, of course... but there are strategies you can employ... to make sure you don’t pay more in taxes than you have to...
And that’s exactly what we’re going to cover in today’s episode of the Help Me Retire podcast... Step 6 of our 7-step process for success in retirement...
So, three goals for retirees when it comes to paying taxes...
One... follow the law... pay what you rightfully owe...
You know the old saying about the difference between tax avoidance and tax evasion, right? It’s about three to five years...
Goal number two... pay as little in taxes as you legally have to... and not a nickel more...
And three... don’t rearrange your life around avoiding taxes... don’t bend yourself into a pretzel... and sacrifice your chosen lifestyle in retirement... just to pay a little less in taxes...
Let’s begin with understanding what’s different about retirement... in some cases... 180-degrees different... for example...
Go from accumulating wealth... with tax advantages... to spending wealth... which triggers taxes...
If you’re smart... you probably saved a lot of money in your 401-k... or other retirement plan... you probably didn’t have to pay income taxes on those contributions... and you might have even gotten an employer match... which you also didn’t have to pay taxes on...
But as you take some of that money out of your retirement plan to pay your bills in retirement... most if not all of it could get taxed... as ordinary income...
Once you retire... you might give up tax breaks... like child tax credits... mortgage interest deductions... and tax-free employer-paid medical insurance...
...and you’ll probably wind up paying some new taxes you hadn’t contemplated... all based on where your income comes from in retirement...
Paying taxes in retirement... is based on a confusing system... full of hidden taxes and penalties...
Some people don’t realize, for example... that for about 40% of Americans... Social Security income is taxable... up to 85-percent taxable...
and if you’re listening to this podcast... you’re probably part of that 40-percent...
And get this... the higher your income in retirement... IRA withdrawals... Social Security... interest... dividends... capital gains... the more likely you’ll pay more for Medicare... possibly three times as much...
When someone starts talking to you... about something called IRMAA... pay attention... it’s not an old girlfriend...
Here’s my point... and I think it applies to just about every step in this seven-step retirement process...
For most people... retirement is a very different way of life... and it’s about more than just... not working...
You live differently... you spend differently... you get paid differently... and... you’re taxed differently than you were before...
And the quicker you understand these differences... and the changes you’ll need to make to your strategy... the happier and more financially successful you’re likely to be...
In an earlier episode of this podcast... Episode 15... we talked specifically about investing in retirement...
And you can’t talk about investing in retirement... without talking about taxes...
Think about your 401-k, for example... or any other retirement plan you might have used to build a nest egg...
You saved a little out of every paycheck... you invested that money in hopes of making it grow...
And thanks to all that saving... and compounding... you might be looking at a lot of money on the day you retire...
But even if it’s a million dollars you’ve got in that 401-k... it isn’t really a million dollars once you factor in the taxes you’ll eventually owe... and the more it grows before you take it out... the more taxes you’ll eventually pay...
By the way... you can’t just leave all that money in there forever
No... at age 73... you’ll have what are called... required minimum distributions...
Every year from then on... every year older you get... the greater percentage of your tax-deferred nest egg you’ll have to take out... and pay taxes on... every year for the rest of your life...
Let’s say you inherit an IRA... even a Roth IRA... from someone other than your spouse...
You’ve got to take that money out... all of it... within ten years...
If those RMDs come from a tax-deferred account... like a traditional IRA or 401-k... that extra income will likely mean more taxable income... which might mean a higher tax bracket... and Medicare surcharges...
So yes... RMDs are a big deal...
They can increase your retirement income... whether you need that income or not...
And they can drive up your tax bill once they start... whether you like it or not...
Your tax or financial advisor can explain how RMDs are calculated... and help you make sure you take out at least the required minimum each year to avoid penalties... which can be as much as 25-percent...
So you might be wondering... is there any way to make those RMDs lower if I’m not going to need all the money at age 73?
Yes, there are... in fact there are several strategies you can use to lower your tax bill once you retire... and we’ll talk about the most popular ones... in just a second...
Retiring isn’t just the day you stop working... it’s a transition... a process...
And as we’re pointing out in this seven-step series... part of that process is being ready to make big decisions... well before you retire...
You don’t want to hand in your two-week notice... and then start thinking about this stuff...
The more you can learn before you retire... the better decisions you’ll make... and the fewer regrets you’ll have later on...
So, here are some of the things that should be a part of your retirement game plan when it comes to paying no more in taxes than you have to...
Start with your income... how much will you be getting... where will it be coming from... and how will it be taxed?
When it comes to investments... it will help you to have three different types of investment accounts: taxable... tax-deferred... and tax-free...
Taxable accounts... as the name implies... generate taxable income in most cases... interest on your savings account, for example... or dividends and capital gains from stocks you bought outside your retirement accounts...
Tax-deferred accounts... like your 401-k and traditional IRAs... have been growing and compounding without getting taxed... meaning you’ll owe ordinary income tax on most if not all of that money as you withdraw it...
And tax-free accounts... like qualified Roth IRAs... allow you to withdraw money without owing taxes... which is a very valuable advantage you shouldn’t take lightly...
When it comes time to creating your retirement income... you’ll need to decide which accounts you’ll withdraw money from first...
Conventional wisdom says taxable money first... cash in the bank, for example... or from after-tax investments...
Then tax-deferred money... like traditional IRAs...
Finally... tax-free money... like Roth IRAs...
Your tax advisor can help you put together a withdrawal strategy... and with money in all three types of accounts... you’ll be able to come up with a blend of withdrawals that’s optimized for your situation...
What about those RMDs? Any way to soften the tax blow when you have to take money out every year? Actually, yes... and here’s how...
First... try to project what your RMD will be the first year you have to take one... if it’s money you’re going to need for spending anyway... then no big deal...
But if those RMDs are likely to be a lot higher than what you need... you might consider converting some of that traditional IRA money... into a Roth IRA...
Roth conversions make sense especially if you’re able to do them in the early years of retirement... while your tax brackets might be lower than when you were working...
Tax advisors often recommend a strategy called... filling-up-the-bracket... converting just enough to keep you in the same tax bracket...
You’ll get more bang for your buck if you do Roth conversions in years when your income is lower than normal... and in years when markets bring down the value of your IRA significantly...
Bear markets allow you to convert a larger portion of your IRA to a Roth... and pay less income tax on the conversion than you might otherwise have to...
Another strategy that’s been available since 2006... is something called qualified charitable distributions... or QCDs...
Once you reach age 70-and-a-half... you can give money directly from your IRA to charity... without paying taxes... subject to annual limits...
If you have charitable intentions... and don’t need the money for spending... QCDs can help you satisfy your required minimum distribution... without paying taxes on it...
Do you have a health savings account?
Remember that you can use money from your HSA to pay for qualified medical expenses... another powerful tax-saving strategy... and we all have health care expenses sooner or later...
I mentioned taxable investment accounts earlier...
Just because these investments generate income that might be taxed... doesn’t mean you always have to pay the full rate...
Depending on your tax bracket... you might find it advantageous to look at tax-free fixed-income investments... such as municipal bonds...
Income from qualified dividends are taxed at preferential rates...as are long-term capital gains...
And you can even offset capital gains with capital losses when you have them... a process known as tax-loss harvesting...
Finally... let’s wrap up this episode with some thoughts on just how to pay your taxes once you retire...
It’s pretty simple when you’re getting a paycheck every two weeks... you tell your employer how much federal and state income to withhold from each check...
And every April 15... you have that money to apply to your tax bill...
It can work the same way in retirement... but it’s not automatic...
You can withhold federal income taxes from Social Security, for example... but not state taxes...
You can withhold federal and state income taxes from traditional IRA distributions... but usually not on income from a taxable account...
So it makes sense to take advantage of opportunities to withhold where you can... but it might not cover all of the taxes you owe each year...
To stay in good graces with the IRS... figure out what your tax liability was last year... and if you’re not able to withhold enough to cover it this year... you might need to start filing estimated tax payments each quarter...
And this is a great time to stress the importance of getting the help of a qualified tax advisor... especially during your transition into retirement...
You might not need professional help every year... that depends on the complexity of your situation... but it’s wise to have someone steer you through the first few years of your retirement...
They can help you avoid costly mistakes that can lead to tax penalties... and show you some tax-saving strategies you haven’t thought of...
And make sure your tax advisor and your financial advisor work in tandem with each other...
You might just discover that good advice can pay for itself... many times over...
In our next episode... Episode 18 of the Help Me Retire Podcast... we’ll wrap up our seven-part series on retiring successfully...
I’m going to show you how to start creating your own legacy...
So that you can pass along the wealth... and the wisdom you’ve accumulated all these years... to the people and causes you care about the most...
Thanks for spending some time with me today... I look forward to talking again soon...
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC.
Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Brown Family Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services.
Any opinions are those of Mike Brown and Brown Family Wealth Advisors and not necessarily those of Raymond James. This material is being provided for informational purposes only and is not a recommendation. There is no guarantee that these statements or opinions will prove to be correct. Investing involves risk, and you may incur a profit or a loss regardless of the strategy selected. Past performance is not indicative of future results. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
Changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
HSAs are never taxed at a federal income tax level when used appropriately for qualified medical expenses. Most states recognize HSA funds as tax-free with very few exceptions but please consult a tax advisor regarding your state's specific rules. Investments available to HSA holders are subject to risk, including the possible loss of the principal invested and are not federally insured or guaranteed, HSA holders making investment should review the applicable fund's prospectus. Investment options and thresholds may vary and are subject to change. Consult your advisor or the IRS with any questions regarding investments or on filing your tax returns. Before making any investments, review the fund's prospectus.
Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and could introduce portfolio tracking error into your accounts. There may also be unintended tax implications. Prospective investors should consult with their tax or legal advisor prior to engaging in any tax-loss harvesting strategy.
