How To Prepare For Year End Taxes | Explore The Significance for Tax Advantaged Income in Retirement

We talk a lot about tax planning on this channel because tax planning is one of the most important things a financial advisor can do for your retirement. But tax planning goes along with income planning. This is why there’s step two and step three in our Oak Harvest Retirement Process process. And we can’t have an income or a tax plan without an investment plan and risk management strategy.

So that’s Oak Harvest Retirement Process risk management, income planning, Tax planning. Today, we’re going to look at different scenarios if you’re married or if you’re single different ages and different income levels compared to different tax strategies and see what the consequences are for having a tax plan versus not having a tax plan.

The first scenario we’re going to look at is, an individual, a single person. So a single taxpayer that wants to spend a hundred thousand dollars a year in retirement Okay, here are the assumptions for this case. Birthdate, January 1st, 1954, $70,000 in IRA distributions and $30,000 in social security. So this is someone who did not save in multiple places leading into retirement.

They just follow the conventional wisdom advice and kept putting money into that retirement account. So when they get to retirement, the only place they have to take income from is from the IRA. Just to give you an idea what the tax calculation looks like. Adjusted gross income, 95,500. The reason is, is only 85% of social security is subject to income tax.

It’s why it’s less than the actual income already. They’re getting bumped into. What’s called the IRMA surcharges. Income-related monthly adjustment amount. It’s an excise tax on your Medicare premiums. You pay it out of pocket. It’s an additional tax $713 a year for part B $148 for part D, not breaking the bank, but still it’s an extra tax.

Deductions and exemptions, $14,250. So this is your standard deduction, as well as being over 65 provisional income. This tells us how much of your social security income is subject to tax. It’s equal to all of your income. Add back in your tax-free interest, but only counting one half of your social security benefits.

So 25,500 of the social security, 85% is taxable brings us to a total tax liability of 14,483. Now, what I want to do is show you some of these thresholds for Medicare, for income taxes, for capital gains, but then also show you what happens if they properly prepared and had more than just IRA dollars.

Okay. We’re going to start with the Medicare premiums, just so you understand how these. So when we have modified adjusted gross income above 88,000, your part B and part D premiums increase, this is on top of the normal monthly cost for Medicare, but you can see as you have more and more income, this is the month.

Extra cost that your Medicare premiums increase. So how do we avoid this? We diversify our tax buckets leading into retirement. We could have Roth IRA distributions here, and that does not count towards your modified, adjusted, gross income. Your dividends, will your capital gains, will your IRA distributions?

Well, the only way to really keep this down, if we want to spend a level of income above this amount is to have savings, non IRA savings outside where we can Paul pull from or Roth IRA distributions, but we need one of those two accounts in order to keep our income levels below. Our income below these levels in order to avoid these surtaxes, many of you are unaware that you could have 0% capital gains tax and dividends tax.

If your taxable income is below 40,401, now, part of the reason why I’m doing this video is we’re going to look at these different scenarios today prior to the pending tax changes, that that is being negotiated in Congress right now. And then we’re going to do another. To compare pre and post legislation to see if it’s true that no one making under $400,000 will see a single penny of tax increase.

I’m really curious to see how this turns out, but right now you can have 0% capital gains. If your taxable income is below 40,400, it’s important to distinguish between what your taxable income is and your actual income. So taxable. Again, the only thing that’s not going to that into that calculation would be withdrawals from savings, or if we can have some capital gains, but then offset them with capital losses.

So they zero out or Roth IRA distributions, but we could spend if it properly prepared for and properly planned, we could spend a hundred thousand, 150,000 and only have taxable income below this level. So our dividends and capital gains are taxed at 0%. It requires a. So for a $70,000 IRA distribution, 30,000 of social security, our effective tax rate is 14.4, 8%, pretty simple math, $14,483.

Now we’re going to look at that same scenario, but instead of having to pull all the money from the IRA, we’re going to look at what happens if we pull it from multiple places, because this example, they properly prepared leading into retirement. So 20,000 from the IRA, 20,000 from dividends, this could be dividends or capital.

So outside of the retirement account, social security, the same $30,000 and some tax free interest of 35. Now the effective tax rate drops from 14 and a half percent to 6%. So the total tax on a hundred thousand dollars of income, $6,000, all we’ve done here, we’re living on the same amount of income. It’s just, we’re pulling it from different places, which allows us to control.

What gets reported to the IRS. Now, this is just a snapshot. A lot of times it will make more sense to pay tax today to protect against higher taxes in the future. It all depends on your personal situation. The overall purpose of these videos is just to introduce the concepts of income and tax planning and how they’re a huge part of what you should be looking at when it comes to either choosing a financial advisor.

Doing it yourself, or trying to keep taxes down today versus tomorrow, you would always have to weigh that today versus in the future, because if. We were to look at this particular scenario only in isolation. This looks like a much better deal. You’re obviously saving a lot of taxes and I’m not saying it is, or it isn’t, but if we then compare this to what we didn’t do and extrapolate that out over the next 20 to 30 years and compare account balances, future taxes, social security, all of these different decisions.

We have to compare those two scenarios. So not to go too deep into the weeds here, but I want to make sure we understand that. Yes, we’d sit, we’re saving taxes and this particular. But what happens if maybe instead of doing this, we paid more tax today by doing a hundred thousand dollars Roth conversion or a 50, or a $200,000 conversion, we’re going to pay more taxes today.

But if we compare that scenario extrapolating out into the future, which one is going to put us in the better situation, not just today, but in 30 years or 15 years. So keep that in mind. Now I want to look at a married filing, jointly case, but no social security. They’re a little bit younger. They’re just taking a hundred thousand dollars from the retirement.

So first thing that we notice here is that the effective tax rate for married filing jointly on a hundred thousand dollars of income. Is 8.5, 9% versus 14 and a half percent on the single case. Now a little bit different simply because this hundred thousand is all coming from IRAs. Whereas 30,000 in that last example was coming from social security.

But keep in mind the adjusted gross income is a hundred thousand here. It was 95,000 or so on that last one because 85% of social security is counted towards that calculation. The point is though it’s not that much different off. And there’s a significant savings on tax as far as 85, 90 versus 14,000, somewhere around 500.

So now I want to look at the medic. Thresholds the Erma thresholds. If you’re married, filing jointly, you do see there’s a significantly higher income base before you cross into the excise tax territory for Irma income related monthly adjustment amount. I encourage you to look it up, get familiar with it.

’cause, these are extra monthly taxes per person. So if you’re married, let’s call this 150 that’s $300 per month in extra Medicare taxes. If your modified adjusted gross income is above 222,000, it starts to get pretty significant as you go down here. So again, per month per spouse, now I’m going to show you what the tax liability is.

If we take income from multiple places, not just from the. Again, the purpose here is to understand if we’re leading into retirement or we’re preparing, we need to be saving in different buckets.

Your effective tax rate is 2.59% in this scenario. So where am I getting this income from 50,000 from the IRA 20,000 from dividends and 30,000 from tax-free interest. Okay. I’m still taking 50,000 from the. But the effective tax rate is only 2.5, 9%. Pretty big difference. Now I want to talk to you about a concept called tax mapping.

And this is where we map out where every dollar of income is coming from and what extra taxation is caused because of that next dollar taken from your accounts. Think of the income tax code in retirement, like a big net, or at least think of your income as a big net. And as you’re scraping that net along, you’re going to pick up other things along.

Well in retirement, when we take income out and we’re growing our income, we’re going to pick up extra taxes along the way. Two good examples are the more you take out, the more likely it is that more social security will become subject to income. Taxation, same thing with dividends and capital gains. If you’re married, filing jointly, your taxable income is below $80,000.

Roughly about 81 right now, then they’re, tax-free 0%. Uh, dividends and capital gains. But as you take more and more out of the IRA, all of a sudden now you’re dragging more of your capital gains, more of your dividends into the world of taxation. So this is a tax map right here. Now this is a different case.

This is $150,000 of income, but I wanted to show you this, particularly because the red line down here, these are your regular tax brackets, but as we take more and more out of the IRS, We start to see that we bring the taxation of dividends and capital gains into the picture. If you’re taking social security, now we’re dragging more social security into the, to the taxation picture because your social security could be a hundred percent tax-free if your taxable income is below certain thresholds, you could also only 50 of it.

50% of it could be subject to income taxation or 85% once you cross over the top levels. So just keep in mind. Not spending a lot of time here, because this is a bit more of a complex, um, study. It would require a video all all by itself, but I just want you to understand the concept of tax mapping. And it’s like a net as we pull more and more out of the IRA, we bring other aspects of the tax code into play, and it’s not just social security and dividend tax.

Once you get to certain thresholds, now you’re bringing net investment income tax into the picture, possibly those Irma. And one thing I’m going to be very curious to see is what this new legislation, what other things are maybe introduced that if you cross over a certain income threshold, now you’re dragging those into the income tax situation.

So I’m curious to what’s in this new legislation, just in case you’re curious with this case here it is $150,000 of income married, filing jointly. And we have 50,000 of IRA distributions, 20,000 dividends, 50 and social security husband and wife. Tax-free interest of 30,000. Total taxes paid on this 150,000 at 7,000 9 51 or a 5.3% effective rate.

The last thing we’re going to look at is if all the money’s inside the retirement account and we have to go in and we have to pull that a hundred grand out of the IRA combined with 50,000 of social security. So at the same, $150,000 spending level married, filing. Now the total tax jumps up to 16,000 7 31 or 11% effective rate.

So this is 16,000 versus about 5,000 in that other one. So that’s an extra what? 10 or $11,000 a year of taxes simply because one, we weren’t prepared the right way leading into retirement and all your money was inside that tax infested retirement account. So big takeaways here. When you’re leading into retirement, please save money outside of that retirement account, depending on your income tax situation.

And what’s your company matches you definitely want to get money into there. It’s it’s can be very advantageous, especially if you’re in your higher earning years at this point in life. Go ahead and max out those accounts, get your company match, but once we’ve done. We can still be saving money outside, possibly into what’s called the after-tax part of your 401k, which allows you to do what’s known as a mega backdoor Roth, which by the way, is kind of under attack.

And it may go away with this new legislation, but then also you can save outside in your savings account or investment account, because those are the places where we will be withdrawing income from. And each year it’s a little bit different. We may take X amount from the IRA X amount from savings, X amount from.

We may do Roth conversions. We need to look at this, not just in the context of what you pay an income tax today, but then we need to compare those scenarios to one another and model them out over the next 15, 20, 25, 30 years to see, okay, what are we doing today to keep taxes down? But what if we pay more taxes and do more conversions?

How do we then compare in 10 years and 15 and 20. This is all part of having an income and a tax plan. This is what the Oak Harvest Retirement Process process is all about. If you liked this video, make sure to hit that thumbs up button. Please put a comment down below, answer one of the surveys, Eric, who helps to produce these videos.

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