Ken Eshelman//April 26, 2023
Ken Eshelman//April 26, 2023
As retirement approaches, it can be so refreshing to think of days without the same level of responsibility, setting your own schedule, and embracing new hobbies with your time. Even if the change feels a little uncomfortable, it is still a freedom you look forward to.
But one way change such as retirement can feel overwhelming is understanding how your cash flow will work. You won’t be receiving a paycheck at regular intervals to cover your living expenses. You know you have been saving for retirement for years. But how will the cash flow work?
For those who are nearing their retirement years in the business world and even those of us who might be helping friends or loved ones with these steps, there are two things to know:
It’s important to consider the most tax-efficient distribution of the assets you’ve accumulated over your lifetime to maximize the value of retirement savings and minimize tax liabilities. This involves careful consideration of various factors such as Social Security benefits, income tax rates, taxable versus tax-deferred accounts, tax-loss harvesting and Medicare premium payments. As a business leader, of course you know the importance of considering all impacting factors before making decisions and working with those who have the knowledge and expertise to help guide you. Some of the factors that affect your income in retirement and how you’re minimizing taxes are included below.
Setting up Cash Flow
The first question that comes to mind is: How do I get access to my retirement income?
In almost all cases, it’s directly deposited into your bank checking account. For Social Security and/or pension income, the funds are directly deposited monthly into a checking account. To access the funds from taxable or retirement brokerage accounts, many options exist. Often, retirees elect to have a set amount directly deposited into their checking account monthly. If the money is coming from a deferred retirement account, the account custodian can withhold Federal income taxes, if desired. For those retirees that don’t need monthly, systematic deposits from their brokerage accounts, they can elect to have ad hoc transfers to their checking account when needed.
Social Security Timing
One approach to consider is delaying Social Security benefits. While it’s possible to start receiving Social Security benefits as early as age 62, delaying benefits until age 70 can result in a higher benefit amount. For every year someone waits after their Full Retirement Age (FRA) for Social Security benefits, they will garner an 8% increase per year. Since the Social Security Administration no longer sends out paper statements on annual basis, you can retrieve yours by registering on their website at https://www.ssa.gov/myaccount/. It’s fairly straightforward. Delaying the receipt of Social Security benefits can provide a larger income stream in retirement and may also reduce taxable income.
Another important factor to consider is income tax rates. By withdrawing funds from tax-deferred accounts such as traditional IRAs and 401(k)s, retirees may be subject to higher tax rates due to the mandatory distributions that start at age 73. To minimize tax liabilities, it may be beneficial to withdraw funds from taxable accounts such as Roth IRAs and brokerage accounts, which are subject to lower tax rates.
Required Minimum Distributions
It’s important to note here that the age when one must take Required Minimum Distributions (RMD) from their IRA has increased over the past few years. The SECURE Act of 2019 changed the age at which RMDs begin from 70½ to 72. Secure Act 2.0, passed in December 2022, increases the age at which RMDs begin to age 73 for those individuals who turn 72 on or after January 1, 2023. Notably, an individual who attains age 72 in 2023 is not required to take an RMD for 2023.
In addition to considering withdrawal strategies, it’s important to understand how Medicare premiums are calculated. Medicare premiums are based on modified adjusted gross income (MAGI), which includes income from sources such as pensions, IRAs, and Social Security. Retirees may be subject to higher Medicare premiums if their MAGI exceeds certain thresholds. To minimize Medicare premium payments, it may be beneficial to withdraw funds from taxable accounts that do not count towards MAGI.
Another important tax-efficient strategy to consider is tax-loss harvesting. This involves selling investments that have decreased in value to offset gains from other investments. By doing so, retirees can reduce their tax liability and potentially increase the value of their retirement savings. Most recently, this has been an invaluable strategy when the market precipitously declined at the onset of COVID-19 in March-April 2020 as well as throughout 2022. Research has shown that, when effectively employed, tax-loss harvesting can increase portfolio returns by 1% per annum. It may not sound like a lot, but when compounded over many years the amount starts to add up exponentially.
Rebalancing and Reviewing
Finally, it’s important to regularly review and adjust retirement asset allocations to ensure they remain aligned with changing tax laws and circumstances. This can involve working with a financial advisor to consider new investment opportunities and adjust withdrawal strategies to minimize tax liabilities.
The most tax-efficient distribution of assets in retirement involves careful consideration of individual circumstances and goals. By delaying Social Security benefits, withdrawing funds from taxable accounts, minimizing Medicare premiums, using tax-loss harvesting, and regularly reviewing and adjusting retirement asset allocations, retirees can maximize the value of their assets and attempt to achieve financial security in retirement while minimizing tax liabilities.
Ken Eshleman, CFP®, is a Partner and Senior Wealth Advisor with Domani Wealth. He creates tailored financial plans for each client, helping them navigate both pre and post-retirement years.