Tax Deferred to Tax Free: Navigating Taxes in Retirement

In this milestone 100th episode of the Common Sense Financial Podcast, host Brian Skrobonja delves into the critical topic of managing taxes in retirement. The episode focuses on strategies for minimizing tax liabilities, especially for retirees with tax-deferred accounts facing potential hefty tax bills.

Brian emphasizes the importance of sustainable income creation during retirement and the role of tax optimization in this process.

• Most people envision their retirement to be built from predominantly tax-free income, but after many years of deferring taxes, retirees are facing a sizable tax bill on distributions taken from their retirement accounts that could be a third or more of what has been accumulated.
• When you’re saving for retirement, growth of your assets is the priority. But many people don’t realize that once they retire that’s no longer true. The priority is actually creating sustainable income to support you through retirement while minimizing taxes.
• A common issue I’ve seen is future retirees knowing they will owe taxes on their deferred accounts, but not realizing the extent of the problem since the rules change once they retire.
• Many retirees we work with tend to have the same income goals in retirement, yet with fewer deductions. They no longer have children or mortgage interest to help them offset their tax burdens, which makes the situation more complex.
• Delaying distributions isn’t an option either. Required Minimum Distributions will eventually force your hand.
• There are two tax problems facing retirees: taxes you will have to contend with today, and taxes that you will have to contend with in the future.
• With the national deficit continuing to rise, do you expect tax rates to go down in the future or go up? The most likely answer is that tax rates are on the rise, so we should be planning accordingly.
• There are two possibilities to help minimize the level at which you participate in paying your fair share towards the government's future revenue increases. You can either complete a Roth conversion or through tax deferred withdrawals contribute to an overfunded permanent life insurance policy.
• Making the decision of which strategy to implement is the easy part. The trick really is completing this process with minimal tax liabilities, which requires specialized knowledge.
• The progressive nature of the code makes understanding your tax burden complicated and miscalculating this could result in having a larger tax liability than anticipated.
• Depending on your income level, a taxable distribution can subject your Social Security to additional taxes. This is a separate calculation from the income tax brackets and uses a two step process to determine how much of your social security will be subject to taxation.
• This is important to know because a taxable distribution may not only push you into a higher income tax bracket, but it could trigger additional taxes on your social security, which could result in a higher effective rate.
• You should also be aware of the impact a taxable distribution can have on Medicare premiums. The impact of any possible premium increase is typically delayed by two years. This is one of those things that often comes as a surprise when people make decisions about distributions.
• The antidote to taxable income is deductions, credits and losses which can help reduce the net income subject to tax. There are a few options that can help offset the burden of taxes and make the transition from tax-deferred to tax-free easier, but they don’t work for everyone, which is why we recommend working with a professional.
• The first thing is a donor advised fund or DAF. This allows you to contribute future charitable donations into a fund that you control when distributions are made that can also receive the tax benefit of the donation in the year you make the contribution into the fund. By making multiple years of donations in a single year into that fund, you have the potential of helping offset a taxable distribution from your retirement account in that year.
• The second is a Charitable Remainder Trust (CRT), where you can contribute future charitable donations into the trust and receive the tax benefit of the donation in the year you make the contribution. You can also receive income from the trust while you're living within IRS limits. A CRT is a more complex arrangement than a DAF with many options and requires an attorney to draft the trust.
• The third is a qualified charitable donation or QCD, which allows for anyone over the age of 70 and a half to make a direct donation from a qualified account to a charity.
• The fourth is something known as IDCs, or intangible drilling costs, which allows accredited investors to participate in the drilling expenses of an oil and gas company that could provide reportable t