Increasing your after-tax retirement income
During your retirement years, it's important to pay close attention to the income tax consequences of your investment decisions. If you receive a great deal of investment income when retired, for instance, the taxation of your Social Security benefits may be impacted adversely. Furthermore, if you have accumulated substantial investment income in a tax-deferred retirement plan and fail to manage distributions properly during your retirement years, you may find yourself pushed into a higher tax bracket when you are forced to take required minimum distributions after age 73. There are several steps you can take to manage the income taxes on your investments.
How can investment income affect Social Security benefits?
To determine whether your Social Security retirement benefits are taxable, you must perform a calculation. Your benefits are taxable if one-half of your Social Security benefits plus all of your other income exceeds a certain base amount for your filing status. (All of your other income includes taxable pensions, wages, interest, dividends, and all other taxable income. It also includes tax-exempt interest income plus normally excludable income such as interest from Series EE savings bonds and foreign earned income.) If you determine that your Social Security benefits are taxable, either up to 50 percent or up to 85 percent of your benefits will be taxable, depending on your filing status and the amount by which you exceed the base figure. Political policies may change this taxation on Social Security, but the aforementioned applies today.
Reducing investment income
Since investment income (e.g., taxable interest income and dividend income) must be included in gross income, reducing the amount of income you earn from your investments will help decrease your adjusted gross income. This, in turn, can help minimize taxation of your Social Security retirement benefits. To reduce investment income, you might consider investing in growth stocks or in mutual funds that appreciate rather than pay dividends. To shift income and tax, you might also consider gifting income-producing investment assets (such as stock) to your relatives or favorite charities.
How might you get pushed into a higher tax bracket during your retirement years?
Most people expect to be in a lower tax bracket after retirement due to diminished earned income. But this is not always the case. For instance, if you accumulated substantial income in a tax-deferred retirement plan over the years and are now over age 73, you might find yourself pushed into a higher tax bracket. After age 73, you must start withdrawing minimum amounts of your money annually from certain qualified retirement plans; this rule is known as the required minimum distribution (RMD) rule. Basically, your annual RMD is calculated by dividing the value of your retirement plan by your life expectancy. Therefore, the higher the value of your retirement plan, the more taxable income you'll have to withdraw.
If your retirement assets are such that you could be pushed into a higher tax bracket after age 73, you might wish to consider withdrawing a portion of your retirement plan money annually upon retirement (or at any time after age 59½), instead of waiting until age 73. For this, you might consider a Roth conversion too, which is an account that defers tax as well as provides tax-free withdrawals, and for which there is no RMD. By controlling and managing your retirement distributions during your early retirement years, you may be able to prevent a tax bracket problem (i.e., higher income taxes) later on. Of course, the challenge will be to figure out precisely how much money you should withdraw each year. Such a calculation is fairly involved; for more information, consult your financial professional.
If you have substantial investment portfolio income, you might consider making gifts of unneeded income-producing assets to lower-tax-bracket individuals such as family members, and otherwise make charitable donations. This strategy will remove a certain amount of taxable interest, dividends, and capital gains from your financial picture. For more information, contact the author of this article.
This information, developed in part by an independent third party, has been obtained from sources considered to be reliable, but Raymond James Financial Services, Inc. does not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investments mentioned may not be suitable for all investors. The material is general in nature. Securities offered through Raymond James Financial Services, member FINRA / SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Lynch Wealth Strategies is not a registered broker/dealer and is independent of RJFS. Private Wealth Advisor is a designation awarded by Raymond James to financial advisors who have demonstrated mastery in anticipating and managing the expansive financial needs of high-net worth individuals, families and organizations.
Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
