Be proactive with tax planning if you want to keep more of your earnings
At this time of year, everyone is focused on getting their tax return completed. If you were not proactive with your tax planning, all your tax preparer can do is work with the situation that they inherited. As a result, you could very well end up paying more taxes than necessary. Good tax planning is important at all ages, and it is especially important for retirees.
Many people who are either in retirement or approaching it fail to consider what should be some of their most important tax planning, since it can have a major effect on how much you and your family have to spend.
Just as everyone’s retirement is different, so is their tax planning.
Tax strategies are different for many reasons. If you will need to spend your retirement resources, your plan would be completely different from someone who plans to leave a legacy to future generations. Regardless of where your retirement plan falls on the spectrum, the idea is to use the 15,000 pages of the tax code to your advantage.
Have you ever considered converting qualified money to a Roth? If so, you have to pay the taxes now, but you receive tax free growth without having to deal with required minimum distributions.
Many people feel like taxes are on sale today because of historically low tax rates, although it does not feel like that when we have to write the check.
While we are working, we get a tax break by contributing to a 401(k), IRA or similar qualified account. For years, we assumed that we would be in a lower tax bracket when we were retired. However, that fact is questionable today.
People should have a scheduled withdrawal plan for their assets. There also is a best tactical decision that must be made as to which assets to consume first. You need to have a plan that is flexible enough to adapt to changing tax laws. Understanding required minimum distributions is important as well as having a plan to make sure that you have the required withdrawals and avoid the 50 percent penalty. Do you understand the concept of the “stretch IRA?” It can have a major multiplier effect on your family legacy. This could mean tens of thousands of extra dollars to your heirs.
Many people do not realize how a decision to withdraw a large sum from a qualified plan can affect other areas of their tax return. I recently heard of an instance where someone pulled a sum out of an IRA to purchase a house and the move caused a much larger portion of their Social Security to be taxed. This raised their marginal tax bracket from 15 percent to 25 percent.
Understanding the effect of taxes on your different asset classifications and types of money are very important. This knowledge can help you employ them in the optimal manner. The reduction in the number of employees covered by defined benefit plans has also had a big impact on retirement planning and taxes.
Some types of assets receive a more favorable tax treatment. Stock gains in a nonqualified account and qualified dividends receive a lower capital gains tax rate. In fact, if your marginal tax bracket is below 25 percent, you may owe no taxes on this money.
If nonqualified money is invested through a variable annuity, it must pay the high ordinary income tax rate.
Remember, it is now how much you make, it’s how much you get to keep that is important.
Gary Boatman is a Monessen-based certified financial planner and author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”
To submit columns on financial planning or investing, contact business editor Michael Bradwell at mbradwell@observer-reporter.com.