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Life Can Get Complicated, But Don’t Fret the Small Stuff

By Harry S. Margolis


Congratulations! You’ve retired. You’re free to spend your time as you like. Life should be simple.

But, of course, many parts of it are more complicated. You no longer have health insurance provided by your employer. Instead, you have Medicare and must decide on what Medigap policy and Medicare drug plan to sign up for. And should you save money by joining a Medicare HMO?

And then we come to tax planning. One client recently asked advice on how to minimize taxes given than he has income from the following sources:

  • Investment account. He and his husband receive dividends and there are substantial capital gains embedded in the stock holdings.
  • Traditional IRA. Once he reaches age 72, he’ll have to start taking required minimum distributions and paying taxes on these. Eventually, these will pass to his heirs who will have to withdraw the funds and pay taxes on them over 10 years.
  • Roth IRA. No taxes on withdrawals by himself or his heirs.
  • Variable annuity. Taxes due on its growth when withdrawn by him or his heirs.
  • Health savings account. He still has an HSA from his former employer through which he can shelter some income to pay health care expenses.
  • Social security income, most of which is taxable given his tax bracket.

Complicated! He wants to minimize taxes both for himself and for his heirs. He’s fortunate to be in a relatively high tax bracket. According to an article published by the Center for Retirement Research at Boston College, 80% of married retirees pay no more than 1.1% of their income in taxes. But those in the top 5%, like this client, pay 16% on average and as high as 22.7%.

So, how can he keep this as low as possible given his various assets and sources of income? While it looks complicated, I think it really isn’t so bad.

First, there are two sources of income he can’t control: Social Security and the RMDs from his IRA, so there’s nothing to be done there.

Second, he should take advantage of the HSA as long as it’s available. That’s tax-free money.

Third, as they say, he should not let the tax tail wag the investment dog. Given that he’s a young retiree, there’s a good chance either he or his spouse will live another 20 years or more. While at death, his holdings will receive a step-up in basis and thus avoid any tax on capital gains, that could be a long time to hold a dog of a stock (to mix metaphors). I’d recommend investing prudently without being concerned about realizing capital gains along the way.

Fourth, that just leaves the Roth IRA and variable annuity. I’d withdraw each to the extent he needs funds. While withdrawals from the annuity are taxable and those from the Roth IRA are not, that will also be true for his heirs who may or may not be in a higher tax bracket than he’s in now. I’d spend these two accounts down as needed without too much regard to the tax implications since it would simplify his financial life and that of his heirs if he had fewer accounts.

In short, with a little analysis, what looks quite complicated at first can be relatively simple.


Related Articles:

Senior Tax Breaks: Boon or Ticking Bomb?

Don’t Let the Perfect Plan Get in the Way of a Good One

Why You Don’t Need to Review Your Estate Plan Every 5 Years (Unless You’re 60+)

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