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Taxes in Retirement: What Every Retiree Needs to Know. · Retire and Thrive

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People like to have their paycheck replaced.
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They like consistency. However, if they're like, I'll
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call you when I need the money and all of a sudden they pull
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out $10,000 one time and then they go months and months and
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months with nothing and all of a sudden they need $30,000 because
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things have popped up. Often times there's a lot of
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inconsistency there. And quite honestly, that
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inconsistency, sometimes people don't realize how much they've
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actually pulled out. Any money that you move from
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IRA, i.e., pre tax to a Roth account.
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The Roths are not subject to required minimum distribution.
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The Irma penalties basically pertain to when you take Social
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Security. Welcome back to another episode
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of Retire and Thrive podcast where I help you build your
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retirement with purpose, wealth, and confidence.
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It's actually kind of hard to believe, but this is episode 29
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and the 1st 24 episodes were a deep dive into the book.
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And the last four episodes, 5 episodes quite frankly, are all
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about some specific strategy, maybe some tidbits that you can
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take away once you are in fact retired or today we're going to
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talk about as you approach retirement.
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But today will be one of the topics again that I feel is
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very, very important. And I'm going to say the title
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of this podcast is Taxes in Retirement, What Every retiree
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Needs to know. And if you want to keep more of
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your retirement, I would say tune into this episode because I
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would say as a firm, we probably spend the majority of our time
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on financial planning. And obviously we focus on
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investments as well. But the financial planning is,
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you know, here's where you're at, here's where you want to go.
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How do we get there? So we build out this plan, but a
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big part of that is the taxes. And we've seen some horrific
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mistakes over the years. And so today I want to basically
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just touch on some of the key highlights of taxes and maybe
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some of the strategies of what every retiree needs to know.
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And so I think the first thing I want to talk about is tax
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surprises. And what I mean by tax surprises
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is it doesn't happen often. Certainly if we're involved,
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we're not, we don't really hear this, but periodically, I would
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say at least every other year, sometimes yearly, we'll have a
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couple clients that'll call us. And often times it's in
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February, March, and they're just like, Oh my gosh, I just
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met with my accountant and we owe, you know, a lot of money,
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5007 thousand dollars. What happened?
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And based on the attacks strategies and the analysis we
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did, we're like, I, I have no idea.
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And they can come from any number of places.
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But often times it might mean that they had a small retirement
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account at a firm or a bank and they just cashed it out and it
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might have been 10 or $15,000. And they use that as a down
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payment for a car or maybe they used it for something else.
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And we weren't even aware of that.
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So we we do get tax surprises from clients and it is a little
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bit scary. And then we got to figure out
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how to pay for it. Other tax surprises might might
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include that they didn't realize that they had pulled as much as
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they did out. And so maybe they didn't convey
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that message to the accountant and didn't have enough quarterly
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withholdings. So tax surprises is one of the
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challenges and one of the things that when we look at retirement
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and we focus on taxes, it's trying to eliminate or reduce
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some of those surprises. The second thing I want to talk
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about is withdrawal sequencing. What I mean by that is
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sequencing is the rate at which you're pulling the money out.
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And so often times what we find is people like to have their
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paycheck replaced. They like consistency.
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And so when they're pulling money out on a consistent basis,
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on a month in and month out basis, it tends to replicate
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what their paycheck used to be. However, if they're like, I'll
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call you when I need the money and all of a sudden they pull
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out $10,000 one time and then they go months and months and
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months with nothing and all sudden they need $30,000 because
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things have popped up. Often times there's a lot of
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inconsistency there. And quite honestly, that
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inconsistency, sometimes people don't realize how much they've
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actually pulled out. So I think the withdrawal
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sequencing can mean a big difference when it comes time to
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determining clients that are pulling money out on a monthly
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basis versus pulling it out when they feel like they need it.
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The other thing on the withdrawal sequencing is pulling
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money out on a monthly basis can also help in terms of
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consistency. But we've also found that people
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look at it more as we'll make that amount fit into our budget
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versus picking up the phone and just saying I'd like $30,000 or
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$20,000, it's much easier. And often times that falls
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outside of what they maybe normally would be spending.
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The other thing I want to talk about that isn't overly popular,
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we seem to do a lot of this and the pros and cons of Roth
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conversions in retirement. And I think the pro of Roth
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conversions is of course moving money from an IRA to a Roth is
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considered a Roth conversion. And when you do this, you're
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actually converting the pre tax money to tax free money.
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And so how does this look from a tax perspective?
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If I've got $25,000 that I moved from IRA to Roth, that $25,000 I
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now get a 1099 and I have to claim that as a regular income.
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So is that a good thing? Again, it depends.
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It depends if you need access to that money right away, because
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if you do, the answer is no. It depends on what your overall
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tax bracket is. If you're already in the 24% tax
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bracket or the top of the 12% bracket, those are the two
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biggest jumps in the tax brackets from 12 to 22% and from
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24 to 32. So if you're at the top of those
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brackets, maybe then it doesn't make some sense.
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But if you're in one of those other brackets, 12% bracket or
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maybe 22% and you're OK with paying some additional taxes,
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then that can certainly be attractive.
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The other thing I would look at in terms of when is it a pro?
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It may be a pro if you predominantly have a large
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percentage of your retirement accounts that are pre tax.
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So what's the large percentage? I would say it could be 60%, it
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could be 80%. It just really depends.
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And again, it depends on where your income is coming from.
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If you've got $500,000 in an IRA account and between you and your
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spouse you have enough monthly income between sources of social
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securities and pensions and everything else that you only
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need to pull $1000 a month, maybe the Roth doesn't make that
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much sense. If you're in a higher bracket as
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I mentioned, then it definitely doesn't make sense.
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The other thing to keep in mind is any money that you move from
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IRA, i.e, pre tax to a Roth account, the Roths are not
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subject to required minimum distribution.
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Let me repeat that. Roth IRA accounts are not
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subject to RM DS. So we have aggressively done
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Roth conversions for clients that are in their late 60s.
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And a lot of people may look at that and say, why would you
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convert for somebody who's 77 years old or 67 years old or 68
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years old? And the answer is maybe they've
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got $2,000,000 and they're required minimum distribution is
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going to be north of $80,000 and they're only in the 12% tax
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bracket. So they want to have some
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control over that. Another situation that we have
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done that I've seen that I feel seems to make sense is Roth
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conversions can make a lot of sense if you've got your
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children who ultimately will inherit this money and they're
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going to be in a much higher tax bracket than what you currently
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are. So we recently did this with
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some clients of ours. These were clients of ours that
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their combined income put them in the 12% bracket, but they had
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a daughter and a son, each of them were in the 24% bracket.
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And as they got older and they advanced in their jobs, it was
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likely they were going to be moved into the next higher tax
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bracket. So in that particular case, we
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converted enough to keep our clients in that 12% tax bracket,
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knowing that their kids probably will be at least at a 24%
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bracket and potentially even a 32% bracket assuming that tax
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rates remain the same. So Roth conversions can make a
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lot of sense for retirees, but it doesn't make sense if you
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need access to the money. And the second time that I would
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say it definitely doesn't make sense is if you need to tap the
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retirement account just to pay the taxes.
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Another thing I want to talk about when it comes to taxes is
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the Irma penalties. The Irma penalties basically
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pertain to when you take Social Security.
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I know I've touched on this briefly in a previous episode,
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but let's focus on Medicare. At 65, everyone becomes eligible
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for Medicare under current laws and there is a slight cost of
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that that typically gets withheld from your Social
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Security if you are in fact taking Social Security.
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But what they do is it's referred to as a two year look
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back. They look back two years to what
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your income was back then. And if your income crossed over
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certain thresholds, then you're going to pay more for Medicare
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than people that didn't have a high income two years.
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And so it always goes back, I refer to as kind of a clawback.
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It kind of claws back or it re looks back two years to see what
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your income was. So we actually have a client of
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ours right now that had a very, very high income at age 63,
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hundreds and hundreds of thousands of dollars.
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And so it was more beneficial for them now that they're 65 to
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stay on a health insurance plan, a private health insurance plan,
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than to go on a Medicare, simply because their income was so high
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at age 63 from their W2 wage, they were an employee and did
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very well. But because their income was so
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high, it actually made sense for them to stay on the traditional
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health insurance for another year because at age 64, once he
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had retired, his income was very, very low.
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So Irma, basically, penalties do make a difference when it comes
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time for Medicare. Next thing I want to talk about
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is RMD rules. So the RMD again, required
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minimum distribution. The rules for RMD currently are
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at age 73. The government is going to force
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you to start taking money out of those retirement accounts that
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you've deferred ever since you started them.
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Could be 20 years or it could be 40 years.
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However long you've been contributing, this pertains only
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to pre tax money. Be it a four O 1K, be it a four
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O 3B. Could be your IRA that you've
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rolled over for one of those sources, but your IRA or 4 O 3B
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or your 4-O1K. Based on current law, at age 73,
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the US government or the IRS will force you to start pulling
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money out of that account and you will start to have to pay
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taxes on that. By the way, just as a little
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FYI, in the year 2035, it goes from 73, then the RMD minimum is
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age 75. So it does go out for those that
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turn 73 after, after 2035, it goes all the way out to 75.
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So you pick up a couple of years if you're a little bit younger.
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So back to the RMD rules, you need to pull out the amount,
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which is called the required minimum distribution.
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And what is that amount? Well, it basically is an
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increasing amount. It's not a percentage, it's
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actually a factor or a fraction. And that that percentage goes up
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every year based on your age. So the way the calculation is
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done is they multiply the value of your account as of December
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31st times the withdrawal rate and then that is the required
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minimum distribution you have to take sometime in the next
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calendar year. So here we sit at the beginning
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of 2026 and people that have IRA accounts and are 73 or older,
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they will actually go back on December 31st, 2025, take a
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snapshot value of the account at that time, apply the formula and
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we'll come back and say this is the dollar amount that you are
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required to pull out in the year 2026.
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Now you can do all kinds of things.
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The government doesn't care how frequent you pull that money
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out. It just has to all be pulled out
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by December 31st, in this case of 2026.
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You can pull it out every single month.
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You can pull it out once a quarter, you can pull it out
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annually, you can pull it all out in January, you can pull it
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all in December. Any way that you want to pull it
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out, you can. And then also because the income
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that's coming out of there has never been taxed, you can have
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taxes withheld state, local, whatever percentage that you
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want to that is kind of a summary of the required minimum
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distribution rules. The next thing I want to talk
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about of taxes and retirement, again, we went a little bit
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heavy on this last time and so I'll just touch on this real
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briefly is the taxability of Social Security.
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If you recall, if you take Social Security, regardless of
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when you take it, whether it's before full retirement or after
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full retirement, the IRS looks at all of your income.
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And if that income is at a certain level, the first level
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is 55. Zero percent of your Social
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Security is taxable and the top is 85% of your Social Security
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becomes taxable. So if you've got an income of
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approximately, let's just say $30,000 coming from Social
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Security or roughly $2500 per month and half of it's taxable,
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you just report that additional $15,000 as income and it just
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gets added in with all of your other income.
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The last thing I want to talk about when it comes time to talk
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about taxes in retirement, and this isn't really going to apply
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as much for those that have retired, and it certainly can,
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but I think about people that are in their 50s, whether
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they're early 50s, mid 50s, is to plan early.
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And when I say plan early, it's never too late when you look at
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your retirement plan to see what the tax implications are going
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to be for all of your income sources.
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We know that any money coming out of a pre tax retirement
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account like an IRA is fully taxable.
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We know that income coming from a pension is fully taxable.
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We can estimate in a non retirement brokerage account if
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you've got dividends or capital gains what the estimate tax is
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going to be there. But if you look at your overall
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portfolio, specifically, if you're still working and the
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majority of your money is still going all pre tax, realize that
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at some point when you need that four O 1K or 4-O3B to kick out
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an income to you to live on, it's fully taxable.
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Today's top marginal bracket at the federal level is 37%.
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Now, I'm not going to predict this, but I'm going to say in my
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opinion, based on where the government is at today, and if
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you think of the government as a business, they have expenses and
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they have income. The majority of their income of
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course, comes from taxes. And when we look at the
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consistent budget deficits, in other words, they're spending
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more money than they're taking in.
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I think it's a pretty logical conclusion that we may see tax
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rates go higher. So planning early simply says if
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you haven't retired, it may not be too late to start making some
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shifts typically inside of your retirement plan to contributing
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to some of these Roth accounts inside of your 4-O1K or 4-O3B,
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whatever qualified plan that you've got.
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So I encourage people to plan early.
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And if in fact you are retired, you can still plan early and
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plan early means let's take a look at all the taxes that we're
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having in retirement. Maybe we're newly retired and
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we're 63 years old, then you can still plan early because when we
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run our models in our financial plan, some of you may laugh at
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this, but our standard mortality age is 90.
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And part of the reason we do that is if we've got spouses
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here, people are living longer and longer due to medical
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advancements. So even at age 62 or 63 or 65,
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if that's when in fact you retire, you can still plan
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early, even in re early stages of your retirement that will
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affect you down the road, maybe when you're in your mid 70s.
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So same principle applies. Look at the taxability of your
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assets, of your income flows and see does it make some shifts?
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So how would that work if I've got a new, a newly retired
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couple that's in their early 60s and they don't have a lot of
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income? We can start shifting some of
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this through Roth conversions so that when they do someday want
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to buy a bigger ticket item and they need $50,000 or whatever
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the amount is, they can pull that money out and it's not
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going to affect the taxability of their other income by pushing
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them into that next bracket. So I hope today's episode on
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taxes was helpful. I know it's a little bit
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overwhelming, just lots of content to talk about and I feel
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like we've just scratched the surface on that.
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But in summary, taxes play a very large percent of people in
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retirement. And when we look at all of these
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different things or options to consider, don't take it lightly.
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As I mentioned, we spend more and more of our time on the
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taxes with different strategy than probably anything else
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other than building out financial plans.
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O roll U your sleeves. Dive into some of this tax
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information in retirement and we'll look forward to seeing you
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next week on another episode of Retire and Thrive.
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Fortress Financial Group, LLC is a registered investment advisor.
20:06
Advisory services are only offered to clients or
20:08
prospective clients where Fortress and its representatives
20:11
are properly licensed or exempt for licensure.
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The opinions voiced in this material are for general
20:15
information only and are not intended to provide specific
20:18
advice or recommendations for any individual.
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All indexes are unmanaged and may not be invested into
20:23
directly. Investing involves risk,
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including loss of principal.