Retirement Tax Strategy Optimization

January 2, 2023

Topics: Tax tips | Taxes | Retirement | Social Security

Media type: Article, Podcast

Retirement Tax Strategy Optimization

4.5 minute read • 

January 2, 2023

Retirement Tax Strategy Optimization

When you think about your future retirement, there are many things to consider. This article focuses on retirement tax strategy optimization, and why it’s important to think about how your different sources of income, such as Social Security or a pension, retirement accounts, and other assets, will interact. During retirement, your tax bracket may change because of required minimum distributions (RMDs) or other external factors. Ideally, you want to avoid sudden tax shocks. Making a plan for tax efficiency, such as when and how to use your different assets in retirement, can have a big effect on how much you owe the IRS each year.

The majority of investors have three categories that form the basis of their retirement savings:

  1. Social Security or a pension plan, which might be considered “non-portfolio” income
  2. A portfolio of taxable “non-retirement” assets
  3. Retirement-specific assets with favorable tax treatment. As we will explore, you may decide to transfer these to a different sort of account if doing so is advantageous

We explore three strategic decisions that can impact your annual taxes over the long term.

The importance of timing. The decision of when to begin receiving Social Security payments is based on an individual’s personal and family circumstances. You can begin receiving retirement benefits at age 62 and receive approximately 70% of your total amount. You may delay receiving 100% of your pension until you reach full retirement age. Alternatively, you may choose to defer your benefit for a few more years and increase it by 8% annually until age 70.

How to develop this strategy

Begin by asking yourself the following four questions:

  1. Have I established additional streams of income for my retirement?
  2. Should I consider a spousal benefit?
  3. Are there any health concerns that could affect my long-term plan?
  4. Do I plan to remain working in retirement?

Keep in mind that 15% of your Social Security benefits are tax-free, regardless of your income. A portion of the benefits of retirees with moderate or higher earnings will presumably be subject to federal taxation. In addition, thirteen states require residents to pay taxes on Social Security income.

In comparison to retirement income from other sources, such as traditional 401(k)s or traditional IRAs, from which withdrawals are taxed as regular income, Social Security benefits have a favorable tax status. A Roth IRA is an exception; contributions are made with after-tax monies, but withdrawals are tax-free. Consider this when deciding whether or how long to wait before applying for Social Security benefits. According to Stephen Kovach, Chief Investment Officer at Global Advisers, “if you can withdraw from tax-deferred assets such as a traditional 401(k) or traditional IRA before you begin receiving Social Security benefits, this can help you balance current and future tax liabilities.

The importance of asset location. If your current income is greater than your expected retirement income, you should utilize tax-advantaged funds such as traditional IRAs and 401(k)s. These allow you to deduct your contributions each year and delay taxation until retirement. Roth IRAs and Roth accounts within employment plans offer a unique tax advantage in that you pay taxes on contributions now in exchange for tax-free distributions in the future.

This is advantageous if you have investments in standard tax-deferred accounts and retire in a lower IRS tax bracket. But if you end up in the same or higher IRS tax bracket, all you have really accomplished is postponing your tax payment. This can come back and take a large bite out of your money if tax rates rise in the future because your payment may also increase. Moreover, if all of your funds are in tax-deferred investments, you will be responsible for paying this debt in retirement.

At Galleon Wealth Management, we believe that tax diversification is equally important to asset allocation, as it pertains to achieving your final financial goals. Put differently, if investors have assets in various locations (i.e. account types such as traditional 401(k)s or IRAs), and each type imposes different tax regulations and requirements, you benefit from greater flexibility when taking your retirement income because you maintain better control over the amount of tax you’ll pay from year to year.

Things to consider when developing your strategy include ROTH IRA conversions (timing and amount); taxes on Social Security (income thresholds); and Medicare surcharges (thresholds and alternatives). Your Galleon Wealth Manager and team will help you accurately create and implement this strategy and optimize it to your specific situation.

The importance of a withdrawal strategy. To determine which of your accounts to access and in what sequence, you must consider all of these internal and external factors. Beginning at age 72, you are obligated to take your RMD from certain types of tax-advantaged accounts, including all employer-sponsored retirement plans and traditional IRAs.

Your wealth manager and team will work with you to spread your withdrawals over a period of time that allows you to withdraw money from both taxable and non-taxable sources before you are forced to reach age 72. Doing so can help lower your annual taxable income.

Ultimately, we suggest focusing on developing a strategy that not only lowers your taxable obligations but also captures opportunities throughout your retirement. This often means implementing a strategy that maintains your tax bracket in order to make it more predictable and thus, more manageable.

To learn more about Galleon Wealth Management Retirement Services, contact us at 1-844-GALLEON.