Tax and Retirement Planning Guide

By Jake T. Erlendson on July 1, 2021

Retirement tax planning is a process that is just as important as your investment management strategy. Whether you’re in your pre-retirement years or have already left the full-time workforce, your tax strategy involves a range of complex decisions. Once you reach retirement, you need to evaluate decisions for claiming Social Security funds, a pension, and your retirement accounts. Tax retirement planning directly impacts your future cash flow.

It’s smart to navigate these decisions early on so that you can focus on the exciting aspects of retirement while minimizing the stress and anxiety that sometimes come with it. Working with a knowledgeable financial advisor helps you navigate both the financial and emotional aspects of retirement. You’ll then be well-prepared to accomplish your retirement goals while avoiding tax pitfalls and other potential mistakes.

Planning for Taxes in Retirement

Before you reach retirement age, consider both the financial and emotional aspects of planning the years to come. It’s important to maximize the potential that your executive compensation could have on your financial future. Here are things to think about which could influence the decision-making process and potentially carry tax implications.

Financial Considerations

In the years leading up to retirement, it’s important to create a plan for financial readiness. Your financial advisor can help you figure out how much money you need to retire and how to create your retirement saving strategy. There are always trade-offs to consider, including work-life balance and how to prioritize investing versus paying off debt.

A financial advisor can help you weigh the pros and cons of these decisions, both in the near-term and long-term. For instance, you might consider whether or not to pay off your mortgage before you retire. Or maybe you’re thinking about retiring early. Not only do you need to think about your income, you may also need to consider the cost of private insurance as you won’t be eligible for Medicare if you retire before the age of 65. These factors are all part of your holistic financial planning strategy.

Finally, your advisor will stress test your financial plan so that you’re prepared for a diverse range of scenarios, both good and bad. Whether the market takes a turn, new policies are established (like California Proposition 19), or life throws you a personal curveball, your comprehensive retirement plan should be ready.

Emotional Considerations

A successful retirement and tax strategy also involves some emotional preparation. At D&Y, we don’t just talk numbers — we also help you craft a vision for what your ideal retirement life looks like. It’s important to define how you plan to spend your time and engage with others when you’re no longer working. It’s common to develop your identity and social network through your career. Once that is over, it’s vital to shift your focus and purpose in other areas that give your life meaning.

There are many ways to approach the emotional changes ahead. Some retirees choose to wind down their careers over-time by continuing to work part-time in the early years of retirement. Alternatively, others focus on quickly replacing work-centric habits and routines with new ones. It’s an ideal time to focus on health, hobbies, and other areas you’re passionate about but may not have had the time to fully explore.

Financial Tax Planning Strategies for Retirees

With a smart overall retirement plan in place, it’s time to figure out how taxes will affect your finances. Learn how to pivot from receiving steady paychecks to withdraw tax-efficiently from your investments, plus identifying and taking advantage of tax planning opportunities.

Cash Flow and Tax Rates

One of the biggest changes that comes with retirement is managing your cash flow and retirement income in a way that is most advantageous to your tax rate and tax bracket. As a retiree, you’ll no longer receive a regular paycheck. Instead, you’ll make withdrawals from your investment accounts to supplement any income from Social Security and/or pension.

In addition to managing your own cash flow, also prepare to potentially have less taxable income and relatively lower tax rates than what you were accustomed to while working. Your financial advisor can help you identify the best strategy for generating the cash flow you need in retirement in a way that is most advantageous for your taxes.

For instance, after-tax accounts like trust or brokerage accounts can be managed tax efficiently to take advantage of favorable tax rates applicable to qualified dividends and long-term realized capital gains or benefit from tax-loss harvesting opportunities during market declines. You may also be able to manage realized capital gains, so they are taxed at 0% federal rates.

Tax-deferred accounts (such as IRAs and 401(k)s) are taxed at ordinary income tax rates when money is withdrawn.  If you are starting retirement in a relatively low tax bracket you may consider strategies to draw money from these accounts to take advantage of your lower marginal tax rates or create an annual strategy for Roth conversions.

Retirement Income Decisions

Other elements of retirement tax planning include prioritizing when and how to elect receiving social security or pension benefits and how to plan for and manage IRA Required Minimum Distributions (RMDs).

You can start receiving Social Security benefits as early as age 62, however you’ll get the largest benefit amount if you defer as late as 70 years old. Work with your financial advisor to weigh the pros and cons of waiting.

If you have a pension, you’ll need to decide whether or not to elect annual payments or a lump sum rollover — both obviously have very different tax implications. You also must consider the need for survivor benefits.

Once you turn 72, you must start taking RMDs from any traditional IRA you have. Your advisor can help you navigate potential solutions to manage and minimize your taxes associated with RMDs, such as utilizing Qualified Charitable Distributions (QCDs) or developing a Roth IRA conversion strategy prior to turning 72. These are complex strategies that require consideration for many, which is why it’s so important to have a trusted advisor to work with.

Emotional Tax Planning Strategies for Retirees

Planning your retirement tax strategy can be an emotional process. Here’s how to shift your mindset to focus on the things you can control and how to navigate through any obstacles that you can’t control.

Withdrawing Portfolio Funds

Transitioning from a regular paycheck to withdrawing funds from your investments can be a psychological adjustment. This is especially true if you’ve made prudent financial decisions and diligently contributed to your portfolio over the years. It can require a major shift in your mindset to become comfortable withdrawing investment funds.

On the flip side, if you haven’t created and committed to a retirement spending plan, you run the risk of diminishing your assets too quickly. Without the proper guidance, a retiree may overspend their financial resources early in retirement resulting in difficult adjustments down the road.

In either situation, it’s critical to take a balanced approach to your spending in retirement. It’s equally important to know how much is the right amount to live your dreams in retirement without jeopardizing your financial security in the years ahead.

Managing Stock Market Fluctuations

Another component of retirement tax planning is handling the financial ups and downs of living on investment returns. You might have control over when you retire, but you don’t have control over how the stock market performs. Your financial advisor can help you prepare for market fluctuations during retirement.

For example, what happens if the market declines right before or after you retire? You need to remove your fear and emotions from the situation and make objective decisions with your investments. Obviously, this is easier said than done, which is why it’s helpful to have a financial advisor to advise you in these situations. They can guide you to make rational decisions and determine if a course correction is really warranted or if you can stay on your current path to retirement.

The Bottom Line

You can’t plan for retirement without planning for taxes. Work with your tax professional as well as an experienced financial advisor who not only helps you manage your investments, but helps you create a smart tax strategy as well. Remember, not all of your accounts are created equally. There is a complex web of decisions to be made in order to manage and minimize taxes in retirement.

You’ve worked hard to accumulate your assets — ready to protect them throughout retirement? Contact Dowling & Yahnke Wealth Advisors today and get started on a comprehensive financial plan.


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