Balancing Act

Answer: Congratulations, you’ve made it to retirement. This means you’ve already had plenty of experience paying taxes. Tax payments in retirement can be a bit more of a balancing act whether it’s for your actual withdrawals or conversions.

Cash Needs and Income

Identify essential versus discretionary expenses and match sources of income. Reviewing these items sooner rather than later can help you create a smart withdrawal strategy. If you need guidance, partnering with your financial advisor and tax professional can uncover the most efficient opportunities and sources of funds. This is the time to ask questions and discuss planning strategies.

Is Social Security income taxable?

The answer is ”it depends” on your combined total income and filing status. This includes adjusted gross income (AGI), nontaxable interest, plus half of your Social Security benefits to determine combined income. Adjusted gross income covers everything, from wages, if you’re still working in some capacity, to rental income and, most importantly, any withdrawals from 401(k)s and IRAs. However, Roth IRAs are exempt.

If your combined income is below certain thresholds, Social Security may not be taxed. If it’s above the threshold, up to 50% - 80% of benefits may be taxable. For example, if you file as a single individual and your combined income is greater than $34,000, you may pay tax on your Social Security benefits. If the combined amount is greater than the threshold, up to 50% or 80% of benefits may be taxable. Consult a tax professional to determine your specific tax exposure based on your filing status. Raymond James does not provide tax services. Please discuss these matters with the appropriate professional.

RMDs: Required Minimum Distributions

Depending on your portfolio, traditional Individual Retirement Account (IRA) required minimum distributions (RMDs) can bump you into a higher tax bracket. It’s important to take RMDs into consideration every year and factor in what you’ll be required to take out of your retirement accounts starting at 72 (or earlier if your plan allows).

Qualified charitable distributions (QCDs) are an option to balance an increased tax burden is with a qualified charitable distribution. After 70 1/2, you can donate up to $108,000 a year to an eligible charity directly from your traditional IRA – and you won’t have to pay any taxes on it. QCDs can also be a way to meet your RMD, with the caveat that you can’t then itemize the donation as a charitable deduction on your return.

If certain conditions are met, ROTH IRA and ROTH 401(k) distributions will be completely income tax free. Unlike Roth IRAs, Roth 401(k) participants are subject to required minimum distributions at age 72 (70 ½ if you reach 70 ½ before January 1, 2020). Investors should consult a tax advisor before deciding to do a conversion. Withdrawals which exceed income will reduce the value of your portfolio.

To convert or not to convert

If you have retirement funds in traditional IRAs or 401(k)s, you have the option to convert these to a Roth at any time. This strategy could potentially lower future taxes – but you’ll have to pay taxes in the year you convert. Look at current tax rates and potential future income from your assets and talk to your advisor and tax professional to forecast whether Roth conversions would make sense for you.

The right amount

For years, conventional wisdom suggests withdrawing no more than 4% of your retirement portfolio every year. But this is only general guidance and deserves to be revisited, especially when there are market waves, inflation, or other headwinds. Be sure to set up a time to renew and adjust your withdrawals as needed to manage your income bracket most effectively.

Too often, tax implications during retirement are overlooked when the focus has been on saving and investing for so many years. Whether you are pre-retirement or post-retirement, there’s always an opportunity to review and adjust. As always, acknowledge the value and importance of working with a collaborative professional team to include your CERTIFIED FINANCIAL PLANNER™ Professional, tax, legal, and accounting advisors to best manage your unique circumstances. Stay focused and plan accordingly.