Helpful miscellaneous articles
regarding our retirement plan and planning.
Like you, I review my retirement nestegg and plan from time to
time. Recently, I went though some
continued education for some credentials I maintain and it occurred to me that
we all could use a review about these issues.
So with your help, we will share and post articles and info that may be
helpful and of interest to many of you in this section.
2
articles in this segment:
How to Use the New Tax Law to Live
Tax-Free in Retirement
How do you position your
retirement savings to protect yourself from rising taxes? Here are your options,
explained.
Feb 19, 2018 7:37 PM EST
By Dennis Drake
Should you really be concerned about higher taxes in retirement?
Didn't taxes just go down? Yes, for most middle-income retirees the Tax Cuts
and Jobs Act represents a significant tax cut.
But, let's look at what's going on in our country. On Jan. 1,
2008, the first of now 75 million boomers began to retire from the work force
and move onto the rolls of our nation's retirement programs.
Since 2017, payroll taxes alone don't create enough tax to cover
the cost of Social Security payments. The government will have to make this
revenue from other areas. Where? And what about, Medicare, Medicaid, and on and
on? We are currently $20-plus trillion in debt. All indications point toward
higher income taxes.
In fact, the Congressional Budget Office projects that if
"Social Security, Medicare and Medicaid go unchanged, the rate for the
lowest tax bracket would increase from 10% to 25%; the tax rate on the incomes
in the current 25% bracket would have to be increased to 63% and the tax rates
on the highest bracket would have to be raised from 35% to 88%."
OK, now the good news. The new tax bill is designed to sunset in
2025. Why is that good news? We have a seven-year tax planning window to remove
these taxes at a minimal level. The question now is "How do you position
your assets to protect yourself from rising taxes?" What are our options?
Let's begin by defining the three basic types of investment buckets: taxable,
tax-deferred, and tax free.
The Taxable Bucket
This consists of things such as certificates of deposit (CDs),
money markets, bonds, mutual funds and checking and savings accounts. Investors
pay taxes on the interest income (and in some cases on the dividends and
capital gains) from these accounts every year. This would also be considered
your liquid account. Financial experts agree that we should have about six
months expenses in these accounts as a buffer against life's unexpected
emergencies. These are not tax-efficient accounts, so any surplus accumulation
should be systematically moved to the tax-free bucket.
The Tax-Deferred Bucket
These are your 401(k)s, 403(b)s, traditional IRAs and the like.
Because the tax-deferred bucket is taxed at ordinary income rates upon
distribution, it is the bucket most affected by the rise of tax rates over
time. Let's explore the planning opportunities we have with the new tax bill
and look at the new brackets.
Table 1. Tax Brackets and Rates, 2018
|
|||
Rate
|
For Unmarried Individuals, Taxable
Income Over
|
For Married Individuals Filing Joint
Returns, Taxable Income Over
|
For Heads of Households, Taxable
Income Over
|
10%
|
$0
|
$0
|
$0
|
12%
|
$9,525
|
$19,050
|
$13,600
|
22%
|
$38,700
|
$77,400
|
$51,800
|
24%
|
$82,500
|
$165,000
|
$82,500
|
32%
|
$157,500
|
$315,000
|
$157,500
|
35%
|
$200,000
|
$400,000
|
$200,000
|
37%
|
$500,000
|
$600,000
|
$500,000
|
How much should be left in this bucket? Everyone has a different
number but there is a mathematical equation that will tell us the perfect
number. It's the amount that your required minimum distributions won't
cause you to be taxed. Each case is different, and numbers could change with
future tax law.
Everything else should be in the tax-free bucket.
The Tax-Free Bucket
What is a tax-free investment? To be truly tax free, there are two
qualifications: First it must grow tax-free. This means free from federal,
state and capital gains tax. Second, distributions from this bucket are tax
free and not counting against Social Security taxation threshold. What are our
options?
Roth IRAs:
- Contributions
up to basis can be withdrawn pre-age 59½ tax free with no penalty.
- Growth can be
withdrawn tax free after age 59½.
- Distributions
do not cause your Social Security to be taxed.
- There are no
required minimum distributions (RMDs).
- Contributions
limited to $5,500 per year per person with an additional catch up of
$1,000 if age 50 or older.
Roth Conversions:
- No age
limits.
- Five-year
rule for access to interest.
- No RMDs.
- Tax-free
distributions, growth and transfer to heirs.
- No Social
Security taxation.
- No dollar
limits.
Cash value life insurance:
- Death benefit
passes to heirs tax-free.
- Dollars can
be distributed pre-age 59½ with no penalty and no taxes.
- There are no
RMDs.
- Contributions
grow tax-deferred.
- Distributions
can be tax-free and cost-free.
- There are no
contribution limits.
- There are no
income limitations.
- Distributions
do not cause your Social Security to be taxed.
Most experts agree that income taxes will be higher in the future.
Shouldn't you pay your income taxes now when you can control the amount of tax
liability you will face on that money?
So how do we transfer the rest of the money to the tax-free
bucket?
Let's look at a couple age 65 filing a joint return for 2018.
Their standard deduction has been raised to $26,400. There are no
longer personal exemptions. This couple can now withdraw $26,400 of fully
taxable money and pay no income tax. If that couple withdrew $26,400 for 20
years they would withdraw $528,000 and pay no taxes.
The next bracket is the 10% bracket. That means the next $19,050
of fully taxable income is taxed at 10%. That is $1,905. If you divide $1,905
by $45,450 ($26,400 + $19,050) the percentage is 4.2%. That is a reduction from
last year's 4.4%. If they withdrew $45,450 of fully taxable money for 20 years
and paid taxes on that money every year for 20 years they would withdraw
$909,000 of fully taxable money. At this level they would pay 4.2% of $909,000
or $38,178 to eliminate the income tax liability on that money.
Compared to last year, this couple could withdraw an extra $68,000
over 20 years and pay only $1,174 more dollars in income tax that the laws
allowed in 2017. Think about it. Why wouldn't anyone do this?
The next $58,350 of income is now taxed at 12% rather than 15%.
That is $7,002. If you divide $8,907 ($1,905 + $7,002) by $103,800 ($26,400 +
$77,400) the percentage is 8.6%.
If they withdrew $103,800 per year for 20 years and paid the taxes
on that money every year for 20 years they could withdraw $2,076,000 of fully
taxable money. At this level they would pay 8.6% of $2,076,000 or $178,536 to
eliminate the income tax liability on $2,076,000. This couple could now
withdraw $90,000 more of fully taxable income and pay $29,954 (less) in taxes.
Now, I believe the new tax law allows us to go even further -- and
move money quicker.
The next tax bracket under the new law is the 22% bracket. That
means the next $87,600 of taxable income is taxed at 22% or $19,272. If you
divide $28,179 ($1,905 + $7,002 + $19272) by $191,400 ($26,400 + $19,050 +
$58,350 + $87,600) the effective tax rate is 14.7%.
Think about this: if you withdrew every year $191,400 for 20
years, you could withdraw $3,828,000 of fully taxable money. The tax on that
would be 14.7%, or $562,716. If you could eliminate the income tax liability on
$3,828,000 and it would only cost you $562,716 would you do it? Of course, you
would.
It is imaginable that tax on that same $3,828,000 could be $1
million, $1.5 million, or even almost $2 million if left for the children to
inherit and piled on top of their income.
Ask yourself, is there someone at the IRS that you are so madly in
love with that you want to leave them a whole bunch of your money? Shouldn't
you be in control of your income tax liability instead of allowing the IRS to
be in control?
When trying to have a tax-free retirement it's crucial that we be
proactive in making calculated contributions to the three types of investment
accounts. A successful strategy will enable you to take tax-free distributions
from your traditional IRA (up to the standard deduction), Roth IRA, Social
Security as well as the cash value life insurance.
Doing this correctly will put you in the 0% tax bracket, giving
you peace of mind and protection, not to mention more money, even in the face
of dramatically higher taxes.
About the author: Dennis Drake is president of SMART Tax-Free
Retirement and a member of Ed Slott's Elite IRA Advisor Group. For more
information about this group, or to find a member near you, visit www.irahelp.com.
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Retirees, Take a Midyear Tax Checkup
What a difference a few months make. When 2017 began, it seemed
all but certain that Republican control of the House, Senate and White House
would quickly deliver wide-ranging tax reform, with much lower tax rates as a
headline feature. After all, when George W. Bush was elected in 2000, he pushed
through big cuts within six months (just before Democrats regained control of
the Senate). The only question was: How much would taxpayers save?
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Fast-forward to the dog days of summer. With Congress bogged down
with health care, tax reform has been starved for oxygen. House Speaker Paul
Ryan still promises a new law before year-end, but face it, even if Congress
acts late in the year, any big changes are likely to be phased in rather than
pay off immediately. That’s what happened the last time true tax reform won the
day, in 1986. That legislation called for 15 tax brackets to be compressed into
two, for example, but there were still five brackets in 1987 and the two-rate
system only lasted for three years after that. Exemptions got a big boost, but
in three steps starting the year after enactment.
We still expect Congress to approve both individual and business
tax cuts, if not fundamental tax reform, sooner or later. But for the 2017
return you file next spring, you should expect the law to remain pretty much as
is. That means any big changes in your tax bill are likely to be a result of
changes in your financial life and do-it-yourself moves to trim the tab.
How’s It Going?
Take a look at your income through the first half of 2017. Is it
roughly half of what you reported on your 2016 tax return? Significantly more?
Much less?
If this year is shaping up to be a much better, or much worse,
year than last year, you may need to adjust your withholding or increase or
reduce your quarterly estimated tax payments due in September and next January.
You can change withholding on paychecks by filing a new W-4 form with your
employer. For IRA and pension withholding, you’ll need to file a W-4P with the
payer. For withholding on Social Security benefits, mail or drop off a W-4V
form at a local Social Security office. Any changes—up or down—should go into
effect with the next payment or two.
On the subject of withholding, are you one of the 75% of taxpayers
who got tax refunds averaging $2,800 this past spring? If so, and your
financial year is shaping up similarly to 2016, consider reducing withholding
so you get more of your money now rather than waiting for a check next year.
Most taxpayers have already banked half-a-year’s refund.
If any of the following changes are part of your life this year,
the tax impact may be far more significant than anything Congress does.
Wedding bells. Marriage can bring a slew of
changes to your tax situation. Consider how blending two incomes will affect
your tax bill. Despite efforts to ease the “marriage penalty” in the law,
two-earner couples often pay more after tying the knot than they did as two
single people. If you married someone with a much lower income than your own,
however, you could see your tax tab drop on a joint return. Did one of you sell
a house when you set up housekeeping together? Most home-sale profit is
tax-free, and if you paid off a mortgage on which you were deducting points
year-by-year, you can deduct the remaining balance this year.
Home mortgage refinancing. If you took advantage of
low rates to get a new mortgage, crank into your planning how paying less
deductible interest could push up your tax bill.
Rebalancing or reallocating your portfolio.
Soon-to-be and recent retirees often ratchet down risk in their portfolios,
which generally means selling stocks and stock mutual funds to move assets to
fixed-income investments. That often means realizing capital gains. The same
goes if you locked in gains from the recent market run-up. Transactions inside
a tax-favored account, such as an IRA or 401(k), are ignored by the IRS. But if
you’re making moves in a taxable account, keep an eye on the potential tax
bill. There’s no reason to wait until year-end to start considering whether to
harvest losses to offset some of those gains.
Enjoying an inheritance. Although much of the
wealth left to heirs is tax-free, be sure you know how any bequests affect your
tax situation. Life insurance proceeds and cash come to you tax-free. For
stocks, bonds and real estate, your tax basis is generally the assets’ value on
the day your benefactor died. If you sell for more, you’ll have taxable,
long-term capital gains; sell for less and you’ll have a tax-saving loss (even
though you come out ahead).
If you inherit or are named the beneficiary of a company
retirement plan, IRA or annuity, different rules apply. You will be taxed on
distributions as the original owner was. For a traditional IRA, for example,
that means you’ll probably owe tax in your top bracket on every dollar
withdrawn. If you inherited a Roth IRA, payouts are tax free.
Death of a spouse. If your husband or wife died
this year, you’ll still be able to file a joint return and claim an exemption
for him or her. But if he or she died in 2016, you will file as a single
taxpayer (unless you remarry).
The loss of a spouse almost certainly means a loss of income. If
you were both receiving Social Security benefits, for example, the smaller of
the two checks stopped. If you were receiving a joint-and-survivor pension, the
monthly payment may have fallen to 75% or 50% of what you had been receiving.
If your spouse was still working, you need to crank the loss of those earnings
into your tax planning. If state income taxes on a spouse’s earnings were a
major component of your itemized deductions, you might find yourself claiming
the standard deduction.
Planning for an RMD. If you turned 70 during the
first half of 2017, this will be the first year you’re required to take a
distribution from a traditional IRA. (If your birthday was July 1 or later,
required minimum distribution rules don’t kick in for you until 2018.) Your
2017 RMD is based on the total balance in all of your traditional IRAs on
December 31, 2016.
Generally, RMDs must be withdrawn by December 31, but you can put
off the first required payout until as late as April 1 of the following year.
Keep a close eye on tax maneuverings in Washington. If tax rates will likely be
lower in 2018, it could pay off handsomely to delay your first RMD.
(As with any of these informative articles,
anyone who needs someone to talk to about
this
very subject contact me and I can direct you to a knowledgeable advisor).
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