One question has rung through loud and clear following my two recent columns on the big rule changes with Social Security and the development of a safe spending rate in retirement.
Soon-to-be and current retirees want help developing a holistic plan for the “living off my savings” phase of their retirement journey.
Specifically, their burning question can be broken down into three smaller questions. First, from which accounts should we withdraw our money and in what order? Second, how exactly will my Social Security benefits affect our tax bill? Third, what steps could we take now to help minimize our tax bill in retirement?
Our financial system is a ridiculously complex maze for retirees to navigate. At the center of the complexity sits our tax code.
Regarding the question of which accounts should be drawn from first and in what order, most retirees have two forms of savings. They have savings that have already been taxed and savings that have yet to be taxed.
To begin, it’s important to understand that the mere act of drawing from your already-taxed savings does not trigger a tax bill. Only your dividends, interest and realized gains result in tax payments. In contrast, the act of drawing from your tax-deferred savings creates immediate taxable income.
Given this, choosing the best source of retirement income clearly depends on your own tax picture. For this reason, sound advice about the best source of retirement income wholly depends on your personal financial setup. This requires some basic tax modeling of your present and future tax picture.
Next, you may not realize that Social Security benefits are often taxed. The proportion of this benefit that is taxed can range from none to a maximum of 85% of the benefit. The tax owed depends entirely on your other income, some of which is voluntarily created by drawing from your tax-deferred accounts, such as your IRAs.
With this understanding, the decision of which pot of savings to draw from – your already-taxed savings or your tax-deferred savings – can impact the amount of tax owed on your Social Security.
Finally, there are planning techniques that might allow you to minimize your future tax bills in retirement. Among these techniques are strategic, partial Roth IRA conversions and the possible utilization of the 0% capital gains tax rate on your federal tax return.
Intelligent planning for the “living off my savings” phase is increasingly on the minds of current and soon-to-be retirees alike. The educational steps you take now will no doubt pay dividends later. Best of all, those dividends are completely tax-free!
Jason P. Tank, CFA of Front Street Wealth Management will hold a free educational workshop on “Retirement Income: From Where & When?” on Feb 10th at 6:30pm in the McGuire Room at the Traverse Area District Library. Call (231) 714-6407 with questions, visit frontstreet.com/workshop to learn more.
