Navigating Taxes in Retirement: Reducing Tax Burden for Switching from Tax Deferred to Tax Free

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 tax losses that can help offset all forms of income, as well as the potential for cash flow back to the investor once the wells are operational.

Mentioned in this episode:

BrianSkrobonja.com

SkrobonjaFinancial.com

Common Sense Financial Podcast on YouTube 

Common Sense Financial Podcast on Spotify

Brian's article - From Tax-Deferred to Tax-Free: Navigating Taxes in Retirement

References for this episode:

https://www.usdebtclock.org/

https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024

https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024

https://www.ssa.gov/benefits/retirement/planner/taxes.html

https://www.ssa.gov/benefits/medicare/medicare-premiums.html#anchor5

https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions

https://www.irs.gov/charities-non-profits/charitable-remainder-trusts

https://www.irs.gov/newsroom/qualified-charitable-distributions-allow-eligible-ira-owners-up-to-100000-in-tax-free-gifts-to-charity

https://www.investopedia.com/terms/i/intangible-drilling-costs.asp

https://www.crfb.org/blogs/tax-break-down-intangible-drilling-costs

Securities offered only by duly registered individuals through Madison Avenue Securities, LLC. (MAS), Member FINRA &SIPC. Advisory services offered only by duly registered individuals through Skrobonja Wealth Management (SWM), a registered investment advisor. Tax services offered only through Skrobonja Tax Consulting. MAS does not offer Build Banking or tax advice. Skrobonja Financial Group, LLC, Skrobonja Wealth Management, LLC, Skrobonja Insurance Services, LLC, Skrobonja Tax Consulting, and Build Banking are not affiliated with MAS.

Skrobonja Wealth Management, LLC is a registered investment adviser. Advisory services are only offered to clients or prospective clients where Skrobonja Wealth Management, LLC and its representatives are properly licensed or exempt from licensure.

The firm is a registered investment adviser with the state of Missouri, and may only transact business with residents of those states, or residents of other states where otherwise legally permitted subject to exemption or exclusion from registration requirements. Registration with the United States Securities and Exchange Commission or any state securities authority does not imply a certain level of skill or training.

Investing involves risk, including the potential loss of principal. This is intended for informational purposes only. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation.

A ROTH Conversion is a taxable event. Consult your tax advisor regarding your situation.

Investments in securities are subject to investment risk, including possible loss of principal. Prices of securities may fluctuate from time to time and may even become valueless. Gas and oil investments are speculative in nature and are sold by Private Placement Memorandum (PPM). Carefully read the PPM before investing. Certain accreditation requirements may apply.

Donor Advised Funds represent an irrevocable gift of assets from the donor to the fund. Contributions made to the fund are irrevocable and cannot be returned or used for any other individual or used for any purpose other than grant making to charities. The gift is not an investment or a security. When evaluating a contribution to the fund, carefully consider the terms and conditions, limitations, charges, and expenses. Depending on the tax filing status, DAF contributions may or may not be tax deductible.