Taxes in Retirement: Don’t Pay More Than You Owe!

Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®

Taxes in retirement are psychologically much worse than in your working years. When you earn a paycheck, and the government takes a chunk out of it, you understand that in two weeks or a month, you’ll get another paycheck, and another, and another – all the way until retirement. In retirement, though, you don’t replenish your savings through labor but through market returns. Every dollar the IRS takes from you is a dollar that will no longer generate compound gains and brings you closer to depleting your retirement savings. 

So why pay even one dollar more than you have to?

Better yet, why pay taxes at all if you can legally reduce your obligation to zero? 

What’s nice about retirement is that you generally have a lot more control over your tax brackets because you (hopefully) have a variety of income sources at your disposal, all with their own tax regulations, thresholds, and brackets. 

However, not everything is always in your control.

Social Security Benefits

Once you start claiming Social Security benefits, you don’t have a choice as to how much the Social Security Administration will issue you. However, you can predict your monthly benefit and manage your withdrawals from other accounts accordingly. Additionally, the IRS won’t tax all of your Social Security, and if you play your cards right, they won’t tax it at all. To help us reduce our obligation is the concept of ‘provisional income.’

Provisional income is a term used by the IRS to determine whether and how much of your Social Security benefits are taxable. It includes:

Your adjusted gross income (AGI): This includes income from wages, self-employment, interest, dividends, and other taxable income that you report on your tax return.

Non-taxable interest: This is typically interest from municipal bonds, which is not included in your AGI but is included in the calculation for provisional income.

Half of your Social Security benefits: You add half of the Social Security benefits you received during the year to this total.

The sum of these three components gives you your provisional income. If your provisional income exceeds certain thresholds, a portion of your Social Security benefits may be taxable. The thresholds are:

Social Security Benefits Taxation Ranges

Taxes in retirement social security table

Again, once you begin receiving your Social Security benefits, you can’t control how much you receive on a monthly basis. But you can choose the age at which you begin receiving your benefits, which certainly will affect your monthly benefit, adding another layer of complexity to your lifelong tax and investment plans.

Dividend Proceeds

Similar to Social Security, you cannot call a company whose equity you own and request a smaller or delayed dividend to help you optimize your taxes in retirement. Dividends are categorized as either qualified or non-qualified for taxation purposes. 

A dividend is classified as qualified if you have owned the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. These qualified dividends are taxed at the capital gains tax rates, which range from 0% to 20%, depending on your overall taxable income. 

To determine your applicable tax rate for qualified dividends, your taxable income—including wages, interest, other dividends, capital gains, and any additional income after subtractions for deductions and exemptions—is used. This could place you in different tax brackets for ordinary income versus capital gains.

2024 Qualified Dividends Tax Brackets

2024 Long-Term Capital Gains Tax Brackets

If you hold the stock for less than this period, it is considered an ordinary dividend and thus receives ordinary income tax treatment. That’s important to understand when determining which assets to sell. If you’re not thinking of the tax implications of every purchase and sale you make, you may see inferior results. 

If your dividend proceeds come from a tax-deferred account, it doesn’t matter if they’re qualified or not. You’ll owe regular income taxes on those proceeds when you take a distribution, so they aren’t really relevant to this section. 

Here, we’re concerned with those dividends that will have an immediate effect on your taxable income. 

So, let’s imagine that you have $5,000 in qualified dividends from a brokerage account for the year, receive $25,000 in Social Security benefits, and don’t work. Let’s apply the formula to determine your provisional income: 

Dividends: $5,000

½ of Social Security Benefits: $12,500

Provisional Income: $17,500. 

How much do you pay in taxes? 

Lucky for you, not a dime. As your provisional income doesn’t reach the threshold of $25,000, your Social Security benefits don’t count as taxable income. What’s left is your $5,000 worth of qualified dividends, which falls well below the 2024 Standard Deduction of $14,600.

Actively Managing Your Tax Brackets

Now that you have accounted for the (more or less) uncontrollable factors of Social Security and dividends, you can begin withdrawing from your various savings accounts as necessary to reach your desired income level while keep your taxes in retirement to a minimum. 

Traditional Retirement Account Withdrawals

This is all highly dependent on your financial situation—perhaps you can’t sell assets in your retirement account because you’re in a down market, for example. But suppose you are capable of selling assets in a tax-deferred account. In that case, you can sell and withdraw just enough to effectively fill the gap between your taxable income and your taxation threshold. 

Any withdrawal you take will be considered standard income, even if it is a stock you’ve held for twenty years. Therefore, your provisional income will increase commensurate with your withdrawal. The trick is to either keep it below the point where taxes will activate or below the next tax bracket threshold. 

That means if you’re single, as long as your taxable income is below $25,000 in 2024, you won’t owe any taxes on your Social Security benefits. If you go over that threshold, you will owe taxes on 50% of your benefits according to your tax bracket. 

Let’s revisit our previous example and add a $5,000 IRA distribution. 

Income (Dividends and IRA distribution): $10,000

½ of Social Security Benefits: $12,500

Provisional Income: $22,500

Again, your Social Security benefits aren’t taxed, so they don’t count towards your final taxable income. Your new income is $10,000 – less than the standard deduction. Again, your tax bill is zero.

Also, keep in mind that once you reach 73, you will be forced to take Required Minimum Withdrawals, effectively adding another uncontrollable factor to your tax strategy. 

Brokerage Accounts

Next, you have brokerage accounts that often consist of assets with a lower tax rate, such as stocks and ETFs. Beyond the lower tax rate, there’s an additional nuance that is important to factor in – you only owe taxes on your actual gains, not the amount that you used to purchase your investments. 

When you make a withdrawal, you don’t choose to withdraw only your initial investment (on which you already paid taxes) or only your gains. Instead, the pro-rata rule is applied. If your account is worth $600,000, and you invested $300,000, that means half of your account balance doesn’t owe any tax. So, if you sell assets worth $45,000, you only owe tax on $22,500.

Let’s add to our previous example. We determined that the total income was $10,000 as we didn’t have to factor in Social Security benefits into our final income equation. The standard deduction easily covers that. 

Looking at the 2024 long-term capital gains tax bracket reveals that the $22,500 capital gain falls into the 0% tax bracket. 

Due to a logical application of the tax code, you’ve successfully gained $55,000 in liquidity without owing any taxes for the year. But is $55,000 enough? If withdrawing more from your IRA doesn’t make sense, there could be other ways to fill your income gap. 

Roth Retirement Accounts

If you’ve followed the rules surrounding Roth contributions and withdrawals, you now have a completely tax-free source of retirement income. You have several options now to help improve your financial fitness. 

One option is to make strategic withdrawals to fill any income gaps left by inadequate withdrawals from taxable accounts. For example, suppose your desired retirement income is $66,000, and any withdrawals from a taxable account to achieve that goal would lead to an avoidable tax liability. Instead, you can withdraw Roth funds to make up for it. You get your desired income and stay in a lower tax bracket – if you owe taxes at all. 

Alternatively, you can make a point of not touching those Roth funds until later in life, after you’ve already extinguished other sources of income. Doing so will presumably give the assets within your Roth account more time to grow and generate compound gains.

Putting It All Together

Admittedly, there are a lot of ‘what ifs’ here. We’re assuming that you also don’t have a pension or other unavoidable sources of income, that your dividends are indeed ‘qualified,’ and that you’re not facing a down market when selling any assets at all is to be avoided. We’re also conveniently ignoring health considerations. Sometimes, sizeable withdrawals that negatively affect your tax plan are unavoidable. 

However, I hope that this article gave you at least an idea of how you can strategically utilize the tax status of your investments and savings accounts to effectively and efficiently manage your tax brackets and potentially end up with a tax bill of zero. Not through any tricks or loopholes but by applying the tax code as it pertains to your investments. However, I am not a CPA, so please don’t take this as professional tax advice. Please consult with a tax professional for a better understanding of your personal situation. 

If you’d like to craft an investment strategy that will allow for maximum tax diversification and, therefore, more freedom to manage your own tax brackets, feel free to reach out by clicking the button below!

Disclosures

Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. All investment strategies have the potential for profit or loss. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author/presenter as of the date of publication and are subject to change and do not constitute personalized investment advice.

A professional advisor should be consulted before implementing any investment strategy. WealthGen Advisors does not represent, warranty, or imply that the services or methods of analysis employed by the Firm can or will predict future results, successfully identify market tops or bottoms, or insulate clients from losses due to market corrections or declines. Investments are subject to market risks and potential loss of principal invested, and all investment strategies likewise have the potential for profit or loss. Past performance is no guarantee of future results.

Please note: While we strive to provide accurate and helpful information, we are not Certified Public Accountants (CPAs). The information in this article is intended for informational and educational purposes only and should not be interpreted as tax advice. It is crucial to consult with a CPA or tax professional to discuss you

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Ken Hargreaves
CFP®, AIF®, AWMA®, CRPC®

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