There’s a misconception that once you retire, your taxes will go down, but often it’s the opposite. Taxes end up being the biggest bill for a retiree. You can work to mitigate this tax bill by planning ahead of time, using proper asset allocation, and having a plan for your Social Security and RMDs and Medicare. Hi, I’m Hunter Brockway, founder of Boca Retirement Strategies, here to guide you to a successful stress-free retirement while spending more and avoiding being killed in taxes. The first tip in creating tax strategies is looking out years into the future by leveling out your tax bill and picking up small chunks of money along the way. 99% of the time, this leads to the biggest impact on tax strategies. If you go your whole life just trying to incorporate ways to get a refund from last year, you’re only looking in the rearview mirror and not planning your life ahead of time. Rarely will we find a single million-dollar tax strategy, but if we can pick up $10,000, $20,000, $30,000 along the way and compound that over years and years, it ends up being a good sum of money.
Now, it’s easy to understand why people assume their taxes will go down in retirement or that they may be in a lower tax bracket and decide to defer all of their income today. However, a few factors can come into play. Tax rates can go up, they already are scheduled to go up, you may have fewer deductions on your tax return, and you may have required minimum distributions. If all of your money is in tax deferred account, that’s going to compound these factors. People also get in trouble by assuming that their social security benefit is not taxable. That is not the case. There are certain thresholds and calculations, but up to 85% of your social security benefit can be taxable. Therefore, your retirement income and tax strategies need to incorporate this social security income. People also fail by not incorporating Medicare IRMA brackets into their tax strategies. Medicare IRMA brackets are surcharges on top of your Medicare that are income related adjustments. They look two years into the past to calculate your current year’s premiums. They almost work like income tax brackets.
However, unlike income tax brackets, which are marginal. Meaning if you go $1 over that bracket, you don’t owe the full sum of money. Only that $1 is taxed at the higher rate. Medicare IRMA brackets are waterfalls. So if your income is $1 over the threshold, your Medicare IRMA surcharges are that next higher amount for the entire year. And it’s no small change either. Therefore, when calculating how you will create retirement income, what buckets of money that will come from, and how it is considered in the eyes of government, incorporate your IRMA brackets. Now, as we’re on the topic of brackets, I also see people going wrong and being scared to fill up and maximize the bracket they’re in. So let’s say that you’re married earning $100,000 and you’re in the 22% marginal tax bracket. Well, you have almost an additional $100,000 of income before you’re bumped into the next bracket. So you’re already paying 22% tax. We can fill that bracket up the rest of the way, have the mentality of in for a penny, in for a penal. Pay taxes on money today to never pay taxes on it again in the future.
Of course, this is where it comes back into play. If we’re already retired, if we’re looking at Medicare, we need to consider that. Well, what’s the next Medicare bracket? So if using the same example, we’ve got $100,000 of income and the 22% bracket maxes out at $201,000 of income, the current Medicare bracket jumps up at $206,000 of income. So we can maximize that income tax bracket without touching the next Medicare bracket in this case. Always keep in mind that these numbers change yearly. This mentality of maximizing your current tax bracket is something you should have throughout your working years and throughout retirement, just the same as investing. Once we retire, that doesn’t mean our planning ends. We still have 30 or more years of life ahead of us that we have to take into account. Maximizing brackets and using this next strategy requires you to be on board and bought into the plan mentally and emotionally. Where most people fail is simply being afraid to incorporate these. The next strategy I’ll point out is not being afraid to shift income. Shifting income can happen in a couple of different ways.
One example of a strategy we implemented with a client. This client was in her working years and had sold an investment property which meant she would have to pay capital gains on this property. Plus it increased her taxable income brackets because she was still working and earning taxable income. But at her employer she had a 401k plan so the strategy we worked up with her was to maximize her contributions allowed to her 401k plan meaning she would defer 100% of her paycheck until her 401k contribution limits were met for that year. Now that meant she would be living off of her savings from the sale of her condo and her existing savings. Naturally that was a little frightening to her at first but when you have a plan in place and can buy into these things you can make the biggest impact on your tax bill. Additionally this client was a couple of years out from retirement and we took the opportunity to practice a little bit of what it’s like to live off of your savings and not have an income paycheck which she ended up being very grateful for. The other way to maximize your tax brackets and shift income is by evaluating your income and how you are saving your money.
Tax deferred or after tax. You’ll have three buckets of ways that savings and investments will be taxed. The first is taxable income. Money you put into a tax deferred account, like tax deferred 401k or tax deferred IRA, will come out and you will pay traditional income taxes on those. The next way your money can be taxed is through gains. So money put into a non-qualified individual investment account will be taxed at capital gains. Lastly is the never taxable, the Roth style account that you pay taxes on up front. You put your money in and never pay taxes on it again, nor do your heirs. So of course, one of the best ways to maximize your tax brackets and eliminate future tax bills down the road, years into the future and level out your tax bill is by making timely strategic Roth conversions and Roth contributions. Of course, the key here is timely and this has to align with your overall plan. We’ve done videos on that in the past, explaining when and why Roth conversions are not the best fit for people. But in the overall general scenario, this is one of the best tools to use to level out your lifetime tax bill. Going into retirement, one of the mistakes someone can make is not properly rolling over their retirement account. Simply mischecking a box could lead to your entire workplace retirement plan rollover being a taxable event or mishandling the way that money is distributed, for example, in a check to you personally rather than a direct trustee to trustee transfer.
Worse yet, if you made a mistake like this, didn’t catch it, paid a huge tax bill on what was calculated as a distribution of your entire funds, but put it properly into a tax-deferred retirement account at your new custodian, once you pull that money out again, it’s going to be taxed again. If you’re getting close to retirement, one of the biggest tax strategies you can implement is a qualified charitable distribution or QCD. A QCD is available to those who are 70 and a half or older. QCD in short form is the ability to write a check to charity out of your tax-deferred account. This checked charity comes out before your AGI, adjusted gross income, so if reported properly, which is the key here, it will not show up on your AGI. QCDs also satisfy RNDs. So if you’re in retirement and the government is telling you that you must take out your required minimum distribution because they want their share in taxes. You do not need that money.
You could satisfy up to $105,000 of your RMD through a qualified charitable distributions. It will not hit your AGI, therefore lowering your tax bill. In planning and working QCDs into your plan, you could implement them prior to required minimum distributions. As I pointed out, you can start QCDs at 70 and a half. So if you are already charitably inclined, which is key, because while donating to charities is great, no tax benefit is going to outweigh the money donated to the charity if you don’t care about that charity. But if you already are charitably inclined and always intend to give to charity, you can give this way, reduce your future tax bill, the amount waiting to be taxed, and make a bigger tax impact than trying to itemize charitable contributions on your tax return.
Lastly, the biggest tax strategy is reviewing your tax return. We review our clients’ tax returns yearly. Now, we’re not CPAs or enrolled agents. We do not think that we’re smarter than your accountant, but we may implement a tax strategy that doesn’t get communicated properly or simply your accountant has so many tax returns to do in such a little amount of time that mistakes happen. We’re all human. Reviewing your tax return to ensure that the tax strategies you implemented are reported properly is crucial because it doesn’t matter how many tax strategies you implement. If they’re not reported properly, they don’t count. So review your tax return yearly. Create a strategy that fits for you, not just to get a refund on this year’s tax return, but a multi-year tax plan. To ensure you stay updated with the latest tax planning strategies, subscribe to our YouTube channel. And if you have any financial questions, you can send us an email at contact at BocaRetirement.com. Enjoy your successful retirement. Thank you for watching. Bye.