Making Cents: A Counter-Intuitive Tax Plan for Retired High Earners

John Napolitano CFP®, CPA, MST

US Wealth Management Chairman and CEO

 

Most Americans are conditioned to postpone the payment of income taxes for as long as humanly possible. Yet for some, this desire to postpone could end up costing you more in the long run.

I’m specifically thinking about those who were high earners during their working years. During the first few years of retirement, before your required minimum distributions (RMD’s) kick in, you may feel pretty good about filing tax returns with a very low taxable income and an equally low amount of tax. But that temporary joy could be even better if you extended your tax planning mentality to all of your retirement years, and not just the first few.

Because of the new tax act, taxable income over approximately $9,500 will be taxed at 12%. That’s a pretty low rate for someone who may be used to paying in excess of 30% in federal taxes. That 12% tax bracket for married couples filing jointly lasts until your taxable income creeps up over $77,400. If you’re likely to be over that amount when you must start taking retirement distributions, this year could be a year when you may consider creating income, but at a lower tax rate. For a retiree, the best way to create income is to withdraw from retirement assets.

Creating income from retirement withdrawals that bring you to the brink of the next bracket, which is 22%, may be one of your last opportunities to pay income taxes at the 12% rate. If you don’t want the income because you have other non-retirement assets from which to draw, consider making a Roth Ira conversion with some of the retirement assets. The amount converted will be taxed at this year at 12% and you’ll now own an IRA that will never be taxed again either to you or your beneficiaries. This is a very powerful intergenerational planning tool, especially for Grandchildren. It’s important to note that Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.

Another consideration is to use this low bracket year to diversify your portfolio. Commonly we see retirees with a few investment positions that they’ve held for years with a very low tax basis. If your taxable income stays under that famous $77,400 amount, your capital gains tax will be $0 for federal tax purposes. Elder taxpayers who have often owned certain blue chip stocks for decades frequently aren’t aware of this tax free way of selling investments.

This is tax planning with precision. In order to benefit most from this type of planning, there are two critical factors. First is that you must act on good information. Get an accurate forecast of your income and tax bracket before the year comes to a close. The second is timeliness. While these strategies can have a profound impact over the long term, there is short term action needed. All of these moves must happen before the year ends.

These opportunities will exist in future years as long as your income stays low. Even a little tweaking each year will add up to a lot over the long term.

John P. Napolitano CFP®, CPA is CEO of U. S. Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. US Wealth Management, US Financial Advisors and LPL Financial do not offer tax advice. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.