Managing Your Wealth

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  From the Total Interest Earned, $26,866, $7,520 was paid to the IRS and the
interest was never touched. Instead of earning $26,866 in interest, AFTER
TAXES was only $19,346. Also, this hypothetical illustration does not take
 inflation into consideration. Net Rate "AFTER TAXES" 3.60%. 

Filling Up Your Tax Bracket – Does It Make Sense for Retirees? 

 Wouldn’t it be wonderful to reach retirement and not have to worry about tax planning?  Unfortunately, even in retirement, it’s important to manage tax planning.

Once retirees begin receiving Social Security, they learn quickly that it’s not necessarily the tax-free stream of income it used to be.  If retirees are single and their income, including half of their Social Security and any tax-free income, exceeds $25,000, then up to 50% of Social Security is taxable, and once they exceed $34,000, 85% of their Social Security potentially becomes taxable. 

For married couples, the income limits are $32,000 and $44,000, respectively; above $44,000 up to 85% is taxable.    

Thus, some retirees who don’t need a lot of money to live on find it advantageous to reduce their taxable income by investing into tax-deferred vehicles such as annuities.  Once retirees reach age 70 ½, tax planning becomes more complicated if they have an IRA, as Required Minimum Distributions (RMDs) must begin no later than April 1st of the year following the year they turn 70 ½.  Many retirees have adjusted their expenses to live without this IRA cash flow and found they don’t need the money.  However, this cash flow is adding to the retirees’ income and thus to their tax burden, including the potential taxation of their Social Security payments.  Many retirees only take the very minimum amount each year from their IRA, but in fact, they probably would be better off by “filling up” their tax bracket.  

For example, let’s suppose that after going through all of the calculations, a retiree finds that he or she is in the 15% tax bracket with taxable income of $42,000.  The top end of the 15% tax bracket is $61,300 of taxable income.  Thus, this retiree could take more out of the IRA and still remain in the 15% tax bracket.  The same logic applies to the other tax brackets.

           Does taking more income from the IRA and “filling up” your tax bracket make sense?  As is often the case, “it depends.”  Yes, it is true retirees will give up tax-deferred growth on the money over time, which could be a negative event.  However, should retirees not do this, then they may find that in future years larger distributions from the IRA will put them into a higher tax bracket, which could mean they will end up with less money. 

        Further, additional money withdrawn above the RMD is eligible to be rolled over into a Roth IRA, which accumulates tax-deferred, and if left on deposit for a minimum of five years,can then be withdrawn tax-free.  Money does not have to be taken out of a Roth IRA until the time of a retiree’s death.  

This leads to an important part of overall family wealth planning.  Should a retiree’s IRA be inherited, it is entirely possible that the heirs will be in a higher tax bracket than the retiree was -- perhaps even in the 35% bracket.  Thus, if the money can be withdrawn in the 15% bracket, as opposed to being inherited at the 35% bracket, there is a 20% tax savings.  

The moral?  Tax planning doesn’t stop just because one retires.  Many times paying less tax is better, but there are occasions where paying more makes sense.  Retirees should seek qualified professional assistance in making their decisions.