Retirement

Taxes on Retirement Income

By Jason Newcomer

April 9, 2021

Taxes on Retirement Income


Key Points – Taxes on Retirement Income:

  • Social Security
  • Pension Income
  • Annuity Income
  • IRA Withdrawals
  • Interest Income
  • 5 minute read | 38 minutes to listen

Taxes on Retirement Income

on America’s Wealth Management Show

» Click Here to Read the Transcript

Taxes on Retirement Income

Links Mentioned in this Episode

Complimentary Consultation

White Paper: Tax Reduction Strategies

White Paper: Retirement Plan Checklist

Dean Barber: Thanks so much for joining us here on America’s Wealth Management Show. I’m your host Dean Barber, along with Bud Kasper. Today, we have a great topic, one of my favorites: taxes on retirement income.

Tax Planning Can Create More Spending Money in Retirement

I believe that once you get your Social Security claiming decisions done the right way, the second most significant impact on a person’s ability to spend what they want to spend in retirement is putting together an excellent structure on tax planning. Okay?

I’m not talking about filing your tax return. And I know that’s what’s on everybody’s minds right now, but this is tax planning. And why do you do tax planning? Because in retirement, you can control your taxes, unlike any other time in your life.

Unless, of course, maybe you were a small business owner or something like that, and then you have some things that you can do that are a little bit different than a regular W2 earner. But when you get into retirement, you’re going to have the ability to control your taxes, unlike any other time in your life.

Bud Kasper: The reason for that is you’re fixed on your income at that point. In other words, you don’t have variability from your employer check and things like that. So once we identify all the sources of income and how they’re taxed, it’s simply coordinating mitigating as much taxes as possible.

There is No Instruction Manual


Don’t invest your money in anything unless you know what the plan is to get the money out.

– Dean Barber


Dean Barber: So while we’re going to talk about taxes on retirement income, and we’ll get to some specifics, there’s no way for us to do a show, to write an article, to do anything that’s going to give you an instruction manual on how you’re going to reduce your taxes in retirement. 

The reason is that every single one of you listening is in a different situation. You have different amounts of money in another kind of tax buckets, and you have different spending needs. Your Social Security amounts are different.

You may have rental income, you may have pension income, and it’s the combination of everything you have and then how much you want to spend that determines the exact tax strategy for you. 

We’ve said this many times, “Don’t invest your money in anything unless you know what the plan is to get the money out.”

Bud Kasper: Right.

Dean Barber: Right. And why is that important?

Bud Kasper: Well, we don’t want to give away any more money to Uncle Sam than we possibly need to.

Dean Barber: Right.

Income Awareness

Bud Kasper: You can postpone income in a given year. Maybe you’re using money out of your IRA account to help support your income, but you have enough income coming from other sources at that time. 

That additional income could throw you into another bracket. Are you aware of that? If not, we can show you that that’s the case. If it does, we can go and do what, let’s not take a distribution this month, this quarter, whatever the case may be. And we just saved you X amount of dollars in taxes.

Now, people don’t go through those kinds of exercises, the vast majority of people, but we do because that’s part of the comprehensive part of it. And these tax overlays are so critically important to you, our listener, because wouldn’t you feel stupid if you paid more taxes than was necessary? I would.

The Power of Comprehensive Planning

Dean Barber: Well, unfortunately, Bud, we see that happen far too often. Of course, one of the things that we do when we take people through our Guided Retirement System™ is complete a comprehensive plan. Then one of our CPAs will look at that plan from a tax perspective and say, okay, what can we do to reduce the tax liability over a lifetime?

Inevitably, what our CPA sees is that individual who’s visiting with us for the first time has overpaid their taxes over the last couple of years because we always request to look at two years tax returns.

Don’t Miss Opportunities

The interesting thing is, Bud, they’re normally not overpaying because their tax return was prepared improperly; they’re overpaying because they missed opportunities that they didn’t know were options. 

They missed those opportunities because their current CPA simply prepares their tax return with the information they have and doesn’t know the entire financial picture. 

But once we understand the whole financial picture and then our CPAs can look at it, we can identify what opportunities have been missed and point out, okay, here’s what you overpaid last year, and here’s what you overpaid the year before.

Here are some adjustments we make, and here’s how we’re going to reduce that tax burden over time. Like, wow, okay. Now we understand why you have to have a CPA review the financial plan from a tax perspective.

Finding CFP® and a CPA

Bud Kasper: I so agree with that. The real issue that I find as a CFP® is that we’ve got pretty good command on a lot of things about taxes, but I’m not, by any stretch of the imagination, an expert. When we bring in the expert on the taxes and put it into coordination with what the planning is, we’ve got a winner that will continue to win forever.

Dean Barber: Winner winner chicken dinner.

Bud Kasper: There you go.

Dean Barber: All right. So we’re talking about this, and we’re getting into some specifics here in a couple of minutes. But the point that I’m trying to make is, as you’re saving for retirement, this is pre-retirement planning, so your tax planning needs to begin at least five to 10 years before you retire. 

Don’t wait until you’re six months out from retirement, and then you come in and sit down with us and go, okay, well, here you guys can put together a distribution tax strategy for me. Well, we can, but it’s going to be based on decisions that you’ve made in the last five to 10 years, which may or may not be right.

Bud Kasper: That’s right.

Your Favorite Type of Income in Retirement

Dean Barber: What is your favorite type of income in retirement?

Bud Kasper: Tax-free income.

Dean Barber: Tax-free income, right? And the best place to get tax-free income is from your Roth IRA. Many people don’t understand the five-year rule on the Roth IRA and the five-year rule on Roth IRA conversions and things like that. 

They think that, well, I can’t touch that money for five years if I put money into a Roth without paying the penalty. Well, that’s not true. 

Roth IRA Five-Year Rule

So here’s how the five-year rule on the Roth IRA works. So I’ve heard many people say the Roth IRA because the rule says that if you put money into a Roth IRA, that it has to be in the IRA for at least five years, and you have to have attained the age of 59 and a half before you can take that out tax-free.

Now, that is partially true. However, you can always take out the contribution to the Roth, or the amount you converted to the Roth before that five years is up, without any taxes or any penalties. Why? Because you already paid taxes on that money.

Bud Kasper: That’s right.

Roth IRA Versus Annuities

Dean Barber: So the Roth IRA is different than an annuity. An annuity is what’s called last in, first out. If you put $100,000 into an annuity, and that annuity over time grows to $200,000. 

Then you start taking income from that annuity without annuitizing it; what’s going to happen is the first $100,000 that you pull out will be taxable as ordinary income because that’s the last piece of money that went into it, was the interest that it earned.

Bud Kasper: Right.

First In, First Out

Dean Barber: The Roth IRA follows a different accounting method called first in, first out. So the first money to go into the Roth, whether it’s a conversion or a Roth contribution, is the first money to come out. And since that money has already been taxed, then the only reason that five-year rule applies, Bud, is to any earnings on that Roth IRA.

Bud Kasper: Yeah, that’s right. One of the other things that confuses people on that is the fact that if you’ve had that Roth IRA for the five years, and let’s say you still had money that was in your company’s 401(k) plan, and now you have some after-tax money that is there, you can roll it over into the Roth IRA account.

By doing that, the five-year rule doesn’t have to be met on that money because it already existed elsewhere. So that’s an excellent benefit for people, especially at the time of their retirement.

Normal IRA Distributions

Dean Barber: So five-year rule on the Roth IRA, that’s a big one. The other one, Bud, when we start talking about taxes in retirement, is just your normal IRA distributions. 

Any pre-tax contributions, any earnings on that pre-tax contribution, and any contributions in your 401(k) your employer made on your behalf are pre-tax dollars in that account.

So the moment you start taking that money out, it’s treated as ordinary income, so you’ll have ordinary federal income tax on it, and you’ll have ordinary state income tax on it if you live in a state where there’s a state income tax.

What you won’t have that you had while you were working is the FICA tax, so the Social Security and Medicare piece. But every dollar that comes out is going to be taxable. Now, if we could get all of your money into a Roth IRA, that would be an ideal situation. However, for most people, that’s not an option.

Bud Kasper: However, things like conversions can be late in the game but still get that end result.

Roth Conversions

Dean Barber: Right, so let’s say that you were making contributions to a Roth 401(k), and your company was making an employer match. Well, the employer match to your Roth 401(k) goes into the traditional side of the 401(k).

So when that comes out and gets rolled over to a traditional IRA, then the distributions from that are taxed as ordinary income, while the Roth IRA distributions rolled out of the Roth 401(k) are tax-free. So conversions may make sense, but it also just may make sense for you to split up where your income is coming from.

Controlling Your Income Sources

Suppose you understand the tax brackets in retirement, and you understand how Social Security is taxed. In that case, you can say, “If I choose to take some money from my traditional, my Roth, and my taxable account, I’m going to spend a little principle there. Now, what am I doing?”

“I’m controlling not only how much is going into my checking account. But I’m also controlling the amount of taxes that I pay by understanding the different tax brackets and the other triggering points that can cause qualified dividends and capital gains to become taxable when they may have been tax-free.”

Bud Kasper: Right, this is all about sourcing your income and understanding the taxes, tax ramifications that occur on each of those tax buckets, if you will. It’s vital because we’re talking about savings that compounded over a person’s retirement lifetime; it’s going to be significant.

Running Retirement Scenarios

Dean Barber: Well, when we start doing our scenarios, Bud, using our Guided Retirement System™ and then having our CPAs review that financial plan from a tax perspective, what we start seeing is we add up, based on current tax law, the distribution strategy that you’re thinking about using today. 

Then, the distribution strategy you’re thinking about using today, taxes will be X. Now, let’s put together a better distribution strategy, one that we know as financial planners and CPAs will give you an added benefit. If you do it our way, taxes over a lifetime are going to be Y.  

In many cases, we see a substantial difference in income over your retirement lifetime of fewer taxes paid by having that proactive, forward-looking tax plan.

Life Expectancy

Bud Kasper: I think many people forget that they will be in retirement for a long time if they have good health. If you retire at 65, and your life expectancy is 95 – some people say, “Well, you’re not going to live beyond 95; ask your relatives.” By the way, if you’re talking to them, they’re still alive.

Dean Barber: I’ve had two clients just in recent years eclipse the 100 mark, so it’s happening.

Bud Kasper: So we have to understand that. And if we’re paying tax on all that money, are we giving money to Uncle Sam needlessly because we didn’t plan appropriately? And the answer is probably.

Dean Barber: We have a couple of different pieces out that I want you to read. One of them is called our Tax Reduction Strategies Guide, and the other is our Retirement Plan Checklist

Of course, I think the most important and proactive thing you can do to control your financial situation, especially take control of your taxes and never overpay, is to schedule a complimentary consultation by clicking here. We can meet by phone, through a virtual meeting, or in person. 

Taxes on Social Security Income

Bud, let’s get into talking about Social Security, the taxes on Social Security, the history of Social Security, et cetera. Most people have Social Security unless you’re a government employee and you didn’t qualify because you’ve got the government pension, right?

Bud Kasper: Right.

Dean Barber: Some teachers, same type of thing. But for the most part, most people will have Social Security. And how we claim Social Security, first of all, will be a big deal, and the average couple’s going to have somewhere north of 600 different iterations on how they can claim Social Security. And the difference between the best and worst strategy can often exceed $100,000 of additional Social Security income, right?

Bud Kasper: Right.

Don’t Disqualify Yourself from Tax-Free Social Security

Dean Barber: So that’s your first step with Social Security. Your second step with Social Security is to understand how Social Security is taxed. If you understand from a fundamental level that Social Security by itself is a tax-free source of income, it’s only if you disqualify yourself that you start paying taxes on your Social Security.

Bud Kasper: And you do that through provisional income.

Provisional Income

Dean Barber: That’s right. There’s a calculator on irs.gov, and I think it’s Publication 915 that will tell you how to calculate whether or not your Social Security will be taxable. We’ll give you a high-level overview of it right now.

Essentially what you do is you take 50% of your Social Security. If you’re married, you take 50% of the combined Social Security benefits. You add to that any other taxable income source, so that would be withdrawals from IRAs; it could be dividends, capital gains, interest, income, et cetera. Then you add to that any income that’s coming off of municipal bonds.

Bud Kasper: Tax-free.

Type of Tax Filer

Dean Barber: Right, tax-free. So if you do that and you’re an individual tax filer, and your income is between $25,000 and $34,000, you’ll pay tax on up to 50%. If you’re married and you’re over $34,000 provisional income, then you could pay taxes on up to 85% of your Social Security. I’m sorry, that’s single and over $34,000. Married, obviously, those numbers go up to 34 and $42,000, I believe, looking for my notes here.

Bud Kasper: That’s right.

Dean Barber: So the point is if that provisional income number is that high, then that’s when you start paying some taxes on your Social Security. But there are ways that you can get money into your checking account without triggering that provisional income and causing more of your Social Security to become taxable.

We’re going to talk about that and some strategies behind that. 

Comprehensive Planning Can Help Clear Up Complexity

Bud Kasper: Yes, and we didn’t talk about the impact that it has on Medicare.

So, think about this, folks; all these different numbers we’re throwing from various sources taxed differently have an incredible impact on the net amount of money you’re able to keep. That’s why a comprehensive financial plan is necessary for you to have a real command of your income in the future.

Dean Barber: Right. I believe very strongly that you can’t just have a comprehensive financial plan. You then have to have a CPA that understands forward-looking tax planning, not just looking in the rearview mirror and preparing taxes on something that happened last year.

Right? Because we’ve said all along, as long as you live in the United States and you have money or make money, taxes will be a factor in your life. 

The fact of the matter is when you get into retirement. You have a unique ability to control your taxes, unlike during those working years. 

So Many Social Security Possibilities

So, people probably know this because we’ve talked about it now for 13 years, and that is that the average couple, age 62, will have over 600 iterations on how they can claim their Social Security.

Bud Kasper: Yes. Now explain what an iteration is.

Dean Barber: So, it’s a combination of how you and your spouse claim together. The difference between the best and worst claiming strategy over the exact same life expectancy with the exact same earnings history is often over $100,000 of additional income from the same Social Security benefit. Right?

Bud Kasper: Yes.

Dean Barber: So, it makes sense to go through and do that analysis as you’re completing your financial plan to understand the best Social Security claiming strategy. 

Now, you can’t stop there. You can’t just go to a Social Security calculator, which there is probably a handful out there that are pretty decent right now, but that’s only part of the answer. Right? 

If the Social Security claiming strategy says that the wife should claim at 62 and the husband should delay benefits to 67, that comes up to our optimum strategy based on their health and earnings history and everything else, and their life expectancy.

That might be the right answer for Social Security.

Bud Kasper: Yes.

Fitting Social Security into the Overall Financial Plan

Dean Barber: Okay? But now, what do we have to do? We have to have already constructed the comprehensive financial plan. Then we put Social Security in with that claiming strategy. 

Now, what are we going to look at? We’re going to look at the probability of success on the plan, and we’re also going to look at how much taxes are paid on that plan’s lifetime based on current tax law.

Bud Kasper: Right.

Dean Barber: Okay? Then what we’re going to say is, “Okay, let’s look at this purely from a tax perspective. Is there a way to use my Social Security claiming strategy to significantly reduce my tax burden over time?”

Tax Ramifications of Social Security

Bud Kasper: Right. So, let’s talk about that from the perspective of tax ramifications. The way I want our audience to think about it is like a faucet.

There might be a time when you want that faucet full-on, you know, let’s say on your municipal bond or your tax-free income associated with it. It might be a time you want to turn that faucet back, so you don’t take as much that’s coming out there. 

Coordinating when you take Social Security and putting that into the tax tables to see the amount of taxes that will be due is imperative. 

If we can mitigate that by using these faucet handles, if you will, to control the amount of money coming out in any given year, that can significantly impact how much you don’t have to pay in taxes.

You Only Have 1-Year to Make Social Security Changes After Claiming

Dean Barber: Right. The problem with Social Security now, once they changed the laws on it, is that you have only one year from the time that you claim your Social Security to go back and say, “Oh, I change my mind.”

Bud Kasper: Right.

Dean Barber: Right? “Oh, I didn’t want to do that.”

Bud Kasper: Yeah. But in the same token, if we’re going to take the wife’s Social Security now and postpone the husband’s Social Security, that’s all great, and that could work, but remember, you have all the flexibility in the world if you’re 64 years old and on your plan, it says to go to 66. 

That doesn’t mean that we don’t go back and say, “Yeah, you know what, let’s go ahead and take it at 65.”

Dean Barber: Right.

Getting Money Without Triggering a High Provisional Income

Here’s why I think this is critical. I’m going to get into some detail here because once you start claiming your Social Security, that will be a source of income that will add to that provisional income that we talked about in the last segment. 

If we want to do Roth conversions, you and I both know that the early years of retirement are some of the most powerful times to do those Roth conversions. So, I’m going to paint a picture for you.

Bud Kasper: Okay.

A Million Dollar Example with Tax Buckets

Dean Barber: Let’s say that I’ve got an individual, and they’ve got a million dollars, right? I have a third of it in a Roth IRA, I have a third of it in a traditional IRA, and I have a third of it in an account that’s already been taxed.

Bud Kasper: Right.

Dean Barber: So, I’m going to come in and say, “What if I could get all of my money into a Roth?” I’m going to retire at 62. I need $60,000 a year to spend. Over five years, Bud, I can spend down that account that’s already been taxed. Maybe wind up with about $60,000 left in that taxable account. While I was doing that, I can convert, over that same five-year period, money from my traditional IRA over to my Roth IRA and stay where? In the 12% tax bracket.

Bud Kasper: Yes.

Dean Barber: Okay? Now, what have I done? Five years later, now we’re 67, both people turn on their Social Security, and they turn on income from their Roth IRA.

Dean Barber: What is their tax bill forevermore?

Dean Barber: It’s a big fat zero.

Bud Kasper: Right.

That’s the Ideal Scenario

Bud Kasper: Yes. I mean, you’ve given a perfect scenario there. If we can live in a perfect world, but we should endeavor for that. Right? Because the opportunity is ours to take, but we have to understand how it fits into the plan.

Dean Barber: Yeah. Most people don’t come in with a third in taxable, a third in tax-deferred, and a third in a tax-free account. Why? Because they don’t talk to us soon enough. They wait too long, and they think that saving is saving. No, it’s not. 

Don’t ever put your money into something until you know what the tax ramifications will be when you go to take it out. 

Schedule a complimentary consultation with a CERTIFIED FINANCIAL PLANNER™. Let us help you sooner rather than later. You can schedule that complimentary consultation here. When you go to schedule, you can choose whether you want to visit with us by phone, if you wish to do a virtual meeting or if you wish to meet in person. You choose the time, and it’s all done.

Also, get a copy of our Tax Reduction Strategies Guide and our Retirement Plan Checklist. 

There is a Ton of Complicated Information

Bud Kasper: I know there’s a lot of information that Dean and I share with you today, but it’s critical. It’s only good if you do something about it if you exercise your right to be able to mitigate taxes in your life and, more importantly, and the retirement part of your life. So, have an opportunity to listen to us, allow us to educate you a little bit.

Where Did Social Security Planning Come From?

Dean Barber: So, Bud, you know, all of this came about, and you and I have been doing this now for a combined over 70 years, right? 

Bud Kasper: That was before television.

Dean Barber: Yes, what happened was it all stemmed from the financial crisis.

Bud Kasper: Yes.

Dean Barber: So, we always knew that tax planning, looking at the tax situation played a significant role. It wasn’t until the financial crisis hit that we were forced to take a step back and say, “Okay, what are we missing?” Because we want to help people not just get to retirement but through retirement.

Bud Kasper: Yes.

Dean Barber:  At the time, you couldn’t make money in stocks, bonds, gold, or anything else. Everything was losing money. 

So we said, “Okay, what are we missing? What could we do?”

Back to the Drawing Board

So, we went back to the drawing board. We found substantial planning opportunities around Social Security. Then we found huge planning opportunities around taxes. 

So, what did we do? We hired in-house CPAs to put that tax overlay on the financial plan, and that has been a game-changer for our firm and, more importantly, for our clients.

Bud Kasper: Right. Now it’s probably one of the best things that you can incorporate into your retirement plan. You need to understand this.

Taxes and Social Security are Complicated

Dean Barber: We’ve thrown a ton of information at you. This is probably the most complicated part of what we do, but it’s also one of the most critical parts. 

If we can control the amount of money that’s going to Uncle Sam every year, which you know it’s not like golf, where you can keep an extra ball in your pocket and go, “I get a Mulligan on this one.” No, once you’ve paid those taxes, you can’t go back to Uncle Sam and go, “You know what? I meant to do this other strategy over here.” It’s too late.

Bud Kasper: You mean you’re limited to one Mulligan? You don’t get any.

Dean Barber: Oh, on the golf course? I always keep two extra balls in my pocket, just in case, right? I’m out there to have fun. I’m not playing competitively!

Taxes on Dividends and Capital Gains

So let’s talk a little bit about taxes on dividends and capital gains. We can clear up any misunderstanding that anybody might have on how your dividends and capital gains are taxed. 

Now, this is true both pre and post-retirement. If your taxable income, your taxable, not your adjusted gross, okay. If your taxable income is anywhere from zero to $80,000, then the tax rate on your qualified dividends and capital gains is zero.

Bud Kasper: Right.

Dean Barber: Okay. Now, if you go from $80,001 to $496,600, the capital gains and dividend tax rate is 15%. And if you go over 496,601, it’s 20%. But then you also have the Obamacare surtax, which will be another 3.8% once you exceed $250,000. 

So there again, complicated, but the tax rates are favorable for qualified dividends and capital gains. Capital gains have to be long-term capital gains, which means you have to have held the money in that particular position for more than a year.

Bud Kasper: Yes, one year and a day.

Dean Barber: Yes.

Bud Kasper: So the information that you just shared with our audience Dean, a person would say, “Well, I’m not at $250,000.” We know that. We know many people aren’t, and some people are. We’re just trying to lay out that you have to understand the rules of the game to maximize the results. We maximize the results by keeping more money in your pocket instead of Uncle Sam’s pocket. They’re already in there deep.

The Tax Code is Huge

Dean Barber: Imagine a book of Hoyle that was 760,000 pages long, and that’s for one game. That’s your tax code.

You can’t remember what was on the first page. By the time you get to page 4,000, I mean, it’s ridiculous.

Bud Kasper: So we got to find those people that can ferret through that information and give us the best advice possible. And we do that through the CPA, so we have inside our firm.

Dean Barber: Right. And quite honestly, not all of the rules apply to you. There’s some esoteric stuff out there, but the point is, once we understand your financial situation, then we can start to apply the rules that do apply to you and come up with strategies to reduce that tax liability. 

Saving Before Retirement

Let’s switch gears, Bud, talk about saving before retirement. And where should you be saving? Should you be putting money into a traditional IRA, Roth IRA, traditional 401k, or a Roth 401k? Should you be saving money outside of those in a taxable account? And if so, maybe you split between the three and how much should go into each one, and then which assets should you own in each one of those different tax buckets?

Bud Kasper: That’s right. Now you’re looking through the investment period to when the distribution starts and the tax consequences on each of those buckets. If we go back to the 401(k), and we ask, “Should I put in pre-tax or after-tax contributions?” After-tax meaning that there’s a Roth contribution you’re making. 

The Long-Term View

I’d like to look at the legacy of each year’s contributions. If you’re a young person and you’re not in a high tax bracket, putting in money on a pre-tax basis makes sense because you’re using Uncle Sam’s money that you might’ve given away to taxes to be able to build for your future.

That’s under the assumption that you’d be in the same tax bracket when you’re retired. We don’t find that to be true. So if that’s the case, that might not be the best place to be. If you were looking at after-tax, which we’d call Roth contribution, we know yes, we’re paying tax in that given year, but we’re never going to pay tax on it again.

Dean Barber: Ever.

Bud Kasper: So when we look at the time legacy associated with those two strategies, what’s the best? My guess would be a combination of the two, based upon your age and your income at that time. But even that is something that has to be calculated in terms of the future of that money.

Always Be Looking Forward

Dean Barber: Right. And that’s where you always have to be looking forward 10 to 15 years, right? In a way, it doesn’t require you to be a visionary or you to predict a future. 

Our Guided Retirement System™ does that for you. It allows us to look forward and say, “well, if we saved to this type of an account, whether it’s the Roth or the traditional or the taxable account, this is our long-term impact. This is what we’re going to be able to spend.” 

We’re concerned about how much money you can spend every month after taxes in retirement. 

So we look for the combination of where to save by running different scenarios that’ll tell us, “Well, if you do it this way, that’s going to maximize your ability to get as much money into your pocket during retirement.” 

We’ve used the same assumptions of investment mix and rate of return. So we don’t mess with any of that. We’re just looking at it purely from an asset location standpoint and a tax diversification standpoint.

It’s Cool When Client’s See it Come Together

Bud Kasper: Yes. I was with a client recently, I sat down at the table, and he had this funny grin on his face. I said, “What are you smiling at, buddy?”

He goes, “You know what, I’m now starting to see the benefits of the conversions that we did into the Roth.”

I said, “Because of this year’s income?” 

He goes, “No, because of what my income is going to look like in two years, in three years. I smile about that now because I know I’ve already handled what needed to be handled to mitigate taxes.”

Dean Barber: Yes. I was having a conversation two weeks ago now with one of our clients. 

We’ve been working on his tax strategy for about eight years. We got down to about 10% of his IRA/401(k) when he retired, and we only had about 10% left in his traditional. 

He’s just now hitting his RMD age. So his RMD is going to be super small. Now we’ve thrown a little wrench in the plan and said, “Here’s what I want to do. I want to start giving away more money while I’m alive because I want to see my kids enjoy this.”

Bud Kasper: Right.

Dean Barber: So we’re doing gifting out of his taxable account to such a degree over the next four to five years that we don’t want to do another Roth conversion. 

We know that we’re already going to be in a super low tax bracket because we’ve got that RMD down to such a small amount, and what the kids will wind up inheriting that dad didn’t give them is going to be Roth money.

What About the Spouse?

Bud Kasper: Right. There is some sacrifice in the earlier part to move the money into a more tax-favored position. But let me leave you with this thought as well. If you’re married and you’re going to have a spouse, and now you pass away after doing this beautiful tax work.

The wife will be filing single, which means it’s going to be in a higher tax bracket. Now there is an additional benefit that the wife got, just because of the unfortunate situation of a spouse’s passing.

It’s a Domino Effect

Dean Barber: It’s a domino effect, just like everything in taxes in retirement, but it’s a domino effect. One thing affects another, and that’s through financial planning as well as tax planning. Listen, this is complicated stuff. 

This is not a-do-it-yourself, read a little book and figure it out yourself. It isn’t as simple as going out and buying an index fund and then assuming that things will go up over time over time. This is real financial planning. 

We appreciate you joining us here on America’s Wealth Management Show. Hopefully, you learned something today, and we didn’t confuse you too much. We’ll be back with you next week, same time, same place. Everybody stay healthy and stay safe.


Taxes on Retirement Income

While most people are working, their tax situation is fairly straightforward. They earn income from an employer, and the employer has certain taxes deducted from their paycheck. 

The income earned is potentially subject to a number of different taxes. Taxes such as federal or state income taxes, Social Security tax, Medicare tax, or local municipality earnings taxes. 

You can do certain things to potentially reduce your taxable income while working. Things like making contributions to tax-deductible savings accounts.

When you leave your job and enter retirement, your tax situation can drastically change. We’re often asked by clients, “How will my retirement income be taxed?” The short answer: it depends. Let’s take a closer look at some of the typical income sources in retirement and learn more about how that retirement income could be taxed.

Taxes on Social Security Income

For a long time, Social Security benefits were received as a tax-free source of income. In the last few decades, a few laws have passed that have had significant impacts on the Social Security system. Since the early 1980’s, at least a portion of Social Security benefits has been subject to ordinary income tax. 

Many people we speak with are surprised to learn that up to 85% of the Social Security income they receive in retirement may be taxable. Want to know how much of your Social Security income will be taxable? You’ll need to know what your provisional income is.

Understanding Provisional Income

Taxes on Retirement Income - IRS Publication 915

Source: Publication 915: Social Security and Equivalent Railroad Retirement Benefits

Suppose you’re already receiving Social Security income. In that case, you can use the IRS Worksheet above to find your provisional income amount (this is also referred to on the Social Security website as “combined income”). 

If you are not yet receiving Social Security benefits, you can estimate your annual benefit and use 50% of that amount on line A. The formula is to take ½ of your Social Security benefits and add to all of your other taxable income (such as pensions, IRA withdrawals, investment income, etc.). You’ll also have to add in any tax-exempt interest income. The sum of these numbers is your provisional income.

If you are filing your tax return as a single filer, and your provisional income is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your Social Security Benefits. 

If your provisional income exceeds $34,000, you may have to pay income tax on up to 85% of your Social Security benefits. There is an IRS worksheet you can use to calculate exactly how much of your benefits will be subject to tax found in IRS Publication 915.

Taxes on Retirement Income - IRS Publication 915 Worksheet

In addition, your Social Security benefits may be subject to state income tax. Some states don’t tax income at all, regardless of the source. At the same time, others may have certain exemptions based on age or income levels.

Taxes on Pension Income

Pension income is generally going to be subject to federal income tax. The gross amount of pension income received is usually reported on line 5 of your tax return form 1040. Certain forms of pension income may be exempt from state income tax (for example, Kansas generally does not consider KPERS pension income as taxable income).

Taxes on Annuity Income

If the annuity income is from a nonqualified annuity contract, it may be subject to ordinary income tax. For example, let’s say you invest $100,000 into a new nonqualified annuity, and over time, it grows in balance to $200,000. 

One of the annuity structure benefits is that the growth was not taxable when it was earned (similar to how your traditional IRA grows tax-free). When you withdraw from the annuity, some of the withdrawal will be considered a return on your original investment. In contrast, the other part of your withdrawal will be regarded as a withdrawal of the growth that hasn’t been taxed yet. 

Fortunately, the insurance company that issues your 1099-R will generally report the amount of the taxable withdrawal and the amount that is a tax-free withdrawal of the original investment.

Taxes on IRA Withdrawals

Withdrawals made from Traditional IRAs are generally subject to ordinary income tax. (In some cases, you may have made a non-deductible contribution to your IRA, in which case you may have a portion of each withdrawal that is received tax-free.) 

Withdrawals from Roth IRAs are received tax-free and do not increase your taxable income (as long as you have satisfied the 5-year rule for Roth IRA withdrawals.

Taxes on Interest Income

If you have a brokerage account generating dividends, interest, or capital gains, that income may be included in your taxable income. The two types of ordinary dividends are qualified dividends and nonqualified dividends. 

Nonqualified dividends are taxed as ordinary income, while qualified dividends generally receive favorable tax treatment by taxing capital gains rates. On your tax return form 1040, you (or your tax preparer) will report the total amount of qualified and ordinary dividends on line 3.

The interest paid by bonds may be subject to income tax. Generally speaking, if you receive interest from a municipal bond, that income will be exempt from federal taxes (and possibly exempt from state income taxes). 

However, if the interest received is from a corporate bond or US Treasury bond, that income will be considered taxable income. The total amount of taxable and nontaxable interest income you receive is on line 2 of your tax return form 1040.

You may owe capital gains tax as a result of selling an investment or property for a gain. To determine whether you will owe tax on capital gains, you’ll need to calculate your total taxable income (with the gain included). In 2021, for single tax filers, if your taxable income is below $40,400 ($80,800 for married-filing-joint), you will not owe any tax on capital gains income. 

For single tax filers whose taxable income exceeds $40,400 but does not exceed $445,850 ($501,600 for married-filing-joint), the tax rate on long-term capital gains income is 15%.

Conclusion

A strong argument could be made that tax planning is just as important, if not, maybe more important, for retirees than workers. Because of the complexity of the tax code and the wide variety of income sources in retirement, it’s important that retirees consider speaking with a qualified tax professional to get a handle on their tax situations. 

For example, someone who has a significant capital gain may trigger a variety of “tax landmines,” such as increasing the amount of their taxable Social Security income, jumping up to a higher tax bracket, or paying more for their Medicare premiums. If you’d like to schedule a complimentary consultation with one of our financial planners or accountants, click here.

Jason Newcomer
CFP®, AIF®, EA | Financial Planner


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The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.