Talk Taxes Now For A Better Retirement

By Autumn Soltysiak

One can’t control the tax rate or the market, but one can work to reduce current taxes and maximize income potential. Perhaps it shouldn’t come as a surprise that taxes can have a substantial impact on the retirement experience, but for many it does. If you’re like most people planning for retirement, you understand the importance of building and preserving retirement savings. By saving and investing as much as possible, one can help ensure a financially secure retirement – right? Unfortunately, such a plan can fall short. A recent survey of 62-75-year-old retirees showed 36 percent reported that taxes were a larger expense than they had anticipated, and 33 percent didn’t even consider taxes an expense for which to plan. Nearly one-third of survey respondents indicated that, looking back, they wish they had focused more on tax planning for retirement.

In 2013, new taxes associated with the Affordable Care Act of 2010 and the American Taxpayer Relief Act of 2012 took effect. Unlike the major tax legislation enacted over the last 12 years, the core tax provisions were passed by Congress absent of any expiration dates. This means that investors with taxable accounts who do not develop a tax plan could experience lower after-tax returns for the foreseeable future. The tax tail should not wag the investment dog.

Improving After-Tax Returns

There are steps that investors can take to improve after-tax returns by mitigating the additional tax bite that began in 2013.

There are a number of tax provisions to look at in the current tax environment: income tax, Medicare payroll tax (additional tax on earned income), dividends and long term capital gains rates, unearned income Medicare contribution tax, itemized deductions and personal exemptions.

A sophisticated approach is necessary for high income or net worth individuals whether you are earning a wage or already in retirement.

Investors with sizable investments in taxable accounts, especially investors who are still working and are not currently living on their investments, should consider a strategy for sheltering tax-sensitive securities. One strategy is asset location, once an optimal asset allocation strategy is in place; the overlay of an asset location approach involves placing a greater percentage of the most tax-sensitive investments in tax deferred accounts. For instance, investors pay tax on the interest from taxable fixed-income securities, such as corporate bonds, at their marginal income tax rate. For high earners, this could be 33 or 35 percent. Even investors in the highest income tax bracket of 39.6 percent face a lower long-term capital gains rate of 20 percent. Given the significant differential in tax treatment, it could make sense to place more taxable fixed-income securities in a tax deferred account, not only to defer taxation now but also because the taxable portion of eventual distributions will also be taxed as ordinary income.

For those making over $200,000 ($250,000 if married), Medicare taxes will go up on their wages and, for the first time, their investment income will be subject to a Medicare tax as well. On wages: high wage earners will pay another 0.9 percent of Medicare tax on wage income over $200,000 ($250,000 if married). That’s on top of the 1.45 percent Medicare tax that they must pay on all their wages (or 2.9 percent if they’re self-employed). On investment income, higher earners with taxable investments are most susceptible to triggering the Unearned Income Medicare Contribution Tax, a surtax of 3.8 percent that applies to taxable investments. Here are some key points to know:

  • Taxpayers who cross a modified adjusted gross income (MAGI) threshold of $200,000 filing single ($250,000 jointly) will trigger a net investment income tax calculation where they will need to compare the amount by which they cross the threshold to the amount of net investment income.
  • The surtax applies to the lesser of the amount over the threshold or the net investment income amount.
  • Although wages and distributions from IRAs and qualified plans (among other things) are not counted as net investment income, they can expose a greater amount of net investment income to the 3.8 percent surtax by pushing more or all of net investment income above the threshold. This surtax is in addition to any other tax obligation incurred, whether it is derived by the standard tax calculation or the alternative minimum tax (AMT) calculation.

Planning for taxes becomes more complicated when one considers 50 percent of couples have one person retired and one who works full time – this can pose some challenges when considering tax burden and how to draw retirement income.  The taxation of social security, pensions, dividends, rental income, capital gains, and buyout agreements should all be considered in the strategy.

When it comes to financial security in retirement, ask yourself:

  • Am I adequately accounting for the impact of taxes in my planning?
  • How do I work more effectively with my advisor to build a tax efficient savings and investment strategy?
  • Can I be doing a better job of availing myself of all the tax minimization strategies appropriate to my situation?

Working with a financial advisor adds to client confidence levels regarding retirement savings. Talk to a financial advisor about the impact of recent tax changes on investments. Reviewing these topics before the tax bill will help avoid unnecessary surprises. Understanding tax rules can be challenging. Understanding them as they relate to one’s own retirement may seem downright impossible, especially considering the uncertain and changing tax environment of late. It is during such times that planning is more important than ever.

Autumn C. Soltysiak, CFP® is a registered representative and investment advisor representative of Lincoln Financial Advisors Corp. a broker-dealer (member SIPC), registered investment advisor and an insurance agency and a member of Sagemark Consulting Private Wealth Services Group of Lincoln Financial Advisors Corp. in Traverse City, 231-668-4147, This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.