OUR THOUGHTS ON:

Golden Years? Part Two in a Series

Wealth Management

By Victoria Rogers

Part two of a five-part series detailing a personal journey into planning for the later years of life precipitated by my father-in-law’s abrupt move to a personal care home.

So you’ve been saving all your life for retirement. You’ve squirreled away pre-tax money in an IRA and you’ve deferred taxes in annuities. Before you get too comfortable, ask yourself this: Can you afford to pay Uncle Sam? Your tax rate should go down in retirement, but depending on the size of those accounts, you may not get the tax break you were anticipating. Retirement becomes a delicate balance between tax and timing. Your portfolio is diversified; your tax burden should be as well.

We found ourselves in this situation with my 90-year-old father-in-law. He needed funds to move into a personal care home. Most of his assets were in an IRA and annuities. We had to be very careful how much we withdrew from these accounts. In addition to the cost of personal care, paying additional income tax would be abhorrent.

Many new retirees are deferring retirement distributions to avoid paying taxes and extend the benefit of tax-deferred growth. At age 70.5, you are required by law to take a minimum distribution from your qualified retirement accounts. The distribution is calculated based on the size of the account and your life expectancy factor as published by the IRS. If your account is all pre-tax dollars, the entire distribution is taxable. Keep in mind that by waiting to take your distribution, not only are your distributions larger, your income tax rate will likely have gone up. It might make sense to take small distributions before you are required, to spread the tax burden over more years.

Non-qualified annuities are funded with after-tax dollars and grow tax-deferred. Upon distribution, the gain is taxed at ordinary income tax levels. The annuities my father-in-law held were small, not enough to provide an income stream. I assume he bought them for the tax deferral. However, if he had invested outside the annuity, gains would be taxed at lower capital gains rates, which at his 2011 marginal tax rate would have been 0%. Of course an annuity can offer other benefits, depending upon the product. Distributions are taxable according to an exclusion ratio which divides the investment by the total expected return. The issuer of your annuity will make these computations.

Be aware that distributions over stated income limits can also affect the taxability of your Social Security income. Up to 85% of Social Security may be taxable if you exceed those limits. The taxable portion of IRA distributions and annuities both are included in the income calculation. You might find that, if you accelerate IRA distributions, you can afford to postpone collecting Social Security. The benefit will continue to grow until you are age 70.

When you first retire, investigate converting your IRA to a Roth IRA. A Roth grows tax-free; distributions are tax-free and are not included in income when calculating tax on Social Security benefits. Proper timing is key since you must pay income tax upon conversion. Make sure you convert before you begin collecting Social Security, or a portion of the benefit may be taxable in the year of conversion. Most people are reluctant to prepay taxes, but when you are 90, a tax-free distribution can make a huge difference.

As you are saving for retirement, don’t forget to allocate a portion to your non-retirement investments. Taxes on long-term gains are generally more favorable than ordinary income rates. If you are under the income limits, allocate a portion of savings to a Roth IRA. When you retire, take a hard look at your cash needs. Don’t assume you should postpone distributions and don’t first spend down your non-retirement accounts. Structure your retirement cash flow to be as tax-efficient as possible.

Next up: Asset Planning


Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax or legal advice. Please consult your tax or legal professional to determine which direction is best suited for your specific needs.

© 2012 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.
This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter. 

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

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