by Dave Kutcher
“Death and taxes” is a phrase commonly referencing a famous quotation written by American statesman, Benjamin Franklin, in his letter of 1789 to Jean-Baptiste Le Roy.
Our new Constitution is now established and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.
We often think of things such as the risk of long-term care expenses, rising inflation and poor investment returns as our primary concerns when trying to manage retirement income resources so as not to outlive our money, the fact is income taxes might be your biggest expense during retirement and may play a consequential role in whether your money is substantive enough to last your lifetime.
A big part of your potential income tax situation at retirement is whether your social security benefits are taxable. Most people enter retirement with the impression that their social security benefits will be income tax free. That belief is true to some extent, but the source and amount of other income you may have will ultimately determine how much of your social security benefits are subject to income taxation.
If you have income from pensions, withdrawals from retirement accounts or you are working part-time during retirement, all these things will have to be considered in terms of how they impact the taxation on your social security benefits.
In a worst-case scenario, 15% of your social security benefits will remain income tax free. In a best-case scenario, 100% of your social security benefits will be income tax free. Everything depends upon what the IRS determines is your “provisional income”. Once your provisional income is determined, you can then determine your social security taxation based upon your tax filing status, i.e., Single filer, Married filing jointly, Married filing separately, etc.
Certain types of income are included, and others excluded when determining your provisional income. Diversifying your retirement income sources can help you manage and reduce your potential tax burden.
Just as a quick example, if I had two married couples the same age, with the same amount if income expected to come into the household, but one had a traditional IRA and the other instead had a ROTH IRA, the difference in how much of their social security benefits will be taxable is astounding.
Here are some ideas for managing taxable vs. non-taxable income … or I should say for managing what will be included in your provisional income calculation and thus what will determine how much of social security benefits will be taxable.
Incorporate some sources of money that allow you tax-free or tax-advantaged access to funds such as life insurance cash values.
Consider converting traditional IRA funds into ROTH IRA. The conversion itself is taxable but once the conversion is done, all the income from the ROTH is tax-free and is not counted in the provisional income calculation.
Manage your withdrawals at retirement from taxable and non-taxable sources to try and minimize your provisional income total and keeps things below the thresholds determined by your filing status.
Consider the timing of your social security benefits. You may want to delay taking your social security if you have other sources that can be used early on. Obviously, you must consider your income needs in general, but it is worth looking at whether delaying the start of benefits can help you minimize provisional income over time and thus minimize the portion of your social security that may be taxed.
If you have any charitable inclinations, consider using funds such as your IRA to make qualified charitable distributions and exclude that income for tax purposes.
My name is David A. Kutcher, a retired Marine Corp Captain. My business partner in the lower 48 is Richard C. Scott, CLU, LUTCF. For nearly 40 years we have been helping folks with their personal retirement decisions. We encourage you to make an appointment and get ahead of your concerns as early as is possible. You can catch us on the radio every Saturday morning, “Retirement in the Last Frontier”, 8:30-9:30 on AM 650, Keni Radio. Frontier Retirement, 10928 Eagle River Road; Eagle River, AK 99577, (907) 795-7452.
