Tax Bracket Management

Hello, Matt from EWA. Chris from EWA. Today we are talking about five tax tips for retirees. And tip number one is how to most effectively manage your tax bracket during your retirement years. So, Chris, first let’s talk about from a federal tax bracket management.

What are some best tips and tactics to make sure that clients are paying as little in tax as possible and keeping as much in their pockets as possible? It’s a great question. So whenever you’re entering retirement, very important that we have a healthy mix of pretax and Roth accounts to supplement your spending during retirement.

Generally, you’ll have Social Security coming in, which will fill up the ten and 12% tax brackets. So we want to coordinate RMDs to make sure that we’re only filling up the low tax rates and avoiding the high tax brackets during retirement.

Yeah, so, for example, what we have up on the screen now are the married tax tables. So our rule of thumb is to always recognize income up to the ten and 12% tax brackets. So the 12% cuts off at 83 550.

But if you’re married filing jointly, you get a standard deduction at 25,900. So our limit is really closer to $108,000. So if we walk through a client example, let’s say Social Security between you and your spouse is $50,000.

This is only 85% taxable. So although you’re receiving 50, that only counts towards $42,500. This allows us to pull out of IRAs or do Roth conversions or even than realized gains in a taxable account environment as you pay a 0% capital gains rate as long as your income is below 83,550.

Interesting. So basically, if a client has a lifestyle, potentially that’s about $10,000 a month, there’s a chance they could pay ten. 12% on federal, potentially pay 0% in capital gains and then manage Medicare brackets effectively Roth conversions effectively.

For clients that live off of more than 10,000, let’s say someone lives off of 20,000 a month what are some tips and tactics for Navigating that properly take into consideration the same tax tables but also, for example, Medicare cost?

Great question. So, for somebody that has substantial income need during retirement our recommendation would be to realize income up to the 24% tax bracket. We could do this by realizing gains up to the 23.8% capital gains rate or from Social Security, pensions IRAs all the way up to 340,100, which is where the 24% bracket ends.

Excellent. So capital gains are part of that 340,100. What ways or methodology will we use if someone needs to spend more than that amount? Where would we pull from at that point to avoid going from 24, for example, to 32?

Great question. That’s where Roth planning really does come into play. Ideally, we have a healthy mix of pretax and Roth accounts. So once we hit that 24% bracket to avoid going into the 32, 35, 37 we can pull from your Roth IRA 100% tax free at that time if additional funds are needed.

So, Chris, what happens if, God forbid, one spouse passes during retirement and let’s say it’s in after requirement of distributions have started? How does the tax situation change at that point? Excellent question.

So this is something that we’ve referred to as it’s called the widow penalty. And if we go back to the tax tables, what this means is if you go from filing as a married couple. Um, for example, let’s just look at the 10% bracket.

You have up until 20,550 here, but this is cut in half if you’re filing a single. So essentially, filing a single versus married, you accelerate through the tax brackets twice as quick. And although it’s just one of you in the picture, overall, your expenses taking into taxes could be just about where they’re at even while you were married, if it’s just one person in the picture.

That’s a good point, Chris. So really, the only thing that changes if one spouse passes and one spouse is still here is we’ve lost one Social Security. But let’s say the surviving Social Security, the higher of the two always stays if the spouse were married for greater than ten years.

So let’s say that the Social Security payment was 40,000 required distributions were 200,000. That’s a total of 240 then. Plus, let’s say dividends and interest were another 60. So that’s a total of 300.

That couple, as we see in the married filing jointly, would have clearly stayed under 24, because we have up to 340,000 of income to pay 24 or 20, 212 ten. However, if it’s now a single payer at that same income amount, you can see that that 24% ends at 170, which is half the amount.

And so a very significant portion of that person’s income is now getting taxed at 32, and part of it’s even getting taxed at 35. So that’s a pretty substantial eight to 11% increase in taxes on a portion of income if one spouse passes.

So, again to what you said before, Chris, Roth can conversions and Roth planning overall can completely offset this risk. If done properly, the widow penalty can be avoided with Roth planning. Absolutely.

All right, well, that is tip number one. Everyone’s situation should be analyzed individually and specifically, and we look forward to doing so for.