Successful retirement; Will you be the one who pays more in tax during retirement?

Posted By: Jeremy Reif
Thu, Dec 24, 2020

If you are/were successful in your career, let me be one of the first to congratulate you.  I am also sure the Internal Revenue Service (IRS) would also like to thank you.  Most likely you walked right into a tax trap.

Now let me explain.  It is human nature to want to pay as little tax as possible each and every year. Our society judges Certified Public Accountants (CPA’s) or tax preparers on owing the least amount of tax for the current tax year.  While on the job and when one is in their peak earning years; many try to reduce the amount of taxes on their current income by deferring into a traditional individual retirement account (IRA) or company retirement plan like a 401(k). They also hope during their retirement years they are able to take their deferred income out in a lower tax than when they were working.  What most do not realize is that investing money into a traditional retirement account it is a hidden tax trap designed by the government.  People tend to forget that the government is around indefinitely, we are only here temporarily.  How does that old saying go? There are only two things that we can count on “death and taxes”.

Many retirees end up compounding taxes upon taxes and can’t get out of this vicious circle.  People realize that when the money is distributed from their retirement accounts it will be taxed as ordinary income.  Most people can figure out if they can afford to retire or hire a financial advisor to help with this process.  Most do-it-yourselfers and financial advisors are not qualified to understand the tax issues at hand. The first question: Can you or your financial professional only quantify if retirement is affordable or not?  Then the second question: What account should I take money from first?  A natural thought is to pay as little tax as possible. Most do-it-yourselfers or less educated financial advisors try to avoid paying unwanted tax and spend their checking, savings, brokerage accounts (non-qualified accounts) first.  Ultimately they are deferring taking their distributions from retirement accounts even further into the future. By spending cash first only compounds potential future tax liability.  Most investors don’t leave their money in cash, they are invested in something that keeps pace or exceeds inflation.  More growth equals more future tax.

Let’s briefly discuss the current tax environment that we are currently in today.  Personal tax rates are at historic lows from the “Bush tax cuts” that have been extended.  In the past, we have seen federal marginal tax rates go as high as 94% in 1944.  Medicare and Social Security are grossly underfunded and on the brink of bankruptcy.  Can a taxing authority really go bankrupt?  Now add “Obama care” to the mix.  The full costs are not fully rolled out to the taxpaying citizens until 2017.  There is no long-term solution in the immediate future.  An easy fix is to raise taxes and we are already seeing this happen.  Social Security, in late 2015, closed one of the loopholes around the ability to file and suspend.  Medicare premiums went up for the first time in a long time.  We have not had anyone in office that can balance the budget, so an educated guess would be that taxes are more likely to go up than down in the future.

Get back to what all of this means about your retirement and the taxes you will pay.  For those who deferred large amounts of money into retirement accounts and don’t plan on touching them your family will likely pay higher taxes than necessary.  Primary beneficiaries on retirement accounts are typically spouses.  This only makes sense, as it is the only person who can inherit the traditional retirement account without having to pay current income tax on the transition from one spouse to the other.  This is what the IRS is hoping you will do.  As medical advancements continue to improve, people live longer and death tends to happen later in life.  Assume mortality ages are late 70’s or early 80’s for healthy married couples.  Most aging couples don’t spend money as they did in their 50’s or 60’s.  After the first spouse passes, the money is transferred into the widow’s name. The widow will now file taxes as an individual.  After age 70 ½ one must take their required minimum distributions (RMD) on all traditional retirement accounts.  Now that all the money is transferred to the widow; the widow (assuming they are 70 ½ or older) is still required to take the RMD, but has a smaller tax bracket to shelter the taxes paid.  End result is the widow is now in a higher tax bracket than when married and filing jointly.  Many wealthy people will be in a higher tax bracket after the first spouse passes than while they were in the peak earning years of their lives.  This situation will only get worse if tax rates go up in the future.  To make matters worse, if the spouse does not take all of the money out of their retirement accounts and passes away, their beneficiaries (typically their children) will pay inheritance tax called income in respect of a decedent (IRD).

There are many ways to reduce the taxes you will pay over your lifetime.  One in specific is worth mentioning.  The government has allowed people to have Roth IRAs and conversion Roth IRAs.  However, most people do not understand if they should or should not utilize Roth retirement accounts.  When the Roth first came out in 1997, most were advised that it was typically for younger people. Roth’s should be strategically used for almost everyone at very specific periods of time based on their given financial situation.  There are many other tax-friendly strategies that should be deployed going forward.  Attorneys and politicians typically come up with the new tax codes; which means they know how to use older tax codes or loopholes to reduce their own tax liability.  It is up to you to figure out these tax codes opportunities or to hire a financial planning professional that can help you navigate a lower tax for your future.


About Jeremy Reif, CRPS®
Jeremy Reif is an independent financial advisor with more than a decade of experience in the financial services industry. He is also the owner of Point Wealth, LLC, an independent financial planning and investment management firm. With advanced credentials and training in retirement planning and financial planning, Jeremy focuses on helping individuals and families pursue financial independence. Regardless of the services he’s providing, he focuses on talking openly about financial planning, the industry, common questions about retirement planning, and more to help everyday investors gain more confidence in their financial opportunities. Based in Wausau, Wisconsin, Jeremy serves clients throughout the state and can work virtually with clients throughout the country. To learn more, visit http://pointwealthmanagement.com and connect with Jeremy on LinkedIn.
Advisory services are offered through Point Wealth, LLC, an Investment Advisor in the State of WI. Whenever you invest, you are at risk of loss of principal as the market fluctuates. Past performance is not indicative of future results. Purchases are subject to suitability. This requires a review of an investor’s objective, risk tolerance, and time horizons. Investing always involves risk and possible loss of capital.
Point Wealth, LLC is not affiliated with or endorsed by the Social Security Administration or any government agency.
Stay In The Loop With Point Wealth!