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How To Lower Your Tax Rate In Retirement

How To Lower Your Tax Rate In Retirement
hey what's up everyone the lats been here for money evolution and today's video I'm gonna be talking about tax st

rate

gies for retirees now this is a topic that we've done several videos about today's video I'm gonna take it from a slightly different angle I'm going to talk about a couple big factors that I think we should be thinking about right now as we're starting to put together some of our tax plans for

retirement

remember the tax plan is one of those seven
how to lower your tax rate in retirement
core elements that we talk about all the time here on the blog maybe one of the most important elements so there's a couple things that I want you to think about as you start putting together this tax plan number one is kind of the big elephant in the room and that's the money that you have in traditional

retirement

accounts and those are monies that as you start to pull those out in

retirement

you're gonna have to pay taxes at

your

ordinary income tax

rate

we're also going to
talk about the tax cuts and Jobs Act that went into effect in 2018 those tax cuts are set to expire in 2025 so I think we have some opportunities here to take advantage of that we're also going to talk about a couple of other things the tax on

your

Social Security we're going to talk about how to coordinate

your

Social Security benefits into this tax st

rate

gy and why maybe delaying those Social Security benefits might give you some opportunity to take advantage of these tax cuts
we're going to talk about what happens if either you or

your

spouse dies what what happens to

your

tax

rate

s then we're also going to talk about the potential for

your

income taxes to cause

your

Medicare premiums to go up so this is something I've talked about again a lot on the blog here but there's a lot of moving parts when it comes to our taxes in

retirement

so so hopefully we'll give you some good ideas here and let's jump right in okay so now let's talk about
some of the tools that we're gonna use to help you create this tax plan there's a number of things that we actually have some control over for example where you save the money if you're still working are you putting that into a Roth bucket or a traditional bucket or a taxable bucket that's going to have an impact on what those taxes are both today and also what those taxes are going to be in the future when you start taking that money out we can control as you're taking those
distributions which account we're going to take those from we could also control when you decide to collect

your

Social Security benefits so these are some of the tools that we're going to use we can do Roth conversions that's another st

rate

gy that might fit in very well to

your

financial plan into creating this tax st

rate

gy for

your

retirement

and remember the earlier that you start to create this tax plan the more options you're going to have as you get closer and closer to
that

retirement

date or closer to the age that you're going to collect Social Security or

your

required minimum distribution age at seventy and a half that just shrinks down the number of options that we have so the earlier the better just opens up those opportunities for us to create this tax plan okay so let's start by giving you a quick refresher here on the three tax buckets and this is something I think I have an entire video just devoted to this but

your

three taxable buckets are
what we call

your

your

tax now bucket and that's gonna be primarily

your

non

retirement

accounts and you know you have money in the text now bucket if you get that 1099 form at tax time that's going to report

your

dividends

your

interest

your

capital gains that's in the tax nail bucket you also may have money probably have money in the traditional bucket and that's going to be those traditional IRA or 401k plans that's money that you probably deducted off of

your

income tax
return when that money went into those accounts but that's going to be money that you're going to have to pay the taxes on later as you start to withdraw that money in

retirement

and then finally you have

your

Roth bucket and that's money that was taxed before it went into the

retirement

account and as that money comes out in

retirement

you don't have to pay any taxes on that money so so we want to create a balance of these three different accounts that's going to not only
give you potentially a

lower

tax

rate

in

retirement

but also balance that with what

your

tax

rate

may be today and and so a couple things quickly to think about here with the text now bucket we want to gain some control over this because I think that's one of the areas that may be lacking with that a little bit here because if you have mutual funds as an example here they're going to just report those capital gains the interest payments and dividends and you're kind of at the mercy
of whatever that fund did so there's a couple st

rate

gies that we can do to maybe gain back a little bit more control over that one of those things is to look at investments that are going to be geared more towards a long-term capital gains approach you know so that basically you're gonna hold them more of a buy and hold and you're not going to have something that's going to be a little bit more actively managed and you could do that through for example an ETF which is an
exchange-traded fund there's a number of very good ones out there that do this and they tend to be very tax efficient one thing we want to avoid here with this is we want to avoid interest payments because interest payments in a taxable account is taxed at

your

ordinary income tax

rate

which is going to be

your

highest marginal tax

rate

so we want to try to minimize that as much as possible with the traditional bucket one of the big things we want to be very aware of is what the growth of
that account is going to be between now and the time that we're going to have to start taking those required minimum distributions at seventy and a half and of course the Roth bucket we're going to look at that and can we potentially shift money from one of these other two buckets over into that Roth bucket that's going to be a completely tax-free bucket and is not subject to those required minimum distributions so we're never forced to take that money out we can kind of do that
as we need to do maybe supplement some of those other sources of

retirement

income okay so now let's start to kind of map some of this stuff out what we want to do is we want to look at a couple of very key dates in

your

retirement

timeline so one of those key dates I've already put up here is the expiration of the tax cuts and Jobs Act which is it is set to expire at the end of 2025 so 2026 we go right back to those tax

rate

s that we had in 2017 you may be still working right now so
how to lower your tax rate in retirement
we're going to go over here and we're gonna say that this is the the point that you're at right now today and one of the very important elements to any tax plan is we want to know and understand what is

your

tax

rate

today as a percentage of

your

income or what that marginal tax bracket is and what is that tax bracket going to look like in the future and there's a couple of things that we need to understand of course understanding what that tax bracket is today relatively easy
things are you know probably have some income you've got some deductions and you're gonna pay some tax and so if you did

your

taxes already for this year you should be able to look right in that text form and figure out what that marginal tax

rate

is but in

retirement

we have a lot more parts and so one of those moving parts is going to be social security and we have some options you can collect Social Security as early as age 62 at a reduced amount you can collect Social Security

your

full

retirement

age which could be 66 or it could be 67 or somewhere in between probably for most of the people watching this video we're going to assume for purposes of this that it's age 67 and you can delay taking Social Security all the way to age 70 and you can get what are called delayed

retirement

credits and we've got some videos where I get into a lot more detail on that so of course

your

Social Security is going to be one aspect of that we're going to do a couple things
here we're going to assume that you're married and we're gonna assume that you have $5,000 a month of Social Security benefits at

your

full

retirement

age and so one of the things that's important to understand is is

your

Social Security benefit going to be taxable and there's a formula for that what they do is they're going to take half of

your

Social Security benefit and they're going to add in any other sources of income it could be a pension if you have a pension
benefit and if you have interest or dividends from stocks if you took money out of an IRA account will put hiya ray withdrawals on here basically pretty much all all forms of income are going to be part of this including tax-free municipal bond income - so that's something that normally you don't have to pay income on but it does go into that calculation to determine if

your

Social Security benefit is going to be taxable so I think this is very important for us to understand there may be
some people that could have a situation where their Social Security benefits are not going to be taxable but I think that's going to be very unlikely and the reason for that is because of this number that I wrote up here so in 1983 the last time there was major social security reform they decided that Social Security benefits were gonna for the first time ever become taxable and if

your

income was over 32,000 dollars half of

your

social security benefit was going to be taxed at

your

marginal
tax

rate

then in 1993 they stepped that up and they said if

your

income is over 44,000 again this is for a joint couple filing a joint tax return if it's over forty-four thousand dollars it's going to be where 85 percent of

your

Social Security benefit could be taxable and those numbers are exactly the same as they were back in 1983 and 1993 so in other words they're not indexed for inflation so if we take a situation here where some of these

retirement

benefit is is $5,000 and
that's going to be what's reported on their Social Security Statement we need to back that up and figure that Social Security does have some cost-of-living adjustments in there and that $5,000 might be considerably more than that but even if we said that is a $5,000 a month times 12 months that's $60,000 a year so to do that calculation we basically would say you know $30,000 is going to be part of the calculation to see if that's taxable and then you're going to add in
anything else and right there you're almost right at that $32,000 level so for most people we're going to just go ahead and assume that you're probably going to have at least some portion of

your

Social Security benefit taxed probably 85% of

your

social security benefit that's going to be is it be part of

your

tax calculation okay so the second big thing that we want to make sure that we're considering are what are those future IRA withdrawals going to do to our tax situation
and in particular what is our required minimum distribution because that's the mandatory withdrawals that we're required to take out after we reach age 70 and a half so kind of coming over here to our timeline here we're going to actually extend this just slightly further we say that's 70 and a half and that's where you're required minimum distributions are going to begin now we can do this using some very simple rules of thumb but what we want to do is kind of project
out what we think that IRA balance is going to be one really great rule of thumb that we use here all the time to just do a quick calculation on growth

rate

s is something called the rule of 72 and what that says essentially is that if you divide the interest

rate

that you're expecting to earn into the number 72 it'll tell you approximately how many years it'll take for something to double so oftentimes when we're talking about these calculations just to use something very soon
people if we said we're gonna earn a 7% average annual

rate

of return on our portfolio and we divide that into the number 72 it tells us we're gonna double our money every 10 years so as an example if you had let's say a million dollars in

your

tax deferred

retirement

accounts that traditional IRA bucket and you had 10 years then we would just simply say that 10 years from now we were going to have 2 million dollars and of course I'm oversimplifying here we don't know what
the actual

rate

s of return are

your

return could be higher it could be

lower

than that 7 percent and if you're still working then you're also going to need to take into consideration the calculations but what I want to do here is just kind of illust

rate

here left unchecked you know because a lot of times people continue to defer to taking those withdrawals from their

retirement

accounts until they absolutely are forced to do that and they maybe take money from other sources maybe even
how to lower your tax rate in retirement
take money from a Roth bucket just because they don't have to pay taxes on it and they continue to let this tax deferred bucket kind of build up there so according to the RMD tables here in the first year the divisor would be 27.4 and what that means essentially is if you go to those RMD tables if you divide 2 million dollars which is the projected value in this example of that IRA account and divided by 27.4 tells us that we're going to have to withdraw about seventy two thousand nine
hundred ninety four dollars I think I got that number correct it's pretty close from

your

just under seventy three thousand dollars from

your

retirement

account at that so then we're going through and we're adding up all of these different sources of income now we can start to look at that tax table and maybe get a pretty good idea of what that future tax

rate

is going to be but we of course have some pretty big gaps there so we have we have the income that we're earning right
now in a tax

rate

that you have today and then we have

your

Social Security and we're going to try in this example to get you to delay Social Security benefit as long as possible and there's a whole lot that goes into that and we're not necessarily saying that's the best st

rate

gy but for this example here to kind of hopefully bring down some of that taxable income a little bit we're going to try to take advantage this area in the middle which are what we sometimes refer to as
the low tax years before maybe you start taking those big withdrawals from the

retirement

accounts that are mandatory at our md time before social security kicks in is there an opportunity here to be maybe in a

lower

tax bracket okay so now let's are putting some hypothetical numbers to this situation here let's say that you're still working and let's say you're in a twenty four percent marginal federal tax bracket so under the tax cuts in Jobs Act that is roughly about two
hundred thirty seven thousand dollars of income all the way up to as much as three hundred fifteen thousand dollars of taxable income is going to keep you in that twenty four percent tax bracket so one of the things we really want to consider here as we're putting together these

retirement

plans is we want to understand of course what

your

retirement

gap is and how much money you're likely going to have to take out of those

retirement

accounts and what that taxable income is and what
that future tax

rate

is but right now again like I said earlier I think we've got a real opportunity here with these tax cuts and Jobs Act so let's just kind of roll forward past 2025 into 2026 as these tax cuts are set to sunset that same level of income two hundred thirty seven thousand dollars to three hundred fifteen thousand is no longer going to be taxed at a twenty four percent tax bracket it's going to be taxed at a thirty three percent tax bracket and I think that's a
huge difference obviously but that really kind of changes a lot of our common you know conceptions about what we should be doing with our

retirement

accounts and where we should be saving that money so one of the primary differentiators between saving money and a Roth account versus a traditional account is is my tax bracket in the future going to be higher or

lower

than it is today and if our tax bracket is going to be higher as we're kind of demonstrating in this hypothetical example then
it makes sense for us to pay taxes today at the twenty four percent tax

rate

and then get potentially tax-free income if we're putting it into a Roth when our tax bracket might be thirty three percent or higher and I like tight like I talked about in some of the other videos we can make some very very good arguments for why we think that tax

rate

s are more likely to go in the future then they are to go down despite even the tax cuts expiring in 2025 in fact actually if we go back just a
couple of decades ago there was believe it or not something we called the success tax but it was actually called an excise tax and it existed for about ten years I think it was repealed in 1997 with the Taxpayer Relief Act but what they had said essentially was that if you took out too large of a distribution from one of

your

retirement

accounts there was an additional 15% tax that was assessed on the withdrawal on top of whatever

your

ordinary taxes would have been on that so very very high tax

rate

s existed in the past and quite honestly if you look at the budget deficit you look at how many people are going onto Social Security and Medicare and what's basically going on you know the chances of tax

rate

s going up I think is a very real possibility here ok so the first tool that we talked about is where to save money for

retirement

now we want to talk about then once you've retired where do you start to withdraw money from and I think this is very important again to understand
what that tax

rate

is in

retirement

but remember we have these three buckets here we've got

your

tax now bucket the non

retirement

we've got the traditional bucket and we've got the Roth bucket so in an ideal situation for most people we probably want to have that Roth bucket be the last money that you ever spend because again any money that this traditional bucket grows to that's just give me more taxes that you're going to have to pay down the road every year you're
going to get that tax bill that is 1099 statements and it's going to be money that you're gonna have to pay from the text now a bucket but there is one thing that I want to mention here from this taxable bucket is that if you have long term capital gains you can actually take out up to seventy seven thousand dollars seventy seven thousand two hundred one dollars and have that be taxed at a zero percent tax

rate

okay that's if

your

total income that's not just capital gains so
depending on how much money you have in that taxable bucket that could be one very good way to kind of fund some of that early

retirement

years especially if you're retiring maybe prior to age fifty nine and a half when you can start to take normal distributions from

your

retirement

accounts but the other thing that I really want to talk about here as it pertains to

retirement

is is what I call low tax years and so there's going to be a period of time for most people from that date of

retirement

maybe retire early at you know 58 even sixty years old remember you're not even eligible to start taking Social Security benefits to age 62 but I'm not going to get into the details but if you take Social Security benefits at 62 they're gonna be at a significantly reduced amount and you're gonna lose a lot of lifetime benefits so for most people if you're healthy we'd like to see people delay that Social Security benefit to at least

your

full

retirement

age if
not all the way out to age 70 where you're getting those maximum delayed

retirement

credits but the other thing that delaying Social Security can do is it can keep you in a

lower

tax bracket longer so if you look at especially if you're retiring while we're still under these tax cuts and Jobs Act you can have up for example up to a hundred and sixty-five thousand dollars and still be at a twenty two percent tax bracket that same amount of income once those tax

rate

s expire is going
to jump up to twenty eight percent so we want to kind of find the sweet spot here of how much money you can take out of the

retirement

accounts and not necessarily just focus on what those tax

rate

s are today but we want to create a balance and and maybe keep that tax

rate

is even as possible over time but at the lowest possible amount does it make sense to save a whole bunch of taxes here today just to have a big huge tax bill in the future and it doesn't make sense like some people may
advocate to try to get this number down as much as possible but it means we're paying all that tax on the front end there's there's got to be kind of a happy medium here so two last tools that I want to talk about here in creating the st

rate

gy so we just talked about where to take money out we talked about the Social Security and maybe delaying that as another potential st

rate

gy to minimize those taxes over

your

lifetime the next I want to talk about our Roth conversion so if you
find

your

self that you're in a bracket where you still have some room before you maybe go up to that next bracket and it makes sense to do so what you could do is shift some money from that traditional bucket over to the Roth bucket and that's going to do two things number one hopefully it's going to mean that you're paying less tax at the

lower

tax

rate

s today versus what that potential tax

rate

might be out in the future but you're also eliminating the required minimum
distributions because remember the RM DS only apply to traditional accounts not to Roth accounts and then the last tool that I want to mention here kind of along the same lines as this is thinking about not only what is

your

tax

rate

today versus

your

tax

rate

in the future but as you get on later in life thinking about maybe who likely is going to be inheriting this money if

your

kids are going to be inheriting it or

your

grandkids and what are their tax brackets compared to what

your

tax
bracket is so if

your

kids are in a

lower

tax bracket than you are then it might be you know make more sense to keep that money in a traditional account you know because they'll be taking that money out in retired distributions at a

lower

tax

rate

than what you're paying on it if they're in a higher tax bracket then it might make sense to try to get as much money over into a Roth and of course you can also do some gifting while you're still alive so you can gift money to

your

any
number of people that you want to I think the limit here for 2019 is maybe about fourteen or fifteen thousand dollars a year I need to double check that we'll put it up on the screen and and you can gift that to as many people as you want and that's a way for you to reduce that estate and maybe you know see some value with

your

kids or grandkids that being able to enjoy that money while you're alive so anyway I hope that all makes sense we're gonna throw a lot of detail here but
creating a tax st

rate

gy for

retirement

s probably one of the most important things that you can do I think there's a lot of opportunities here especially like we've been talking about with the tax cuts in Jobs Act that's only gonna be around for so long and anyway I hope you got some great value out of this don't forget to hit that like or subscribe button if you think there's some value here hit the share button as well too if there's other people there within

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social networks that you think might be able to benefit from the information here hit the share button we'd love to get the word out there to as many people as possible and with that I'll see you back in one of my next videos have a great day you