May 2015 Monthly Insight: Setting Your Retirement Income Strategy

Posted By T. Lee Sherbakoff, CPA/PFS, CFP® on May 15, 2015

Over the last month or so, several folks have asked Don and me several questions regarding taxes, retirement savings, and the tax issues associated with drawing money out of a retirement account. Although I’m sure you’ve heard myths and all the long-standing conventional wisdom about how and when to draw money out of retirement accounts, you’ll find your own best after-tax solution after a thorough analysis of your options.

Clearly, the most important key to a successful retirement is saving during your working years. If you start early, your “accumulation phase” could approach 40+ years. However, after you retire, managing the “de-accumulation phase” is also extremely important ― especially when you need to maintain purchasing power over a retirement lasting 30 years or more. Successfully funding your retirement is much more than just trying to reach a magical number before retiring. You must also develop and execute a comprehensive income and distribution strategy.

Managing taxes is an important part of a comprehensive retirement income planning strategy.  You may not realize that tax regulations require you to take a minimum distribution out of your qualified retirement plans each year after you reach age 70½. The Required Minimum Distribution (RMD) is based on your age, and the percentage amount that you must withdraw increases each year. For example, at 71 years old, you must take 3.77% of an IRA balance, while at 80 you must take 5.35%. Even though you’re taking your RMDs each year, over the long term, the cash withdraws could increase because your investment is growing and the minimum percentage you must withdraw is also increasing. Therefore, your taxable income would be increasing each year too, and you might even find that, although you were expecting to be in a lower income tax bracket upon retirement, that may not be the case.

In actuality, a detailed, well thought out retirement income strategy might debunk the myth that you should leave the money in your tax-deferred accounts as long as possible. A thorough analysis may indicate that taking distributions sooner (prior to age 70½) and over a longer time offers you opportunities to manage current year and future year tax brackets and expose your RMDs to the lowest possible tax rate.

Another myth concerns RMDs and Social Security. Many people hope to delay Social Security to age 70 in order to get the largest Social Security benefit. This practice, coupled with RMDs, could adversely affect your taxes. You probably know that RMDs from IRAs, 401(k)s, and other retirement plans will be taxed at ordinary income tax rates rather than the lower capital gains (investment) tax rates.  However, what you may not realize is that income from RMDs can trigger Social Security benefits to be taxed. In fact, up to 85% of your Social Security benefits could potentially become taxable.

In general, a single taxpayer with modified adjusted gross income over $34,000 and a married filing jointly couple with income over $44,000 will have 85% of their Social Security benefits taxed at ordinary income tax rates. RMDs are included in the income calculation as well as municipal bond interest, which would otherwise not be included in an adjusted gross income calculation.

The inclusion of Social Security benefits in taxable income gives you another reason to manage your retirement plan withdraw, and perhaps to plan differently than the conventional wisdom of delaying as long as possible. For example, lifetime tax planning could justify delaying Social Security until you reach age 70, while beginning to draw from retirement accounts in your 60s. Doing so would get you both the highest guaranteed Social Security lifetime benefit beginning at age 70 and lower future RMDs (and associated income taxes) from retirement accounts.

A thorough analysis of projected retirement income ― including Social Security, pensions, retirement annuities, and projected RMDs ― may show that, in fact, your projected income tax rate during retirement may not be lower than your tax rate during your working years. Further, a comprehensive, detailed retirement income plan may prove that your retirement planning should not follow certain rules-of-thumb or conventional wisdom, but should be an individual analysis based on your particular situation, goals, and objectives. We look forward to working with each of you in developing your retirement income strategy.

As always, Don and I appreciate and thank you for the opportunity to serve you and your family as your financial planners and wealth advisors. Please let us know if you have any questions.


DISCLOSURE: Any US tax advice contained in this document was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax provisions; and such tax advice may not be promoted, marketed, or recommended to another party.