…and taxes

A picture of the other Emirates cable car over the Thames. You go for a very long way, on a cable, over water. Screaming was heard from our car.

emirates

Taxes – retirement may provide planning opportunities

“…in this world nothing can be said to be certain, except death and taxes.” Benjamin Franklin

“Anyone may arrange his affairs so that his taxes shall be as low as possible…” Judge Learned Hand

Dan and Mikala

I had the opportunity to talk to Dan and Mikala (pseudonyms) this week about their retirement plans. Because of their early planning and good benefits, they are in pretty good shape for full retirement next year. In fact, they reminded me of Bob and Sarah in the Success Story post. As part of the Dan and Mikala discussion, we talked about something that Bob originally discussed with me, taxes.

Mandatory, boring, but important disclaimer

I am not giving tax advice and do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Retiree planning opportunities

As always, you should strongly consider using an Enrolled Agent, CPA, or tax attorney to assist with your tax planning. That being said, there are constraints and opportunities for retiree tax planning that you may not have had when working.

Required Minimum Distributions (RMD)

As part of the tax deferral deal with the government, you got to defer taxes on 401(k), IRA, and certain other types of retirement money. The second part of that deal is that the government requires you to remove a portion of those funds, based on your life expectancy, when you turn 70.5, to collect the taxes on the deferred funds (and any growth).

The amount you will need to withdraw is dependent on the size of the pot of deferred money and your age. It may be small or it may be large, but, regardless of size, there may be planning opportunities for you. As an example, you may find yourself in a low tax bracket in your early retirement years (10, 12, or 22% marginal rate). If you look out to age 70.5, you may find that the RMD moves you to the next higher rate (12, 22, or 24%). (The rates go all the way to 37% – if the higher marginal rates apply to you, quit reading and go to your CPA and estate tax attorney now.)

You may have a planning opportunity in earlier retirement years to take post-59.5 distributions from your deferred pot of money and ‘use up’ your lower marginal tax rate for a given year. That would leave less in the pot for 70.5 and beyond and may leave your RMDs taxed at one of the lower marginal rates when you hit 70.5. If you, hypothetically, could get money out at the 12% rate early, you might save 10 percentage points over getting hit with the 22% marginal rate at 70.5. Heck, even a 2% saving, from 12% to 10%, is a win!

Even after age 70.5 there may be opportunities for planning for the lowest rate. One way could be taking a larger amount one year and lower the next, but it will depend on age, amount in the account, and tax rates at the time.

But there’s more

There are other factors to consider, such as capital gains on non-tax qualified accounts, non-taxable funds, eligibility for social service programs, and partial taxation of Social Security. You, and likely your tax professional, will need to factor these in also.

Martin Luther King, Jr. Day

I am writing this on Martin Luther King, Jr. Day, also known as the Martin Luther King Day of Service. Last week I finally got to attend the weekly retiree breakfast with the retired guys from the old neighborhood. I was happy to hear of some volunteerism – Habitat for Humanity. Good for the community and the RAP (Retirement Activity Plan). I just finished my IRS volunteer recertification and will again volunteer with the IRS VITA program for tax season. What’s your volunteer plan?

Actions you can take include:
Assess your opportunities for RMD tax planning. Talk to your friends about who they use for tax advice. Remember, only Enrolled Agents, CPAs, and attorneys can legally give tax advice for your specific situation.

Find a volunteer activity that engages you and uses your talents. www.volunteermatch.org is a great website to help find opportunities in your area that fit your time and talents.

And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here.

Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.

Danger, money mirage!

First a picture that’s kind of a mirage.

Georgia O’Keefe, Canyon Country, 1963. Phoenix Art Museum.

Fidelity says

Fidelity Investments recently published their second quarter 2018 Retirement Analysis . Fidelity administers over 30 million retirement accounts, so my suspicion would be that their results should be reflective of the total population of retirement account holders. For the second quarter of 2018, Fidelity found average account balances $104,000 for 401(k)s, $106,900 for IRAs, and $83,400 for 403(b)s.

For millennials, Fidelity determined an average IRA balance of $15,150.

So far, very positive, but there’s more. Fidelity has 168,000 401(k) millionaires and 156,000 IRA millionaires.

Money mirage

You may look at Fidelity’s figures, and possibly your own 401(k) or IRA, and feel reasonably good about the state of retirement savings. You are in a money mirage and seeing what is not real.

What makes the Fidelity figures (or yours!) a mirage has three parts:

Taxes – in a regular 401(k)/IRA/403(b), you will likely owe taxes on your withdrawals and that makes the money shrink, like water in a mirage as you get closer.
Price changes – if you are in mutual funds, your amount could go up but it could also go down. If the market goes down, that makes the money shrink, like water in a mirage as you get closer.
Longevity – the amount may look big, but it may need to last you for a 20 to 30 year retirement. Taking some out, year over year means the money shrinks, like… you get the idea.

Taxes

The problem with taxes on regular 401(k)/IRA/403(b)’s (let’s call them retirement savings), is that the more you withdraw, the more tax you will owe. Not only more tax, but if you withdraw enough from your retirement savings in a year, you may make your Social Security payments subject to tax. Depending on how much your MAGI is, you may make 50% to 85% of your Social Security taxable.

The $62,000 example

Now let’s say you’re a couple (the Example family!) with close to the average Social Security of $1400/person per month or about $33,700/year. The Examples’ budget and retirement income plan (see the RIP here) has them grossing $62,000/year so they will need about $28,300 from their 401(k). Now the mirage hits. The Examples are well over the standard deduction of $20,000 for a married couple, so there will be tax on the 401(k) distribution, plus they will exceed the Social Security MAGI so part of their Social Security benefits will be taxable. I eyeballed it (don’t try this at home if you don’t do a LOT of 1040’s) and it looks like the Examples will have approximately a $1,900 Federal tax liability. The mirage was the $28,300 from the 401(k) that turned out to be about $26,400 after Federal taxes. There may also be state income taxes that shrink the initial amount.

Price changes

If your retirement savings are in a mutual fund (non-money market) and the price goes up, we’re all happy. If the price goes down (remember 2007-2008?), we have the mirage of shrinking fund balances. If you are nearing retirement, this mirage can be a real problem unless you have some cash for the early years of retirement, so you don’t have to sell shares at a low price. Consult your financial planner to have a plan for this.

But I saw it with my own eyes!

We saw Fidelity’s decent average retirement plan balances and the impressive number of retirement plan millionaires, above. But what happens if they live too long?

Your retirement savings balance, like the average balances above, may sound fairly high, but once you start withdrawing funds, your accounts can deplete rapidly. Remember the Example family, above. They were planning to use approximately $28,000 from their retirement plans annually. Unfortunately, if they have an average 401(k) or IRA balance, that will only be possible for about three to four years before they are out of money and living solely on Social Security and any other sources of income.

And here’s a mirage-like Victor Vasarely (Tridim-mc, 1974) from the Phoenix Art Museum:

Actions you can take include:

Develop a retirement income plan and discuss it with your tax advisor and your financial planner.

Know what the tax impact of withdrawals will be to your income.

Manage your retirement budget with your income plan to avoid bad surprises.

And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here

Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.

Maybe MAGI is not a gift

We got to visit the Aalsmere flower auction facility near Amsterdam a few years ago. They have a cafeteria for visitors and workers, welcomed by what I call scary Chef!

The Gift of the Magi

The original Gift of the Magi is an O. Henry story about a young couple sacrificing their individual prized possessions to give the other a special Christmas gift. For Social Security and Medicare, MAGI is a whole different ballgame that gives you the potential opportunity to plan (a gift to yourself!) to avoid sacrificing (money.)

This blog post will be a little technical, but could contribute to tax savings when you plan for MAGI. I will try to keep it as entertaining as possible given the subject matter.

What is MAGI

MAGI is Modified Adjusted Gross Income and is calculated by taking your Adjusted Gross Income (AGI) and adding in tax-free income, like interest on state and municipal bonds. There are some other, less common items, that get added back also, for example savings bond interest excluded from income because it was used for post-secondary education; check with your tax advisor.

Why is MAGI important?

For pre-retirees, a higher MAGI may restrict your ability to contribute to a traditional pre-tax or a Roth IRA.

For retired people, a higher MAGI may subject some of your social security income to taxation and may cause you to pay higher Medicare Part B premiums. The Medicare higher premium, the Income Related Monthly Adjustment Amount, is called IRMAA (I pronounce it like the name, Irma.) The wind is called Mariah. (The Mariah link is fun, really.)

But I’m not rich!

Most of us aren’t rich, but MAGI can still affect us. A MAGI as low as $25,001 for a single person (or $32001 for a married couple) will start to subject Social Security payments to income taxes.

How can I plan around MAGI?

First the disclaimers – If you’re a wage earner, like me, your planning possibilities are limited. Small business owners have more control over wage versus business income and can exercise some control over timing of income. I have to warn you again to discuss planning with your qualified tax advisor; we are discussing generally available information here that will not directly apply to your personal tax situation.

For pre-retirees, you may be able to use a technique called the ‘backdoor Roth’ to fund a Roth IRA, regardless of MAGI. A good article from Ed Slott, an IRA expert, on backdoor Roth IRAs is here.

For both pre-retirees and retirees, the ways to lower MAGI are fairly straightforward:
-lower your W-2 and/or 1099-R income
-lower your tax-exempt income.

One way for retirees to lower 1099-R income is to take out less from the retirement accounts you have control over (IRA, SEP, 401(k), 403(b), etc.), subject of course to the Required Minimum Distribution (RMD) for those 70 ½ and over. If you have a Roth IRA, withdrawals from the Roth won’t count towards MAGI.

Zero coupon municipal bonds exist that would pay out no tax-exempt interest until maturity. Your financial advisor could help you plan the use of municipal zeros, instead of municipals paying semi-annual interest, to support MAGI planning.

If you have bank accounts, you could use withdrawals from savings accounts or CD’s as a substitute for the 1099-R income that you are avoiding.

Finally, selling mutual funds or stocks that have capital gains will contribute to AGI and MAGI only to the extent that you have a gain when you sell.

MAGI – gift or not?

I guess there are similarities to the Gift of the Magi because MAGI planning and executing requires you to give up something special, your time and perhaps payments to a tax advisor. The gift you get back (a gift to yourself and loved ones) is the tax and Medicare Part B premium savings from your efforts that could be significant.

Citroen

When I was a child I lived in France for a while courtesy of the USAF. Citroen cars were popular and this model of a DS in the window of a toy car shop in Haarlem, NL brought back memories.

Actions you can take include:

-Consider how MAGI can affect your tax situation pre- and post-retirement.

And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here.

A correction

Back in the post Why not make money on your groceries? I thought a quote was from the movie ‘An Officer and a Gentleman’. A reader informed me it was from ‘A Few Good Men’. Thank you for the correction!

Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.

When does 70 ½ equal 2?

A picture!

Since a reader asked for pictures, here is this week’s photo and a question for you. What is the furthest away license plate that you have seen driving near home?

Truk

Yes, you are correct, I got a picture of a license plate from Truk of the Federated States of Micronesia right here in Minnesota. Truk is in the Pacific, north of Papua New Guinea and SE of Guam. Anyone seen one from farther away near your home?

When is 70 ½ equal to 2?

We will be discussing RMDs here – Required Minimum Distributions. RMDs are what the government requires for you to generate taxable income (and, likely, taxes!) on the untaxed income you put away in your IRA/401(k)/etc. At some point (70 ½) they require you to take money out (or for most of us, we need to take money out…)

Remember that No Surprises Retirement’s goal is to help you not have bad retirement surprises. A key element of many people’s retirement income plans is the use of funds from IRAs/401(k)s, etc. Frequently those will be rolled into an IRA, so we’ll just use IRA as the example here. As always, please seek professional advice when you need it, because there are some wrinkles with defined contribution plans v. IRAs.

70 ½ equals two when you are required to take two RMDs in the same year!

As it happens, I will (hopefully) turn 70 in one calendar year and then (again, hopefully) turn 70 ½ in the year following. I was planning to take my first RMD, by April 1^st of the year following 70 ½th year (that April 1^st thing is the ‘Required Beginning Date’), which is also my 72^st year. Confused? I sure was; it reminded me of algebra class. Then I remembered a CRPC class I had taken which noted that in some cases two RMDs may need to be taken in the same calendar year! Yikes, that has the potential to affect the taxation of Social Security benefits in the RMD year as well as Medicare premiums in the following year!

I went to my friends* at the IRS who have this covered. They have a website that explains it all and it’s easy to understand, mostly.

Here’s a quote from the IRS RMD site (I added the bold italic underline):

“Date for receiving subsequent required minimum distributions

For each subsequent year after your required beginning date, you must withdraw your RMD by December 31.

The first year following the year you reach age 70½ you will generally have two required distribution dates: an April 1 withdrawal (for the year you turn 70½), and an additional withdrawal by December 31 (for the year following the year you turn 70½). To avoid having both of these amounts included in your income for the same year, you can make your first withdrawal by December 31 of the year you turn 70½ instead of waiting until April 1 of the following year.

Example: John reached age 70½ on August 20, 2013. He must receive his 2013 required minimum distribution by April 1, 2014, based on his 2012 year-end balance. John must receive his 2014 required minimum distribution by December 31, 2014, based on his 2013 year-end balance.

If John receives his initial required minimum distribution for 2013 on April 1, 2014, then both his 2013 and 2014 distributions will be included in income on his 2014 income tax return.”

Now you know! Also, that’s why you should save your year-end statements and Form 5498s’.

Now that we all know the rules, we can plan on when we will take that first required distribution from our plans that require RMDs. Good news, it won’t be a surprise.

Actions you can take include:

-Review the IRS RMD site and update your retirement income plan.

-Check out Volunteer Match https://www.volunteermatch.org/ for a volunteer opportunity that fits you.

And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here.

Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.

* – Seriously, I work with a number of IRS people when volunteering and they have all been professional and try very hard to get everything right for the taxpayer.

A Christmas 10%, 15%, 25% or more short term return!

I forked over

I paid my 2018 property taxes early and I will net at least 15% on the deal! My county made it extremely easy to go on their website and eCheck the 2018 payment. I reviewed our 2016 Schedule A and our deductions were less than the 2018 tax year standard deduction ($24,400 for a married couple). I roughed in 2017 and it looked like the same case for what I’ll be filling out here in a month or so, still below the 2018 limit. Poof – easy choice to accelerate my 2018 payment, so then I went and found the money to put in checking to pay it (less poof there!).

Disclaimers, always disclaimers

Again, no, not a scam. This may actually be an opportunity for you. The latest tax changes have passed and will take effect in 2018 (mostly). We noted some tax planning opportunities in the “Urgent money opportunity!” post. Still acting quickly, there may be another 2017 tax planning opportunity with property taxes for you that could be the equivalent of a 10-25% return (or more depending on your marginal tax bracket). We’re providing general advice here, please check with your tax adviser for your specific situation. And by act quickly, that means by 12/31/2017.

Facts, again

Tax rates – generally going down next year, meaning that deductions are worth more this year than next.

Standard deduction – going up next year, meaning you need more deductions to obtain any benefit from a Schedule A deduction. Also, your state and local tax deduction (property and income taxes) will be limited to $10,000.

Property taxes

The facts above may add up to a planning opportunity for you this year with property taxes.

Hypothetically, maybe you are a retiree or near retiree that has paid their 2017 property taxes and you itemize on Schedule A and your Schedule A deductions exceed the standard deduction. The 2017 property taxes will be part of your Schedule A deduction.

You may be able to prepay your 2018 property taxes, on or before 12/31/2017. If you do, you will also include those on your Schedule A and the tax ‘reduction’ from that additional deduction should decrease the tax you owe by your marginal rate, 10 to 25% or more. That’s kind of like getting a CD paying a huge rate – something you likely don’t want to pass up.

Example

As an example, let’s say your 2018 property taxes are $1,000 (easy round number) and your marginal rate is 15%, and the extra $1,000 deduction does not move you into a lower marginal rate – that’s an extra $150 back as a refund. Or, like getting a one-year CD with a 15% return. You’ll have to pay the tax anyway, why not make it a little less painful.

In this example, we assume that in the 2018 tax year (the one you file by April 15, 2019) the $1,000 is ‘buried’ in the standard deduction and there is no ‘additional’ tax benefit. You only get an explicit deduction and bigger refund if you accelerate the payment to 2017.

If, based on your tax advisers’ analysis and your state/county/city allowing it, you make your 2018 property tax payment now, you may get a bigger deduction (and lower taxes/bigger refund) on your 2017 return.

How to from WUSA

Here’s a piece that WUSA 9 in DC did to help people understand how to prepay. They mention mortgages where taxes are escrowed.

Actions you can take include:

-Call your tax advisor and analyze your 2017/2018 planning opportunity.

And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here https://nosurprisesretirement.com/2017/07/09/first-blog-post/

Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.

Urgent money opportunity!

No, not a scam.

This may actually be an opportunity for you. The latest tax changes have passed and will take effect in 2018 (mostly). If you act quickly, there may be some 2017 tax planning opportunities that will save you more money this year than next! (We’re providing general advice here, please check with your tax adviser for your specific situation). By act quickly, that means by 12/31/2017.

Facts

Tax rates – generally going down next year, meaning that deductions are worth more this year than next.

Standard deduction – going up next year, meaning you need more deductions to obtain any benefit from a Schedule A deduction.

These two may add up to a planning opportunity for you this year.

Charitable scenario

Hypothetically, maybe you are a retiree or near retiree that has charitable goals or commitments. You’re trying to make the world a better place, but you don’t want to squander cash. If, based on your tax advisers’ analysis, you make your 2018 gift now in 2017, you may get a bigger deduction (and lower taxes/bigger refund) on your 2017 return, and the charity likely won’t care if they get the 2018 gift a little early.

Stock loss scenario

Also hypothetically, maybe you are a retiree with some stocks that have losses. If, based on your tax advisers’ analysis, you sell and take a 2017 loss, that will mitigate more taxes than the same action in 2018. And, your tax adviser may tell you that if you really love the stock that had a loss, you can buy it again after 60’ish days. Or, your tax adviser may tell you that it will give you the cash to make that charitable gift (above). So, give your tax adviser (and you!) a holiday season gift by calling them tomorrow!

Actions you can take include:

-Call your tax advisor and analyze your 2017/2018 planning opportunity.

And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here https://nosurprisesretirement.com/2017/07/09/first-blog-post/

Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.

My wife asked…

My wife asked, “Why isn’t your blog more upbeat?” I said, “Because ‘No Surprises Retirement’ is about preventing or mitigating bad retirement surprises. It’s not ‘happy everything goes right retirement’, that’s a different guy.” Then she hummed a funeral dirge. There’s no pleasing some people.

Ch-ch-ch-changes – Retirement Adaptability

Things change over time, in our work and our life. They also change when our ‘work’ is retirement. A big topic in the news right now is the Republican tax bill that will make changes to taxes on individuals as well as corporations. We won’t make any value judgments on the tax bill here, because the key No Surprises lesson is that tax changes will periodically happen (regardless of party) and your retirement plan will need to adapt to them.

The tax bill is not passed yet, so anything could happen to the individual provisions, but let’s examine a few of the current proposals and discuss their general effects on your retirement income plan. My retirement income plan extends from next year, in case I have to retire suddenly and early, to age 90. I don’t plan to retire until about 2020, but if I have an unforeseen early retirement, I have a plan.

Speaking of an unforeseen early retirement, the Society of Actuaries, in their 2013 Risks and Process of Retirement Survey, found that, “People actually retire at a much earlier age than people say they want to retire. In the 2013 study, the median age at which people retired was 58 compared to 65 as the median age when people said they want to retire. This is not surprising when involuntary and “pushed” retirements are considered.”

Tax rates change

As part of my budget, I look at my planned retirement income for the year (gross), then calculate what the Federal and state income taxes would be. Subtracting the taxes from the gross leaves our spendable retirement income (net). Those calculations are based on what the current rates (2017) are. Once the Congress passes the tax bill, I will have to check out the new rates and recalculate to enable us to see what our new spendable income will be.

FIFO capital gains rules change

The easy explanation on this one is, if you were going to sell your stocks with the lowest gains first to minimize taxable income and capital gains taxes, you won’t have that flexibility in the future. Specifically, if you are a person using non-qualified (not 401(k), 403(b) or the like) investments who planned on using stock or mutual fund sales, the revised tax code may require that all stock sales be made first in-first out. Generally, this will mean greater gains subject to tax, with a corresponding impact to the retirement income plan and budget.

As it has been since Biblical times

Taxes are a fact of life. It looks like they will change in 2018. Given the demographics of the USA, with a lot of baby boomers retiring and using Social Security and Medicare, my suspicion is that they will change again in the relatively near future (8-10 years).

What you can do about taxes

The controllable parts of taxes are:

-Understand your retirement income plan and how the income components are affected by the income tax (yep, up to 85% of Social Security is taxable, depending on income). You may want the advice of a trusted financial professional on this.

-If there are tax code changes you want, call your elected representatives, vote, and support advocacy organizations that advocate for your preference.

-Know that the ‘rules’ for 2018 taxes will be changing and figure out (perhaps with a professional tax advisor) if there are things you should be doing right now in these waning days of 2017. You might be able to take advantage of the current ‘tax rules’ that will mitigate the impact of effects of the 2018 changes that would be negative for your personal tax situation. (Example – Gifts of highly appreciated securities to charity are more valuable, tax wise, when rates are higher.)

Actions you can take include:

-Make sure you have an updated retirement income plan

-Make sure you have a retirement budget, based on a realistic assessment of net retirement income.

-One of the next No Surprises Retirement blog posts will be on life insurance. If you’re thinking about getting rid of a policy and don’t have to this instant, you might get some ideas from the upcoming post.

Note: I plan to put out Excel templates for samples of both a retirement income plan and a retirement budget before the end of 2017, but you can likely find some with web searches if you want to start now, which you should…

Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.

Tax and Legal Disclaimer
The materials available at this web site are for informational purposes only and not for the purpose of providing tax and/or legal advice. You should contact your Enrolled Agent, CPA or attorney to obtain advice with respect to any particular issue