3 Ways to Reduce Taxes During Retirement

Troy Sharpe: We all want to pay less taxes in retirement. The question is, how do we do that? This video is going to show you three ways to reduce taxes on your retirement income and help you have a better understanding of how the tax code works as it pertains to your retirement income. [music]

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®) , host of the Retirement Income show, and author of the upcoming book Core4. When we talk about retirement income, first there is no retirement without income. We don’t want to pay more in tax than we necessarily have to.

We see tons of mistakes when prospective clients are coming in to see us for the first time, when we look at their portfolio and how it’s constructed and some of the side effects that it’s causing other income to be taxed.  We’re going to get into three ways today of how you can fix that.

Behind me, before we have any discussion about taxes and your retirement income, we have to understand the environment that we’re in. This is the US debt clock. It’s a real-time tracking of the national debt and many other aspects of debt. We have total interest paid, we have US total debt.  What I want to focus on up here though is the US national debt, $22,306,985,800,000 and counting.

Whenever companies bring me in to speak to their employees about retirement, or if I’m getting hired to do public speaking, or if we’re  putting on our own events here. We put on a lot of our own events, I like to ask the audience a question. That is how long ago was a trillion seconds? Someone who will inevitably will raise their hand and say, “30 days ago.” Someone else, “100 years ago.”

A trillion seconds was closer to 32,000 years ago.  If you started trying to count to a trillion, one-one thousand, two-one thousand, it’s going to take you almost 32,000 years to get there. When we understand how much national debt we have, $22 trillion  is just an unfathomable number. Then we understand that it’s possible even likely the taxes are going to be higher in the future.

The challenge that the country faces is every day more than 10,000 people go on to Medicare. Medicare is a mandatory expense. It’s constitutionally mandated to be paid, along with interest on the debt, Social Security, some other entitlement programs. Since we’re an aging population, and more and more people are going on Social Security  and Medicare, the mandatory side of the annual budget is continuing to expand and expand and expand.

As a matter of fact, the Congressional Budget Office, the CBO, expects by 2027 that the mandatory side of the budget it’s a total about $4.3 trillion. That’s astronomical. Not only are we concerned that taxes are going to be higher in the future, but as a certified financial planner professional, it’s my job to put my clients in the best position possible to succeed, and part of that responsibility means paying less taxes on your retirement income.

Now, you don’t cheat the tax code, that’s not what this is about, but it’s about being smart, about being intelligent, about  how we’re taking our income so we can pay the least amount of tax possible. Under current tax law, in 2026, rates are going up. President  Trump passed the Tax Cuts and Jobs Acts of 2017 that reduced income tax rates and also widen the brackets.

All this means is that you can take more money out of your accounts and have more income and pay less taxes than any time in a very very long time, but that’s going away in 2026. We do know taxes will be higher then,  and it’s quite possible when we look out into the future 2030, 2035, 2040, that because of this national debt and the way it’s expanding and growing, that taxes could be  much higher.

Income tax planning, retirement income planning, is a very critical part to a successful retirement. We’re going to go through some case studies and some examples so you can have a better understanding of how the tax code works as it pertains to your retirement income. We have some case studies up here. The first one that we’re going to look at, this is a pretty  common situation here.

This ordinary income, $15,000 dollars, that’s bond interest. Traditional advice is put 60% of your money in stocks, 40% of your  money in bonds. Bonds generate interest, and if they’re held outside of your retirement account, you have to pay tax on that interest. Ordinary income of $15,000. This couple has an IRA distribution of $15,000. They have qualified dividends of $20,000, and total Social Security of $60,000.

This is a $110,000 of retirement income, and the total tax paid here, $4,367. This shows you under the new tax code, if you have $110,000 of retirement income in this particular order, ordinary income, IRA distributions, dividends, and Social Security, your effective tax rate is only 4.36%.

4.37%, if you round up. That’s a historically low effective tax rate, and that means there  could be some opportunity for planning here. Before we get into planning, I want to compare this to what we often see when a prospective client first comes in to sit with us. They may be working with  an accumulation phase advisor, or maybe they’re self-managing their own money.

Or maybe they’ve never had an advisor. They just have some different investments. This is very common. Here we have the base case, it’s everything we just looked at. 4.37% income taxation. Nothing has changed over here, except the two parts  I’ve highlighted here. The $10,000 in long-term capital gains, and the $6,000 in short-term capital gains.

This could represent stocks that were sold,  bonds maybe that were sold for a gain. Often what we see is that mutual funds when they’re held outside of the retirement account, the capital gains that the mutual funding  occurs passes through to you, and you’re responsible for all the actions from a tax standpoint of the mutual fund manager.

Not only when you buy the mutual fund and then if you sell it  for a gain do you have to pay capital gains tax, but over the course of the year, if the manager is in their buying and selling stocks and the markets going up, those gains get passed through to you, and they can go on your tax return causing other of your other income to be brought into taxation or for you to pay more tax than you were otherwise planning.

This is just an additional $16,000 of capital gain. That’s the only difference here. Notice that the adjusted gross income from the base case goes up to $30,000.  How is that? How can our adjusted gross income go up to $30,000 if the only difference is we’ve had $16,000 in gains? Well, the answer is  it causes more of your Social Security to be taxed.

You see in the base case, we had $60,000 of Social Security per year, husband and wife.  Only $36,000 of it was subject to income taxation, but because this $16,000 of gains occurred, it  brings $50,000 of your Social Security into taxation. That’s almost the maximum amount allowed. Also, many people aren’t aware, but there is a 0% tax bracket for long-term capital gains and also dividends.

What happens here is these gains  passed through to you cause more of your gains and dividends to be taxed than they were previously. Not only is more Social Security being subject to taxation, but now you have more long term gains and dividends being subject to taxation. Ultimately, this means an extra $4,000 roughly in income taxes, simply for having $16,000 of capital gains passed through to you.

The first way to reduce taxes on your retirement income is to be very aware of investment placement and investment selection. Which financial tools are you using outside of your retirement account? If you have bonds, they’re taxed at ordinary income tax rates. If you have mutual funds, those mutual funds pass through capital gains taxes.

They could be short-term, they could be long-term, but often they also pass through income  distributions that could be subject to ordinary income tax as well. Mutual funds are very hard to plan around if you have them outside of your retirement account for  income tax planning. Be aware of where you place your financial tools, inside the IRA or outside of the IRA, and also which tools that you’re using.

The second example that I want to go through here is exactly similar to the one we just looked at, the only difference is we increase the IRA distribution  from $15,000 to $25,000. What this does now is it jumps the income taxation up to $11,203. It makes $51,000  of your Social Security, subject to taxation, but also it pushes a much larger amount of your dividends and capital gains into the taxable bracket  and very few are left in between this 0% long-term capital gains bracket.

Not having a clear understanding of how the rest  of your income is impacted by little decisions. Let’s say this was somebody who just wanted to go on to a vacation. They said, “You know what? Tax rates are lower under this new tax law, we’re going to take $10,000 out of the retirement account.”

That decision effectively cost 30%, cost $3,000, because taking an additional $10,000 out of the retirement account caused an additional  $3,000 in taxes. Now, it’s not $3,000 on that. What happened was it caused a little bit more of your Social Security to be taxed and more of your dividends to get bumped into the 15% bracket out of the 0% bracket.

Being aware of the income sequencing and where you’re taking your income from is very critical as well. Now, that’s bonus one, but it ties in very closely to the first one as far as being aware of where you place your investments, which accounts, and the types of tools that you’re using, and the tax characteristics of those tools.

The second way to reduce taxes on  your retirement income is to think a little bit outside the box, because traditional asset allocation in retirement is 60% stocks, 40% bonds. Well, the problem with bonds  in an increasing interest rate in environment is that bonds go down in value. Bonds can be a very inefficient tool when interest rates are increasing, like we’ve seen over the past five years.

Thinking outside of the box, if we can use something like a fixed annuity or a fixed index annuity, if you’re a conservative investor and you simply want your principal protected, fixed indexed annuities give you 100% principal protection, and they allow you the opportunity for potentially double-digit returns.

They’re designed to average  somewhere between 4% to 6%, the very best growth ones out there, but they have a very unique characteristic when it comes to income tax planning. See the gains are tax-deferred. Here’s a new example. We have the base case here, the very original base case. What we’ve done is this $500,000 portfolio here that we had in bonds,  a high-quality bond portfolio.

You can make about 2.5% maybe 3% interest right now. When you put that inside your non-retirement account, we go back to the first one here, it creates ordinary income tax. In this scenario here, what we’ve done is replace the inefficient bond portfolio  with the fixed annuity or fixed index annuity that gives principal protection. The fixed annuity, it’s a guaranteed rate product.

The best-fixed annuities right now, you can  get about 4% compound interest per year for five years. The fixed index annuity provides principal protection as well, but gives you the potential to average around 5% to 6% per year,  the very best growth ones out there. By replacing that bond portfolio with a fixed annuity or fixed index annuity here, that interest comes off the tax return.

Now what happens is your Social Security, not $36,000 is subject to taxes, only $23,000 is subject to taxes. Just by adding this tax-deferred  tool in lieu of bonds, it drops our overall income taxation from $4,300 to $1,188.

The fixed annuity not only is a more efficient and versatile tool, I believe, in an increasing interest rate environment, but it has tax planning benefits when used outside of your IRA, which can cause your dividends to go into the 0% bracket, which can reduce the tax on your Social Security. Effectively, it’s going to help potentially to reduce the overall income taxation that you pay.

If we look here, this is 60, 80, this is $95,000 of retirement income with an income tax obligation of only $1,188. That’s really cool. The second way is to consider a tax-deferred tool in lieu of bonds like a fixed annuity or a fixed index annuity as part of your overall asset allocation.

When incorporated into a tax plan, it can have benefits that go beyond just the tax deferral of that tool. The third way to reduce taxes on your retirement income is to have a proper retirement income plan sequencing strategy and also a Roth conversion strategy. When I sit down with a client and we get to the tax planning discussion of the process, one question has to be answered.

Do you want to save taxes today, and each year keep taxes down as much as possible? Or do you want to preserve more of your wealth for your family over the course of 20, 30, 40 years, and then pass that on for the kids and the grandkids to have security and to create a true family legacy and family wealth?

With the current tax law provide us this opportunity of historically low-income tax rates, this is an optimal time for many people to be considering a Roth conversion strategy. Before you can decide a retirement income strategy, we have to come up with a retirement  income plan. Then once the income plan is in place, then we can start to look at different alternative for Roth Conversions.

This is one of the tools that we use for our clients to help determine what is the appropriate retirement income strategy and what is the appropriate amount to convert to Roth IRAs. As you can see,  there are tons and tons of different retirement income sequencing scenarios. All of them have a different value in accumulative amount of taxes that are paid.

Under this top one right here, pays a little bit more taxes, $1.1 million in taxes over the course of retirement, but it has the highest value.  Now just because it’s the number one doesn’t mean that it’s necessarily the best one for you. It just quantifies the mathematics of different retirement income withdrawal scenarios and Roth conversion scenarios. There’s a qualitative aspect that needs to be considered as well.

A subjective component. What’s most important to you about your money? What’s your retirement vision? What are you trying to accomplish in the grand scheme of things? When you can combine the quantitative and the qualitative analysis of different retirement income scenarios, that’s how you get the best combination for you and your family.

Understanding retirement income sequencing and Roth conversion strategies can help reduce taxes. If you get down here, $725,000 in accumulative taxes paid versus $1.19 million. If you look at some of these bottom ones, you’re looking at over some of these down here, $1.9 million, $1.8 million, $1.6 million in taxes.

That’s hundreds of thousands of dollars and extra taxes paid by having an inefficient retirement incomes sequencing strategy. The way you take income means a big deal in retirement with taxes, but also with how long your portfolio will last. If you’ve enjoyed this video, I encourage you to share it with friends, share it with family members, send it to a coworker.

There’s a great opportunity to save taxes with today’s tax laws, but your retirement  income is very important because without retirement, there is no income. Those are the three ways to save taxes on your retirement income. The first one, be aware of your investment placement  and which tools that you’re using.

The second one is to consider instead of the inefficient bond mutual fund for retirement, adding to the asset allocation a tax-deferred tool  for money outside of your IRA like a fixed annuity or a fixed index annuity. Then the third way is to come up with a proper retirement income sequencing strategy that considers  Roth IRA conversion that brings into picture not just the quantitative, the mathematical calculation, but also the qualitative, what’s most important to you about your money.

If you like this video today, please, share it with a friend, share it with a family member. Make sure to hit subscribe, and that little bell icon down below, so you can be notified of when we upload similar retirement income planning, tax planning, and investment planning strategies for your retirement.

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