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Unknown Tax Liability on Your Retirement Accounts

Unknown Tax Liability on Your Retirement Accounts

By J. Scott Fain

July, 2018

You’ve worked most of your life to accumulate assets in various forms, likely to some extent in Individual Retirement Accounts (IRA’s). The government has allowed you to defer income into these accounts and to delay paying taxes on them until a later date…the date the funds are withdrawn to fund your retirement or beginning at age 70½ when your required minimum distributions (RMDs) begin.

The upside is you have been able to use those tax dollars to generate growth for yourself and to defer the withdrawals and payment of taxes until you are potentially in a lower tax bracket. On the other hand, this creates some unknowns: what tax rates will be at the time of the withdrawals and what your tax bracket will be…so essentially there is an unknown tax liability on your account.

Some clients have substantial assets and may never need to access the funds other than as directed for RMDs. Other clients rely on these funds for retirement and often do not realize ahead of time the impact of having to withdraw not only the amount of funds they need for living expenses, but also the funds to pay the taxes on those withdrawals.

Further, clients often do not consider that the tax burden on their retirement accounts follows the accounts to the beneficiary and will be paid at the respective beneficiary’s tax bracket and rate.

What are some planning opportunities regarding these taxes on your retirement accounts?

Roth Conversions – Many times parents are in a lower tax bracket during retirement than that of their children.  Further, Georgia provides a Retirement Income Exclusion for taxpayers beginning at age 62, so Georgia retirees often do not pay state income taxes.  Parents with excess assets should consider Roth conversions to allow for payment of taxes now at their tax rates and to provide their children with Roth IRAs growing tax free.

Qualified Charitable Distributions (QCDs) – Many people write checks directly to charities, not knowing there are more efficient methods available.  One of these methods is through Qualified Charitable Distributions (QCDs).  QCDs allow you to make distributions from your IRA(s) directly to your charity of choice, never having to report the funds as taxable income to you.  In many cases, this provides a greater benefit to you than writing a check for a donation directly to the charity and then taking a deduction on your taxes.  By not counting the IRA distribution as income, you may reduce the amount of your Social Security benefits that are taxable, and you may reduce your Medicare premium, as both of these amounts are based on your amount of income.  As a bonus, QCDs count towards satisfying your Required Minimum Distributions (RMDs) which begin at age 70½.

You must have attained age 70½ to be eligible, and QCDs are limited to $100,000 per taxpayer, per year. The distributions can be done on demand or may be setup as recurring on a monthly or quarterly basis.  The distributions generally come in the form of a check made payable to the charity and are mailed to the client’s home address.  It is very important to coordinate with your advisor and your tax preparer to make sure these distributions are reported correctly.

Life Insurance – Another way to address taxes on retirement accounts is through life insurance.  Utilizing a permanent life insurance policy, such as Guaranteed Universal Life (GUL), on the individual or on a joint-life basis allows one to leverage a portion of his or her assets to provide a death benefit to pay the taxes on the account.  It is important to note that the death benefit comes in tax-free.  By utilizing a GUL policy, which is designed to provide the largest death benefit for the lowest premium, on a guaranteed basis, we can forecast the internal rate of return on the policy for a given date of death – i.e. the rate that you would have had to earn on the invested premium dollars to end with the amount of the death benefit on that date.  Assuming good health and insurability, these are generally favorable rates of return. (See also my article on Life Insurance as an Asset Class).  This option can be a good utilization of excess funds from RMDs as well.

Estate Planning – A simple, yet often overlooked, planning opportunity involves charitable bequests.  When selecting assets to leave to various individuals or charities, consider leaving your retirement accounts to charities and other assets to your children or other individuals.  Again, the tax burden on the retirement accounts follows them – whether to your children or to other beneficiaries.  Most other assets will receive a step-up in basis at your death to fair market value, thus they will have no tax burden.  Since non-profit 501(c)(3) organizations do not pay taxes, it is more efficient to leave them your IRAs and to leave your children your investment accounts, real estate, life insurance, etc.  Remember: Beneficiary designations supersede your Last Will & Testament.  Be sure to review your beneficiary designations on your IRAs, life insurance policies, and 401k accounts, and to review any Transfer on Death (TOD) designations, etc. in context of your desired estate plan.

Utilize the Roth Option – As an alternative to deferring taxes into retirement, the Roth IRA allows individuals to contribute funds into the Roth IRA account on an after-tax basis, meaning that you pay the taxes on the income now at your current tax bracket and rate and then defer use of the funds until retirement (after 59½ ).  Under this option, the funds grow tax free going forward until withdrawn.  If necessary, you can withdraw your contributions (not the growth) prior to age 59½ without penalty.  Many 401k plans now offer a Roth option for deferrals.

In summary, there are several planning opportunities that exist and should be considered regarding your retirement accounts and the unknown amount of taxes that will be due and payable by someone at some time.  Contact CapSouth for more information on these concepts and how they might apply to your particular situation.

800-929-1001

CapSouthWM.com

***This article is not intended as specific advice or recommendation. All decisions should be reviewed and considered in the context of your individual situation.  Please contact us for more information on how this information may be utilized under your circumstances.  CapSouth Partners, Inc., dba CapSouth Wealth Management, is an independent Registered Investment Advisor.  CapSouth does not provide tax or legal advice.  Please consult your tax or legal advisor before making decisions that may have tax or legal consequences.***

 

How Should you Prepare for Military Retirement?

Around 1.3 million people serve in the U.S. military; more than 800,000 are part of the reserves.[i] More than 2 million Americans are considered military retirees.[ii]

Upon retirement, many military retirees will receive 50% of their final salary for the rest of their lives, and the system allows various service members to retire around the age of 40. The U.S. military’s pension system is considered one of the most generous in the nation.[iii]

In its 2015 fiscal year, the U.S. military paid veterans $57 billion in pension benefits, which is nearly 10% of the service’s annual budget.[iv] Even though military pensions are generous, meeting the requirements to qualify for benefits can be challenging. Only 17% of service members stay long enough to qualify for retirement benefits.[v]

Service members are eligible for pensions after serving active duty in the U.S. Army, Navy, Air Force, or Marine Corps for at least 20 years. They may also qualify for pension benefits if they retire for medical reasons from the service.[vi]

While the commitment to the military’s mission, the service’s professional training, and the more regimented workplaces may differ from the civilian world, everyday life is similar.

Service members sleep in regular beds, shop at the same stores, and conduct business at the same banks (or credit unions) as civilian workers. However, the transition to civilian life can be trying.

If you or someone you know expects to retire soon from the military, read these four financial tips to prepare for the transition.

Look at your budget.

Life in the military provides a level of financial stability. If you lived on base, you may have taken some expenses, such as for clothing, health care, and housing, for granted.

While pension checks may fill some of the void, you still have to monitor expenses you may have ignored while in the service. Car payments, rent or mortgage payments, and clothing costs may place an unanticipated burden on your budget.

Veterans are also eligible to receive savings and discounts on services, but few take advantage of the opportunities. Using some of the veterans’ discounts can save you money and put more cushion in your budget. Go to https://militarybenefits.info/military-discounts/ to learn more.

What about taxes?

You paid taxes on your military income while you were in the service, and your pension payments are also taxable as income on the federal level.[vii] States have their own taxation rules; some don’t tax pension benefits while others do. The tendency for many retirees is to move to a state that doesn’t tax military pensions, which might be a mistake, analysts warn.[viii]

You should consider other factors, such as cost of living and other taxes and fees, before making your decision. By doing the math you can find a place to live (and work) to fit your needs and budget during your retirement.

Filling the life insurance gap.

Once you leave active duty, you and your family members lose the Servicemembers’ Group Life Insurance (SGLI).[ix] You have one year and 120 days to apply for Veterans’ Group Life Insurance (VGLI), which doesn’t require medical exams. However, if you apply after 240 days, you’ll be required to respond to health questions and may be subject to a medical examination. Your maximum coverage equals the SGLI coverage amount you had during your service. You may apply for lower amounts in $10,000 increments. You may also increase your coverage by $25,000 every five years to a maximum of $400,000, until age 60.[x]

Learn about retirement benefits.

While the military’s pension benefit is an attractive incentive, service members should learn the specific retirement plan that’s available to them. Eligibility depends on your enlistment date.

Service members who entered the military:

  • Before September 8, 1980 are eligible for the military’s Final Pay retirement system.
  • Between September 9, 1980 and July 31, 1986 may receive the High 36 system.
  • Between August 1, 1986 and December 31, 2017 are eligible for the REDUX system.[xi]

To learn more about developing a financial strategy to suit your retirement needs, contact us at 800.929.1001.

Investment advisory services are offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information.  This material has been prepared for planning purposes only and is not intended as specific tax or legal advice.  Tax and legal laws are often complex and frequently change.  Please consult your tax or legal advisor to discuss your specific situation before making any decisions that may have tax or legal consequences.

This article contains external links to third party content (content hosted on sites unaffiliated with CapSouth Partners). The policies and procedures governing these third-party sites may differ from those effective on the CapSouth company website, as outlined in these Disclaimers. As such, CapSouth makes no representations whatsoever regarding any third-party content/sites that may be accessible directly or indirectly from the CapSouth website. Linking to these third-party sites in no way implies an endorsement or affiliation of any kind between CapSouth and any third party, including legal authorization to use any trademark, trade name, logo, or copyrighted materials belonging to either entity.

[i] http://www.governing.com/gov-data/military-civilian-active-duty-employee-workforce-numbers-by-state.html

 

[ii] https://www.statista.com/statistics/217354/forecast-number-of-military-retirees-in-the-us/

 

[iii] https://qz.com/929153/only-one-in-five-people-take-up-this-incredibly-generous-pension-to-retire-at-40/

 

[iv]https://comptroller.defense.gov/Portals/45/documents/cfs/fy2015/13_Military_Retirement_Fund/2015_MRF_AFR_Final_20151110.pdf

 

[v] https://qz.com/929153/only-one-in-five-people-take-up-this-incredibly-generous-pension-to-retire-at-40/

 

[vi] https://www.dfas.mil/retiredmilitary/plan/eligibility.html

 

[vii] https://www.military.com/money/personal-finance/taxes/taxes-on-military-disability-and-retirement.html

 

[viii] https://www.kiplinger.com/article/saving/T065-C000-S003-smart-money-moves-if-you-are-leaving-the-military.html

 

[ix] https://www.benefits.va.gov/insurance/sgli.asp

 

[x] https://www.benefits.va.gov/insurance/vgli.asp

 

[xi] http://www.military.com/benefits/military-pay/the-military-retirement-system.html

Two Ways to Trim Your Spending in Retirement

Two Ways to Trim Your Spending in Retirement

Saving money before and during retirement so their standard of living doesn’t suffer is important for many retirees. Unfortunately, many Americans aren’t saving nearly enough and are falling short of setting aside adequate funds to support their retirement needs. The average retirement savings for people aged 56-61 is only $163,577.[i] Meanwhile, one estimate of what retirees can expect, on average, to spend on healthcare is nearly $275,000.[ii] The National Institute for Retirement Security estimates that America has up to a $14 trillion gap in retirement savings.[iii]

If you are retired and find that balancing your savings and spending is an ongoing challenge, follow these tips for ways to trim your expenses and save more.

  1. Cut Your ‘Time-Saving’ Costs

When you’re employed and busy managing your career and family, spending money on time-saving items—like professional house cleaning or monthly food-subscription services—can be helpful. Once you retire, however, you typically have more time on your hands. You may be paying for items that are no longer necessary. You can save money each month by trimming or eliminating any time-saving resources you don’t need to support your retirement lifestyle.

  • Actions to take:
  • List all the monthly, quarterly, and annual subscriptions and services you have. Identify which ones aren’t necessary.
  • Consider taking over household chores you pay someone else to manage.
  • Assess how much you spend on eating out, and switch to eating in for some of those meals.

2. Reduce Your Health-Care Costs

Actions to take:

Retirees typically spend a large amount on health care, often siphoning income that could be used for other expenses. Unless you have the money to pay these bills, they could leave you in a financial bind. You can help reduce some of your medical costs by learning to shop around. For example, changes like getting an MRI at a radiologist instead of a hospital can make a difference in your medical bills, as the radiologist is typically less expensive.[iv]

  • Get comparative quotes from hospitals and other medical professionals.
  • Check prescription costs at different pharmacies and consider buying generic.
  • Revisit your insurance plans to help identify if you’re receiving the best value.

Every retiree’s financial life and needs are different, so knowing a true breakdown of your daily, monthly, and yearly costs (your budget) is important for finding ways to save. By taking time to assess what may be unnecessary spending in your life, and reducing or eliminating these expenses, you may have more money on hand for other lifestyle needs.

To learn more about how you can trim your spending or pursue other financial goals in retirement, please contact us at 800.929.1001 or visit our site at http://capsouthwm.com/services/financial-estate-planning/ We’re happy to help you explore strategies for your unique needs.

Investment advisory services are offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information.  This material has been prepared for planning purposes only and is not intended as specific tax or legal advice.  Tax and legal laws are often complex and frequently change.  Please consult your tax or legal advisor to discuss your specific situation before making any decisions that may have tax or legal consequences.

This article contains external links to third party content (content hosted on sites unaffiliated with CapSouth Partners). The policies and procedures governing these third-party sites may differ from those effective on the CapSouth company website, as outlined in these Disclaimers. As such, CapSouth makes no representations whatsoever regarding any third-party content/sites that may be accessible directly or indirectly from the CapSouth website. Linking to these third-party sites in no way implies an endorsement or affiliation of any kind between CapSouth and any third party, including legal authorization to use any trademark, trade name, logo, or copyrighted materials belonging to either entity.

[i] https://www.thebalance.com/average-retirement-savings-by-age-4155888

[ii] https://www.cnbc.com/2017/08/24/average-couple-will-spend-275000-on-health-care-in-retirement.html

[iii] https://www.forbes.com/sites/andrewbiggs/2016/07/21/how-much-retirement/#1c4486b94d28

[iv] http://www.investopedia.com/articles/personal-finance/091615/7-ways-reduce-healthcare-costs-retirement.asp

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