\u201cIt\u2019s not how much you make, but how much you keep\u201d.<\/em><\/p>\n This fairly well-known quote gets at the heart of financial planning and investment management. It\u2019s one thing to earn a nice income, to live within your means, and to save diligently. But it\u2019s equally important to understand how taxes work, so that you maximize your after-tax return. In other words, be tax savvy. Tax-smart investing is key to preserving wealth in retirement.<\/p>\n The first step in minimizing the amount of tax you\u2019ll pay is understanding how tax brackets work<\/strong><\/a>, what tax bracket you\u2019re in, and what the transition amounts are for each bracket based on your filing status.<\/p>\n One common misunderstanding is that when your income reaches a higher tax bracket, all of your income is taxed at that higher rate. However, that\u2019s not the case. If your income rises from one bracket to another, only the income over the transition level is taxed at the higher rate.<\/p>\n To keep your taxes low, you\u2019ll want to keep your taxable income in lower tax brackets as much as possible.<\/p>\n One of the smartest things you can do when you\u2019re retired is meet with your CPA, accountant or financial advisor to review your financial situation each year and determine the most efficient way to generate the income you\u2019ll need. Typically, you\u2019d do this in the fall for the coming calendar year. The objective is to minimize the taxes you pay each year, but also over your entire retirement horizon.<\/p>\n Let\u2019s look at an example: You\u2019ve retired, and just turned 71. You and your advisor conclude that you\u2019ll need an additional $75,000 in addition to the $35,000 in Social Security benefits you\u2019re receiving. Since you\u2019re not yet 72, you\u2019re not required to take a minimum required distribution, known as an \u201cRMD\u201d, this year. Nevertheless, you may want to do so. Why? Because the dollars you withdraw may be taxed at a lower rate than they would if you waited and had to take more out next year, when an RMD is required.<\/p>\n You may also want to take some of the additional $75,000 from a taxable account, because if doing so generates capital gains, in most cases these gains will be taxed at 0% or 15%, which is less than the ordinary income tax rates on IRA distributions.<\/p>\n Hopefully you now see that the overarching theme behind income distribution planning is to carefully consider the tax rates related to the distributions you\u2019ll take each year in retirement. The strategy is to \u201cfill up\u201d the lower tax brackets and avoid the higher ones.<\/p>\n Asset location<\/strong><\/a> is a strategy designed to exploit the fact that different types of investments receive different tax treatment. To work, the strategy requires that you have both taxable and tax-deferred accounts.<\/p>\n The tax treatment of an investment should determine in which type of account you hold it. Under the current tax code, qualified dividends and capital gains receive preferential treatment. Interest income \u2013 received on bonds or cash holdings \u2013 is taxed as ordinary income, while qualified dividends and capital gains are taxed at lower rates.<\/p>\n Investments in stocks (either individual stocks, mutual funds, or exchange-traded funds) generate returns from both dividends and capital gains. If you hold these investments in your taxable account, this return will be taxed at favorable rates. But, if you instead held them in your tax-deferred IRA, 401(k), etc, the dividends and capital gains would be taxed as ordinary income when you withdraw them from the account.<\/p>\n Similarly, investments like bonds and real estate investment trusts (REITs) produce a regular distribution. These distributions are taxable as ordinary income if you own them in your taxable account (albeit that REITs receive slightly preferential treatment<\/strong><\/a>, due to Section 199a of the tax code). But, if you hold them in your tax-deferred retirement account, you can shelter the income from tax until you take distributions from the account.<\/p>\n If you\u2019re consistently in a high income tax bracket, and you can\u2019t avoid owning some of your bond investments in a taxable account, you may want to explore using municipal bonds. So-called muni bonds are issued by local governments or one of their agencies. Interest paid by the issuer to bond holders is often exempt from federal income tax, as well as state or local taxes depending on the state in which the issuer is located. While the interest rate paid on muni bonds is typically lower than that on taxable bonds, the fact that the interest is tax-exempt can mean that your after-tax return can be higher.<\/p>\n If you own investments in a taxable account, like a brokerage account, you\u2019re probably familiar with the concept of gains and losses. If the price of your investment goes up, and the value is higher than what you paid for it, you have an unrealized gain. Conversely, if the price goes down, and the value is less than what you paid, you have an unrealized loss. Those unrealized gains and losses only become \u201crealized\u201d when you sell the investment.<\/p>\n It may seem counter-intuitive to intentionally realize capital gains in your brokerage account, but there are times when doing so makes sense. Remember that capital gains tax brackets are progressive, so if you need to sell a certain investment \u2013 maybe as part of a rebalancing exercise, or to raise cash for a particular need \u2013 it may make sense to realize smaller amounts of gain over a few years, rather than a single, large amount in one year.<\/p>\n If you need to sell an investment that has an unrealized gain, you may want to do so in a year when your income is relatively low. This could be because you have investment losses than can offset the gain, because you\u2019ve retired but not yet started receiving Social Security, or because your pension or deferred compensation payments haven\u2019t started yet.<\/p>\n What about intentionally realizing a capital loss \u2013 selling something that\u2019s worth less than what you paid for it? Well, under the current tax law you\u2019re allowed to offset capital losses against capital gains. So, if you have a particular investment in your taxable account that hasn\u2019t performed well, you can sell it and realize the loss. That loss can be used to offset any capital gains you may realize, either in the same year or in the future \u2013 capital losses can be carried forward. Remember, though, that if you\u2019re using a prudent investment strategy<\/strong><\/a>, you\u2019ll want to replace the investment you sold with something in the same asset class \u2013 similar, but not identical \u2013 so that you don\u2019t run afoul of the IRS\u2019s wash sale rules<\/strong><\/a>.<\/p>\n If you\u2019re charitably inclined, a Qualified Charitable Distribution (or \u201cQCD\u201d) may be a great strategy for you, particularly because it helps in preserving wealth in retirement.<\/p>\n The tax reform package passed into law at the end of 2017 reduced or eliminated many tax deductions and credits, while also increasing the standard deduction. As a result, many more taxpayers no longer itemize their deductions, including the deduction for charitable gifts. <\/p>\n A QCD allows people who own an IRA and are at least 70 \u00bd years old to directly transfer up to $100,000 each year from their IRA to a charity, tax-free.<\/p>\n A QCD is attractive because it allows the donation from your IRA to be excluded from your taxable income. This is much more attractive than taking a large, taxable distribution from the IRA and then making a charitable donation with the remaining funds.<\/p>\n QCDs also lower the balance in your IRA, making future RMDs smaller.<\/p>\n Hopefully you\u2019ve learned from reading this that minimizing the taxes you pay is a key to preserving wealth in retirement.<\/p>\n The tax code is complex, and tax planning can be complicated. If you\u2019re unsure whether you\u2019re making the right decisions, or you\u2019d like to work with someone who can help you decide which strategies make the most sense for you, consider working with a financial advisor. The right advisor will work with you and your accountant or CPA to plan out a strategy for today, and for the future.<\/p>\n","protected":false},"excerpt":{"rendered":" Introduction \u201cIt\u2019s not how much you make, but how much you keep\u201d. This fairly well-known quote gets at the heart of financial planning and investment management. It\u2019s one thing to earn a nice income, to live within your means, and to save diligently. But it\u2019s equally important to understand how taxes work, so that you […]<\/p>\n","protected":false},"author":2,"featured_media":5186,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","_mi_skip_tracking":false,"footnotes":""},"categories":[3,5,152,10,11],"tags":[21,66,86,117,118,132,136,140],"aioseo_notices":[],"_links":{"self":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/5181"}],"collection":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/comments?post=5181"}],"version-history":[{"count":0,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/5181\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media\/5186"}],"wp:attachment":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media?parent=5181"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/categories?post=5181"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/tags?post=5181"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}Know Your Tax Bracket<\/h2>\n
Understand Income Distribution Planning<\/h2>\n
Be Smart About Asset Location<\/h2>\n
Consider Municipal Bonds for Your Taxable Account<\/h2>\n
Know When to Harvest Gains and Losses<\/h2>\n
Qualified Charitable Distributions<\/h2>\n
Work with an Experienced Professional<\/h2>\n