Taxes in Retirement Planning: What You MUST Know! (2018)

In this episode, I share how a recently widowed friend of mine was told by a large investment firm that her money would last until she was 93 years old. She’s 61 now.

How did they figure that? Well, they ran a Monte Carlo analysis of course! And if the Monte Carlos says you are good to go, well, who’s going to argue with that?

I do! The three things that must be looked at when it comes to the Monte Carlo are:
1. Rates of returns the software is using
2. Investment fees
3. Taxes

I go into detail of all three in the podcast. But, if the software from which the Monte Carlo is based is saying cash will return you 3% and a conservative portfolio (20% stocks / 80% bonds) 6.2%, that is way overly optimistic in a world today when the 10 yr Treasury bond is paying all of 2.80%.

How about investment fees? Investment fees that run say 1% will eat approximately 25% of your total returns on a more conservative portfolio. That needs to be addressed in your Monte Carlo analysis too.

Oh, you don’t pay a money manager but instead have mutual funds? Are there NO fees on your funds?

Ever hear of taxes? Well, if you have the bulk of your assets in qualified accounts like an IRA or 401k, every penny you take out from those accounts is taxed at Ordinary Income.

My widowed friend only needs to generate $37k or so of income before she is in the 22% tax bracket!

Monte Carlo doesn’t take that into consideration either.

What am I getting at? Simple. If a call center employee at a big firm says you’re fine with your retirement projections because he or she ran a Monte Carlo and it says you have an 85% success probability, the first thing you need to do is ask “huh. interesting. What are you using for rates of returns? Are you adjusting for the investment fees you want me to pay? Are you adjusting for the taxes I will pay?”

If the answer is no, which undoubtedly it will be,  you need a second opinion.

If you are not looking at the NET, you could be in big trouble.

Retirement Income Planning is critical for soon-to-be and current retirees.

Because it is so important you MUST get as specific as you can for YOUR situation.

Need To Understand The Tax Code

This means not relying on rules of thumb. Or financial planning concepts that are somewhat dated. Or generalizations of the tax code.

In the video below, I dissect a recent article in the Atlanta Journal and Constitution where the author completely misses the mark with his analysis of the tax consequence a hypothetical couple will pay.

Because of this error, the couple will engage in part-time employment to generate income when in fact under current tax law they would not need to do that.

Work When You Don’t Need To?

In fact,, with proper tax planning, this couple could have used the time they spent working part-time to do something maybe more meaningful.

In the article, the author has the couple paying a 17.22% tax rate on gross income of $100k which includes $42,000 of Social Security.

This GREATLY over states the taxes these folks will pay, nearly by a factor of 3!

Taxes Under Trump Tax Bill

Under the new Trump tax bill, each taxpayer has a standard deduction of $12,000.

So, immediately, this couple’s taxable income drops to $76,000. For a married couple with taxable income below $77,000 means they are in the bracket.

But it gets better for them.

Social Security Taxes Are Favorable

Social Security is much more tax-favorable than straight ordinary income. Depending on your PROVISIONAL INCOME a significant amount of your Social Security will escape taxation.

Unfortunately, by heeding the author’s advice and working part-time, this couple will pay tax on 85% of their Social Security benefits. This is the maximum allowed by law and actually increases their taxes by 50% as compared if they did not work!

Does that extra income from working give them more needed disposable income though? NO!

The author states they need roughly $83k a year to live comfortably in retirement. He puts them in a 17.22% tax bracket and, lo and behold, $100k of gross income nets them the $83k they need.

Simple Tax Planning Nets Same Results As Working Part Time

But in reality, by NOT working, they have $88k of gross income, pay about $5k in taxes and still net the $83k!

Also, this assumes their investment income is ALL taxed as ordinary income rates. What if were long-term capital gains (LTCG) and/or qualified dividends(QDI)???

In this case, there would be a good chance NONE of that investment income is taxed at all because of the favorable tax treatment for those in the 12% and lower brackets on LTCGs and QDI.

Pay 0% Tax On Qualified Dividends And Long Term Capital Gains

Remember if you are in the 10% and 12% tax brackets, (that means your TAXABLE INCOME is below $77,000 married filing jointly) you pay 0, yes I said 0, in tax on long-term capital gains and qualified dividend income!

So, it’s even likely that I am over-estimating this fictitious couples tax because I don’t know from where their investment income derives.

Either way, on the basis of NOTHING ELSE other than the new Standard Deduction rules we know, for a fact , this couple will only be in the 12% MARGINAL tax bracket.

How Marginal Tax Works

This means, the first $19k is taxed only at 10% and the next $58k of TAXABLE INCOME is taxed at 12%, unless some of that income is LTCGs and QDIs then that part is taxed at 0.

So, what does all this mean for you???

Taxes Are HUGE In Retirement

You’ve got to know the true nature of your taxes. Taxes are one of the largest, if not THE largest, expense retirees have.

If we overestimate taxes we are risking the clients will be too conservative in their spending and not fully enjoy their beginning stages of retirement.

The last thing we want to happen is for a widow to have more money in her accounts than she knows what to do with being disappointed because she and her late husband didn’t do more, out of worry of running out of money.



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