Jason and Emilia discuss taxes in retirement.

Below is the full transcript:


Announcer: Welcome back America to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom, as you prepare for and transition through retirement.

 And now, here is your host, Jason Parker.

Jason: Welcome back America, this is Jason Parker. You’re at another round of Sound Retirement Radio. We are always looking to bring experts onto the program we believe can add significant meaningful value to your financial life. Today’s episode … You’re listening to episode 090, Taxes in Retirement. Not Texas in Retirement, Taxes in Retirement. It’s my good fortune to have Emilia in the studio with us this morning. Emilia, welcome back.

Emilia: Thank you. Welcome. Good morning everybody. How are you doing today?

Jason: You know, with all of the rainy weather that we’ve had this winter, with some of the sunshine we’ve had recently, it has just made me really, really grateful for sunshine. I love that so much. I was out working in my yard during some of these sunny days. I was listening to The Beatles, you know, Here Comes the Sun. I was listening to Kat Stevens with Morning has Broken. Anything that’s kind of bright and hopeful.

Emilia: Definitely. It’s nice to walk out and feel that sunshine on your face.

Jason: All right. I want to start with a verse to renew our minds before we get started on the program today. Mark 12:17. You know, this is April. This is tax time. I thought we would talk about taxes and some of the strategies, some of the things people should be thinking about in retirement. This verse, Mark 12:17, speaks to taxes. “Then Jesus said to them. “Give back to Caesar what is Caesar’s and to God what is God’s.” And they were amazed at him.” There you have it. Even Jesus said pay your taxes.

Emilia: Pay your taxes everyone. You have until next Friday.

Jason: What I’ve learned is that most people that we serve love living in America. They don’t mind paying their fair share of taxes, they just don’t want to pay more than their fair share in taxes. We’ll talk about some tax planning.

 We better start with a joke because …

Emilia: Start it off a little light.

Jason: Yeah. We might as well talk about death too. Everybody’s favorite subjects. Maybe even long term care. Throw that one in there too. All right, so what is the most expensive fish?

Emilia: Well, I kind of heard this one earlier, but I think it’s got to be Goldfish right?

Jason: Gold fish. Of course. I would tell you, being a boat owner and somebody that enjoys fishing, I would say Salmon are the most expensive fish for me. If you look at how much money I spend on fishing equipment and boating equipment with Salmon. I tell you, I’d be a lot better off just going down to the grocery store just buying a Salmon.

Emilia: It’s very good.

Jason: All right. Let’s get into this topic. Tax planning in retirement. Everybody’s favorite subject this time of year.

Emilia: Yes. Jason, why should people be thinking about taxes in retirement?

Jason: First of all, I’m going to say that retirement is all about cash flow. It’s your income that will determine your lifestyle in retirement, not your net worth. I sound like a broken record when I say that because I say it so often. The reality is I meet with a lot of people, I talk to a lot of people about what’s most important to them in retirement. People have worked really hard to save money their entire lifetime and ultimately, when I really drill into that question with people, what most people tell me is they say “Jason, I want to know that I have enough income and that I’m going to able to live and maintain the lifestyle that I’ve grown accustomed to for the rest of my life.” Really, the reason that people are saving money now in their working years is so that when they get to retirement they’re going to be able to live, travel, and spoil their grandkids. Ultimately, that all comes back to cash flow.

 The thing about cash flow is it’s not about how much income you have. It’s about how much you actually get to keep that really is important. The tax man, he wants his fair share. If you think, and you’re strategic about where you’re taking cash flow from at different areas in different times of your life, it can really significantly impact how much the government is going to get at any one point.

 A couple of other things we want to take into consideration here when it comes to taxes is our national debt. Right now, the national debt in our country is 19.2 trillion dollars. We’re quickly approaching 20 trillion dollars. We’re still running a budget deficit of 493 billion dollars a year. We’re still spending more money than we take in our country. We have 10 thousand baby boomers looking to retire every single day in our country right now. The work force that is supporting those boomers has been shrinking. We’re down to about two people working for every one person retired and collecting benefits, which is putting a greater strain on some of our biggest budgeted items in this country. Social security and Medicare. As interest rates start to go up, we’re going to start to see the amount of interest that we have to pay on the national debt increase as well.

 If you look at the largest budgeted items in our country, Medicare is number one. Social Security is number two. Defense and War is number three. Income security is number four. Net interest on debt is number five. Federal pension is number six. Those are the top items that we’re spending money and that situation is getting worse. One of the things that people have to be thinking about as they evaluate our national debt and our spending and the amount of people heading into retirement is also the fact that we have some of the lowest marginal income tax rates in our countries history. Right now, the top marginal tax rate is only 39.6 percent. You don’t have to look very far back into history to see times in our country where the top marginal rate was 70 percent, even as high as 90 percent. I think one of the concerns that a lot of people share, that I meet with, is they say “Jason, we’re really worried that taxes are going to go up in the future. What kind of impact could that have on us as we’re heading into retirement?”

Emilia: What are some of the specific considerations?

Jason: Let’s start with Social Security because Social Security is such a wonderful benefit. So many people mess this up. I hope that one day people will look back and say because of Sound Retirement Radio, because of my book “Sound Retirement Planning”, we made better decisions on Social Security. A couple of the reasons that Social Security is such a good benefit is number one, you’ve got an inflation adjusted benefit. Since the mid-1970s, Social Security has increased at over two percent a year. You’ve got a benefit that is helping increase over time. For a lot of our country, the only guaranteed income source they have or that they’re going to have in retirement is Social Security so you don’t want to mess that up. In fact, a bad decision on Social Security can cost people anywhere from 50 to 100 million dollars of lifetimes benefits, especially for married couples. Really important that they get that right.

 Social Security also has a survivor benefit associated with it. When one person passes away, the survivor gets to step up to the higher of those two benefits. We’re not just trying to maximize benefits for one person but over two people’s lifetimes.

 Then, Social Security’ is tax efficient income. It started out, Social Security was not taxable initially when people started receiving it. In the 1980s, they started saying okay, well if you meet certain requirements under the provisional income rules, then 50 percent of your social security income can become taxable to you. In the 1990s, they increased that and said okay, as much as 85 percent or 85 cents of every dollar that you get from Social Security, under the provisional income rules can be taxable to you.

 The provisional income rules when it comes to Social Security, because that’s such a great benefit and because it represents a foundation for people’s cash flow/ income plan, it’s really important that we’re taking into consideration the tax impact of Social Security as part of that plan. Amelia, what that might mean for some people is it may mean that they want to start Social Security benefits early, as early as age 62. What we find often times, especially in the low income tax environment that we’re in now, what a lot of people are considering is tapping into their 401K or their IRA and taking income from those sources early on, allowing those Social Security benefits to compound and grow because most people know that once you reach full retirement age, if you were born between 1943 and 1954, at full retirement age, which is 66, beyond that point, those benefits grow at 8 percent per year, all the way up to age 70. It’s possible to receive 132 percent of what you would’ve received. Because it’s tax efficient income, people are saying well maybe we tap into our 401K, our IRA, or maybe even a Roth IRA, or we pull money from non qualified accounts early on so that it allows them to delay taking their Social Security benefit because that is such an important component of a good retirement cash flow plan.

Emilia: Jason, you talk about tax efficient income and tax free income. What is the difference?

Jason: Like I said, Social Security … If you do this right … We have a webinar coming up that we want to make sure people know about because that’s an opportunity for people to log in, we’ll spend probably about 30-45 minutes talking about some of these different retirement tax strategies and we will record that event. If people can’t be at the live event, they can still have access to the video afterwards. It’s looking at tax efficient versus tax free.

 Social Security is a great benefit for tax efficient income because in a worst case scenario, only 85 cents of every dollar you receive is taxable. We often times find situations where people are paying less than that in taxes and having a really great retirement at the same time.

 The other thing that people would consider is things like Single Premium Immediate Annuity Contracts issued by insurance companies that are from non-qualified dollars. A lot of people don’t understand this, but there is something called the exclusion ratio where the federal government says when you annuitize non-qualified money, a portion of it is considered taxable income and a portion of it is just considered a return of your original investment. That’s one way that people can create tax efficient income.

 Another thing that we see a lot of times are people that invest in real estate, because of the expenses and depreciation associated with real estate investments, many times people have pretty good cash flow coming in from those investments, but from a tax standpoint, after they take into consideration the expenses and the depreciation, it doesn’t usually hit their tax return as hard, at least many times in the early years of those investments. Once all the depreciation is gone and people start selling those properties that could become a different issue. Many times, the income from rental properties can be pretty tax efficient.

 Another area that we see is things like … An area that we see people mess this up is a lot of people are conservative these days so they’re sticking money into bank CDs so they get a 1099 for the interest incomes that they earn from those bank CDs every year even if they’re not using the interest income. You just want to make sure that if you’re going to be paying taxes on income that you’re actually using the income. We encourage people, if you don’t need the income right now, try not to pay taxes on income that you’re using, otherwise we’re just giving more money to the government than we really need to.

 I know this is kind of a long winded answer but there are so many little nuances here within the tax code and within how people take cash flow. Another area that can be tax efficient are qualified dividends from corporate stocks. Those currently get taxed at long term capital gains rates, which for some people, long term capital gains rates, that’s fifteen percent for most people, that could be a lower tax rate than what their marginal or ordinary income tax rate is. Sometimes taking dividend income is a good way to reduce taxes.

 In terms of tax free income, that gets us into things like municipal bonds. Many municipal bonds are federally tax free. Not all of them but many of them are. The other big one there is the Roth IRA. I really love those vehicles. Given the tax considerations, given the national debit, given the amount of people heading into retirement, given the low marginal income tax rates, I think that’s definitely something that more people should be thinking about. Whether or not they’re contributing to those accounts or converting money from traditional accounts over to Roth IRAs, those can be really powerful. One of the things people don’t take into consideration sometimes with tax free income … Let’s say they buy some municipal bonds. When we talk about Social Security income, municipal bonds come as federally tax free but still counts against people in terms of the provisional income rules regarding Social Security. It may be tax free income but it could be causing them to pay more money in taxes on their Social Security. More of their Social Security income could become taxable as a result of those municipal bonds.

 There’s a lot of moving parts with the tax code. One of the things I would warn people about with taxes especially is that we have this public policy risk. Congress can come along and change the rules on us overnight. Especially when it comes to the tax code. We saw this happen with Social Security just last year. Congress came along, changed the rules, and really hurt a lot of married couples in terms of the Social Security planning that they had been putting together.

Emilia: Yeah. This is a lot of great information. That was a great answer. I want to remind our listeners that if you want to learn more, get more detail, or ask Jason some questions regarding any of the information we’ve just discussed, we are scheduled to have a webinar on Wednesday, April 20th, at 1:15. Just a reminder, that’s going to be on retirement tax planning. That’s Wednesday, April 20th, at 1:15.

Jason: Another thing I want to throw in there … Thank you Emilia. One of the things I want to throw in there is another consideration especially for early retirees, people retiring I would say before age 65, is health insurance expenses. That’s a huge piece of many people’s retirement budget. Right now, we’re seeing people pay anywhere from 1200 to 2000 dollars a month for health insurance. We met with some folks recently from a tax consideration again, but also from a health insurance consideration, the new affordable care act, one of the ways that they determine how much money you pay for health insurance is based on your income tax return.

 We met with some folks that chose to take their incomes from non-qualified accounts, so technically they’ve already paid tax on that income from their tax return standpoint it doesn’t really look like they have much income, but really they’re living on 100 thousand dollars a year of this money that’s already been taxed. Their tax return says they don’t have any income. They haven’t started Social Security yet and they’re not tapping into their 401ks or their IRAs. They’re tapping into non-qualified assets that have already been taxed. They have very little interest income and dividend income. As a result, they’re paying almost nothing for health insurance expense because they’re taking into consideration where they’re pulling that income from. Specifically, they’re choosing not to start Social Security yet because they know as soon as they do, that’s going to bump up their income and all of the sudden they’re going to have to pay a lot more for their health insurance expense.

 Again, another little nuance and it’s one of the reasons that many people in our community, people around the country would be better served if they would sit down with somebody that spends the time doing the retirement planning to help them come up with a good strategy. Not just so that they’re not paying too much money in taxes, but also so that they understand how that income is impacting their Social Security, how that income is impacting the amount of money they’re paying for health insurance expense.

 Now, once people reach age 65, Medicare is a wonderful benefit. We see people paying more like 600 dollars per month out of pocket for Medicare supplemental insurance, part D, and those types of things. It can really significantly … In fact, some people don’t retire before age 65 just because of the Medicare piece and the health insurance component.

Emilia: Wow. That’s a lot of great information.

Jason: Probably too much information. Most people are not this technically oriented.

Emilia: It’s not but it’s very helpful. It might just catch somebody’s ear and you know what, that’s exactly the kind of question I have.

Jason: I think this show is going to put people to sleep frankly. You really have to be a nerd to enjoy this kind of stuff.

Emilia: Well I’m not sleeping yet.

Jason: I’m the kind of guy that likes to figure out … Most Americans will say I don’t mind paying my fair share in taxes, I just don’t want to pay more than my fair share in taxes. If we can do that legally, we’re playing within the rules, it’s black and white, and we’re following everything the IRS says we have to follow, then … Well, for some people, they like paying a lot of money in taxes. In fact, Bernie Sanders has promised he’s going to increase people’s tax rates up significantly. Because he’s getting so much momentum in the polls these days, it tells me people must want to pay more money in taxes. There’s a lot of people that want to pay more money in taxes. For me and a lot of the people we serve, we don’t want to pay more taxes.

Emilia: To me, this is just very important information. These are typically things that you don’t think about from day to day. Most people don’t. To learn more about it is the best way to make changes. I wanted to ask, what are your thoughts about IRAs, 401Ks, TSPs, and other differed accounts?

Jason: Again, here’s another area that a lot of people don’t take into consideration. A lot of people have a financial advisor. A lot of people have a CPA. Most people have never sat down to say what’s the future tax implications of these accounts. They’ve been contributing to these accounts for a long time. They don’t pay taxes on the money in most instances when they’re making those contributions, but they’re going to be paying taxes on those accounts when the money comes back out. We call those accounts tax hostile accounts.

 We do a lot of these public speaking events and one of the questions I like to ask people … We show them that the marginal income tax rates are at all time lows. We show them that the national debt is blowing up out of control. We show them the amount of people that are retiring. Then we ask for a show of hands, how many people think tax rates are going to go down in the future. The majority of the time, most people are pretty logical thinkers and they say that doesn’t seem to make a lot of sense. How do we continue to spend more money than we bring in and at the same time continue to provide these benefits for some many people that we’ve promised benefits to.

 It seems like something’s got to give. Either benefits have to be reduced or taxes are going to have to go up, or we end up in a situation like Greece where there is a lot of people feeling a lot of pain because countries around the world have lost confidence in their ability to repay their debt. If people lose confidence in the United States, and they say hey, we want to know what your game plan is for paying back all this money that you’re borrowing, that could be a real consideration.

 Anyways, when it comes to IRAs, 401Ks, TSPs, we call those tax hostile accounts. I think just like you diversify your investments, you diversify your cash flow, you also want to diversify future tax obligations. We don’t know what Congress is going to do. We don’t know if our elected officials are going to try to reduce or raise taxes. What we do know and what we can control is we can diversify. We can say lets have some money that’s tax free, let’s have some money that’s non-qualified and taxable, and lets have some money that’s tax hostile in those retirement accounts. Hopefully, we will be able to pick and choose where we’re pulling income from at different times just to help manage the tax implications in retirement.

Emilia: I understand that there’s another big part of retirement. Jason, can you help our listeners understand the RMD, or required minimum distribution?

Jason: Yeah. This is a piece that messes a lot of people up. A lot of people aren’t even thinking about this before 70 and a half. What a lot of people don’t realize is that once you turn 70 and a half, you’re required to begin taking money out of your retirement accounts, even if you don’t need it. We’ve run into more issues with this topic in terms of tax penalties and anything else. Basically, the IRS says at 70 and a half, you have to being taking out … The factor is 27.4, ends up being about 3.6 percent that first year, and then every year after retirement, those distribution, the money you have to pull out of your retirement account increases. A lot of people are thinking I’ll just sit on this money and I won’t take money out but at 70 and a half you have to start taking money out. A lot of people say, well in retirement, I’ll be in a lower tax bracket. A lot of the people we serve, they’re not finding that to be the case. They’re actually in the same tax bracket that they were in their working years.

 Be careful with the required minimum distribution. If you’re approaching 70 and a half, you definitely want to take that. There was a point I wanted to make on those required minimum distributions and I …

Emilia: One of the big things that always sticks out to me is when you talk about the penalty.

Jason: Yes, thank you. The penalty if you miss that required minimum distribution is 50 percent.

Emilia: That’s just crazy.

Jason: Yeah. We ran into a situation several years ago. A client was supposed to take a required minimum distribution of 40 thousand dollars and he was looking at a 20 thousand dollar tax penalty for missing that. Fortunately, he was able to write a letter to the IRS and the IRS forgave that penalty. He didn’t have to pay it. That kind of makes the hair on the back of your neck stand up when you start thinking of a 50 percent tax penalty. That’s pretty stiff.

Emilia: Yes sir. I wanted to ask, also related to taxes, how about taxes in gifting?

Jason: One of the things that congress made permanent last year was the ability for people that are 70 and a half to take those required minimum distributions and gift those to a qualified charity … There is limitations on this and I’ll include a link but Emilia, I’m realizing that we’re out of time. I’ll just remind people really quickly that we do have this webinar coming up. They can find that at Soundretirementplanning.com. That’s going to be …

Emilia: April 20th. Wednesday, April 20th.

Jason: If you’re getting ready to retire, maybe you’ve recently retired and you want to make sure you’ve got a good tax strategy going forward, this might be something you want to plug into. Until next week, this is Jason Parker and …

Emilia: Emilia

Jason: Signing out.

Announcer: Information and opinions expressed here are believed to be accurate and complete, for general information only, and should not be construed as specific tax, legal, or financial advice for any individual and does not constitute a solicitation for any securities or insurance product. Please consult with your financial professional before taking action on anything discussed in this program. Parker Financial, its representatives, or its affiliates have no liability for investment decisions or other actions taken or made by you based on the information provided in this program. All insurance related discussions are subject to the claims paying ability of the company. Investing involves risk. Jason Parker is the president of Parker Financial, an independent fee based wealth management firm, located at 9057 Washington Ave NW, Silverdale, Washington. For additional information, call 1-800-514-5046 or visit us online at soundretirementplanning.com.