Over dinner with friends who live in the Northeast, they expressed concern about how the recent tax changes may increase their federal income taxes. They’re right to worry. New rules limit the amount of property and state income taxes that can be deducted – and they live in a high-tax state.
Like everyone, I am a fan of legally minimizing your taxes. But I think – if you are retired or about to retire – you should concentrate less on minimizing taxes and more about increasing after-tax spendable income and your financial legacy to heirs. Sounds like a non-sequitur, but it isn’t.
As an example, you could invest your entire savings in high-quality municipal bonds and pay no taxes on interest earnings. But you would earn something like 2.5% in annual income. Wouldn’t it be an improvement if you paid some taxes and generated an income stream equal to, say, 6% after taxes.
Here are five ways to increase after-tax spendable income – and your legacy. As you will see, I am mindful of the tax burden, even while I concentrate on boosting spendable income and your legacy.
1. Use dividends and interest from personal savings
Personal savings are those that have already been taxed, and the income on these savings enjoys some tax benefits. Dividends on stocks or from mutual funds/ETFs are taxed at 50% of the ordinary income rate. Interest payments on municipals can avoid taxes entirely, so that if half of a fixed-income portfolio is in muni’s you’re taxed on only half the interest. You can generate a nice after-tax income from this combination.
2. Include tax-advantaged annuity payments from personal savings
Annuity payments purchased with after-tax savings receive a break because a portion of each annuity payment is considered a return of previously taxed principal, until the principal has been paid out. To illustrate, a 70-year-old female in a 25% tax bracket can generate nearly 7% in after-tax annuity payments until age 88, and around 5.5% thereafter. If you own a deferred annuity (fixed, indexed or variable), then these savings can be converted into annuity payments and the tax-deferred gain in the deferred annuity will be spread as part of the annuity payments.
3. Reduce taxable distributions and guarantee future income in a rollover IRA
Withdrawals from a rollover are taxed as ordinary income, whatever the type of investment earnings. On top of that, the IRS requires that you start taking withdrawals when you turn 70½ years old whether you need the money or not. One idea virtually every IRA holder ought to consider is to allocate a portion of the account to a Qualifying Longevity Annuity Contract (QLAC for short). With a QLAC, you can defer up to 25% of required withdrawals. You won’t pay taxes on that money until the QLAC starts generating annuity payments. To illustrate, an allocation of $100,000 to a QLAC by our 70-year-old female retiree can generate over $30,000 a year in annuity payments starting at age 85.
4. and 5. For legacy planning, “die rich” with your personal savings and “die poor” with your rollover IRA savings
While every retiree’s split between personal and rollover IRA savings is different, you should consider that (1) all growth (unrealized capital gains) in personal savings is passed to heirs income tax free and (2) similar growth is taxed as ordinary income if from a rollover IRA. One way to change that balance is to gradually convert a part of the rollover IRA into a Roth IRA, which is passed on income tax free. Another approach is to use annuity payments to generate more cash flow in the rollover IRA to enable more growth in your personal assets. My own personal retirement plan is to have little or no rollover IRA assets at my passing, having converted most to annuity payments, and to a Roth IRA.
Bring these ideas to meetings with your advisor
Retirement planning alone can be complicated and is made more so when taxation is considered. Further, it must be personalized to the individual. However, by taking advantage of these tax-break opportunities you may earn attractive income from your hard-earned savings, both before and after taxes. You will likely need a financial advisor in these areas but be sure to challenge the advisor with these tax breaks.
Maybe next April 15, whether your tax bill is up or down, you’ll feel more secure about your future.
To create your own retirement plan that recognizes all of the above, go to the income allocation page at Go2income.com.Once you get your Income Allocation report, request an appointment so we can discuss these tax breaks. If you have other questions about retirement, simply post at Ask Jerry.
Note: Annuity payment amounts above are based on the Go2Income proprietary annuity pricing methodology. To get a quote from three top-rated annuity carriers, go to Income Annuity Shortcuts on the Go2Income site.