The Big Picture of Taxes in Retirement

Everyone has a different financial and tax situation. But when you are entering retirement, there are several tax areas all retirees should examine.

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Those of you have been following my blog know I have been focusing on very specific topics of taxation in retirement. I have had several requests for more of a ‘big picture’ look at taxes. Because everyone is different, with many different tax variables, this is difficult to do. That being said, there are several general issues everyone should consider.

Taxes on Social Security

For people with total retirement cash flow under $150,000, a very detailed analysis of Social Security benefit filing strategies should be done. Taxation of Social Security is based on the income you have from other sources. I don’t want to restate the blog article on Social Security taxes but the bottom line is, for most people, the higher your Social Security benefits are in relation to other income, the lower your taxes will be.

Long-term Capital Gains

Short-term Capital Gains are taxed as ordinary income. Only Long-term Capital Gains (generally gains on assets held longer than one year) have preferable tax treatment. Like Social Security, the amount of Capital Gain tax you pay is dependent on your other income and can be taxed at either a 0%, 15%, 0r 20% federal rate. Even if your Capital Gains are not taxed (are in the 0% Capital Gain bracket) Capital Gains are still included in Adjusted Gross Income which can cause more of your Social Security to be taxed which effectively means the Capital Gains do have tax consequences even if you pay no Capital Gain tax. To mitigate this you should consider, if possible, spreading Capital Gains over more than one year.

Many people recognize Capital Gains through the sale of rental property. Over the years a rental property is owned, the owner can recognize depreciation expense on the property which lowers the taxable income on the rental income. This is a nice tax benefit until the decision is made to sell the property. At the sale, all depreciation taken must be recaptured at a 25% federal rate, regardless of the federal rate paid on the rental income when realized. Make sure you have a clear idea of how the sale will be taxed so you don’t get a nasty surprise.

Roth Conversions

Jason McBride and I just hosted a podcast covering Roth conversions in detail. Converting a traditional IRA to a Roth involves many variables are assumptions of what your financial life, and that of your heirs, will look like over a long period of time. Changing any of the variables can change the benefits of conversion.

One variable that typically is kept constant when determining the benefits of a Roth conversion is tax rates. While my crystal ball isn’t any better than anyone else’s, I strongly believe taxes will be going up in the future. When you look at the rising deficit, with no serious talk of reducing federal spending, it seems obvious that taxes will go up at some point – I just don’t know how much. For this reason, for most people, it typically makes sense to convert a portion of traditional IRAs to Roths, especially if you can shift income to other years to convert at a very low bracket.

These are just a few of the topics that need consideration. In order to give a broader view of taxes in retirement, I will be hosting a webinar on December 11th at 6:30 in the evening. I will show several examples of how you can exercise control of the taxes you will be paying over your retirement years. Go here to sign up for the webinar.

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