Tax Wealth Network, service of Boston Tax Planners

Ruminations on Monte Carlo Results and Retirement Plans

2024-09-30

Like people, every retirement plan is different. And the key takeaway is that even if using sophisticated financial modeling software, there is no one-size-fits-all rule. The “comfort zone” that a client may seek may or may not be appropriate. And for clients who are willing and able to make course corrections along the way, they will benefit from on-going guidance from advisors who can interpret the results and provide clarity about the options to be discussed – even if there is a 50% or lower Monte Carlo probability of success.

What is a Safe Withdrawal Rate for Retirement?

2023-11-13

What is your retirement safe withdrawal rate? Do you really need to limit it to the 4% Rule or is there a better way?

Are Withdrawals from a Roth IRA Taxable?

2018-02-26

Have you taken money out of a Roth IRA? At this time of year, it is common for tax preparation clients to ask me about Roth IRAs and taxes. So, are withdrawals from a Roth IRA taxable?

Let’s say you withdrew $10,000 from a Roth IRA and you’re trying to prepare your taxes on your own. How do you calculate the taxable amount if any?

Before I can answer this, we need to know some of the background. So let’s meet Dan.

Dan has had a Roth IRA account for three years. He withdrew $10,000 from this account to pay off some debt. He was taxed on 10% of the total amount, which left him a balance of only $9,000. Currently, Dan lives in Texas which has no state income taxes. He received a Form 1099-R showing a taxable amount in Section 2A of the form as blank. How can he calculate the taxable amount? His 1099-R form has his prior Washington, DC address, but as a member of the military he has been relocated to Texas now.

Boston Tax Planner Answer:

You only pay taxes on the gains above what you invested. Your initial and subsequent investments into the Roth IRA form your basis. I recommend that you go back to your statements to calculate the amount of your investments. If you need help, reach out to the investment custodian (the folks who prepared the 1099). They should also be able to tell you what the amount invested was.

It’s possible that you have no taxable gain and this is why there is no taxable amount listed on the 1099. For example, if you invested $10,000 and withdrew $1,000, then for tax purposes you received a partial return of your principal. There is no tax on this in a Roth IRA.

When you contact the custodian you should update your address information. But it should not be a problem for filing your federal income taxes. Since you live in Texas where there is no state income tax, you shouldn’t have to worry about that either. Whether or not you need to file a different state tax return will depend on which state and how long you lived there.

If you are like Dan and need help with your taxes, please contact Steve Stanganelli, CFP(r) at BostonTaxPlanners.com.

Ways to Avoid Capital Gains Taxes on Sale of Rental Property

2018-02-25

There may come a time when you want to sell your rental property. After putting in all the time dealing with toilets, tenants, and trash, you’re looking to cash in and relax. But there’s one problem: Taxes. Despite common wisdom, you may be able to avoid them. While death is inevitable, there actually are two ways to avoid capital gains taxes on the sale of rental property.

Meet Wayne and Marcia

Let’s meet Wayne and Marcia. Back in the 1980s shortly after getting married, they decided to buy a place of their own to raise a family. Prices were rising as were interest rates. The $60,000 they paid for a four bedroom home seemed like a lot but they figured they could manage it. For several years they lived in the home raising their three children. Eventually, they decided they needed more space so they bought a new home and decided to rent out their first one. Interest rates had dropped so they refinanced a few times. The neighborhood was near good schools and in demand. The cash flow from the rent was steady.

Now with the kids grown and out of the house, Wayne is getting tired of spending weekends fixing up the property. And the kids are looking to buy their own piece of the American Dream. Both Wayne and Marcia want to help them out.

What’s Next?

When they arrived in their advisor’s office, they wanted to know how they could best sell the rental property now and split the profits between their children so that they could have money for down payments.

Wayne, as a resourceful guy, had done some research that started his mind to thinking of options. He came across IRS Publication 523 that discusses taxes and selling your property. He figured that he could add one or more of their kids to the rental property’s title. Perhaps one or more of the adult children could even live in the property and make it their primary residence.

But he was fuzzy on the details and had some questions that he asked:

If One of the Kids is Added to the Title and Lives in the Property for Two Years, Will the Sale of the House Be Exempt From Capital Gains Taxes?
Does the Adult Child Need to Own the Property for at Least Five Years and Live in the Property for Two Years to Exempt the Sale From Capital Gains Taxes?
Wayne and Marcia Are Still on the Title of the Property. Do They Have to Make the Property Their Primary Residence?

Picking Apart Wayne’s Plan

As an owner of investment real estate, you’ve decided to sell. But unlocking the value and turning it into cash can also result in a large tax bill especially if your asset has appreciated since your initial investment back in the 1980s.

First things first: Since Wayne and Marcia no longer occupy the property as their primary residence, they cannot use the Section 121 exemption of $500,000 over basis (married filing jointly) to shield themselves from a capital gain tax liability.

Second, he is correct that he could add someone to the title and that person would need to occupy as his primary residence for two of the last five years. But, no, he wouldn’t need to live there for five years to take advantage of the Section 121 exclusion.

Third, if they choose not to live in the property while their son does, they each must apply Section 121 individually. If they and a joint owner other than a spouse sell a jointly owned home, each of the co-owners must figure their own gain or loss according to their ownership interest in the home. Each applies the rules on Section 121 found in IRS Publication 523 on an individual basis. So, unless they move back into the property for at least two years out of the past five, then Wayne won’t be sheltering any of the gain for his portion of the property.

Now, you may think it’s hopeless and you should just pay the tax. While that is an option there are innovative strategies available to you if you want to lower your income tax bill when you sell and investment property (or business for that matter).

Ways to Avoid Capital Gains Taxes on Sale of Rental Property

The first way to avoid capital gains is to not sell the property but die. Why? Because when you die, those who inherit your property get a “step up in basis”. Instead of inheriting the property at the $60,000 that they originally paid back in the 1980s, the children would inherit at current market value. Let’s say that is $600,000. If they decide to sell the property that they inherit for $600,000, they will pay no taxes on the sale.

Great news. But you first have to die for this to happen.

So, what better ways are there to sell now and avoid capital gains taxes? And are there any ways to free up cash that can be used now for investment in other properties or even stocks?

Typically, when a business or real estate owner sells they will need to deal with capital gains tax, state taxes, depreciation recapture and, in some cases, the alternative minimum tax. But through savvy tax and estate planning, you can take advantage of opportunities in the tax code to minimize your current tax liability while allowing you the flexibility to control the sale proceeds.

1031 Exchanges, Installment Sales, or Trusts

Real estate investors can use a 1031 Exchange, a provision of the Internal Revenue Code which allows an owner to relinquish property and replace it with a similar type of asset without recognizing gain and deferring taxes.

While a 1031 Exchange offers tax deferral, it is ONLY a replacement option. You must replace income-producing property with other income-producing property but you may not receive cash upon the sale without paying tax on the gain. You can keep selling and exchanging property into other properties for as long as you live. Eventually when you die, your estate will inherit the last property at a stepped-up basis and then they can sell and not pay any capital gains taxes. See above.

Other options offer even more flexibility to sell highly appreciated assets like stock in a privately-held business or ownership of residential rental or commercial real estate while also controlling use of the cash that is freed up from the sale. These include strategies like a Opportunity Zone Fund investing or a type of irrevocable trust or a “structured installment sale.” (NOTE: A previous option known as a “monetized”” or “collateralized” installment sale is no longer a valid option for non-agricultural property after IRS guidance released in mid-2021).

In a structured installment sale, cash is directed to a trust that buys US Treasury bonds and in turn pays out interest to the original buyer. Since the bonds are of high quality with low risk of default, the payout may be low. A variation on this might be to have the trust also hold higher-yielding Treasury inflation-protected securities (aka TIPs) to mitigate inflation risk. The payout to the initial seller is over time and only a portion of capital gains is paid out and subject to tax with each installment.

Opportunity Zone Funds were created as part of the federal tax overhaul package for 2018. By investing in real estate projects sponsored in select zones, the taxpayer will defer taxes. And if the investment is held in the fund for a certain period of time, then the taxes on the capital gains from the original transaction that generated all the proceeds used for the OZ Fund investment will be waived.

By using a certain type of irrevocable trust, you may be able to defer taxes while increasing the amount of cash proceeds for investment. This option requires the use of a specialized network of tax attorneys, trustees, and investment advisers. But the costs may provide an investor with greater flexibility on types of investments while significantly reducing taxes on the sale of any type of assets (not just real estate).

The Opportunity Zone and irrevocable trust options offer you a chance to salvage a failed 1031 Exchange which can occur if a seller of a property cannot locate a suitable replacement property or a closing fails to occur within the 180 days required by law. In addition to deferring taxes while freeing up cash that can be used today, they may also offer you a great estate planning tool. This is because of the discount that an estate receives for something called ‘lack of marketability.’

Next Steps for Sellers

Any one of these strategies may be an effective way to defer taxes, but typically requires a professional tax advisor’s assistance. To learn more about setting up one or more of these strategies and how they may fit into your broader financial, estate and tax plan, contact Steve Stanganelli, CFP® at Clear View Wealth Advisors /Boston Tax Planners at 617-398-7494 or steve@ClearViewWealthAdvisors.com.

You Sold Your Business. Now What?

2017-06-27

You’ve worked hard. And now you want to enjoy your rewards after having invested blood, sweat and tears building your business. If you’re lucky you get someone or some company to buy you out. Before you pop the cork off that champagne bottle, you better get your ducks lined up. You sold your business. Now what?

You Sold Your Business. Now What?

Most every business owner and entrepreneur has one dream and one dream only — growing a company and making it big on the “exit.”

They imagine the day when they sell their company for cash or a bazillion shares, and then just… chill. Or buy 5 cars. Or 5 houses. Or… do what exactly?

There’s the obvious answer, which is “who cares what I do, I’m rich!” Which may be true, it is an arrival for so many. But with newfound wealth comes the concerns about who to trust, how to preserve your money, and of course the weird family/friend interactions that can follow. (HBO’s Entourage comes to mind for instance).

Here are 5 things to consider after you’ve sold your business.

1.) Get help. But choose carefully

Just because you sell a company doesn’t mean you know how to handle the money aspects. There are going to be tax considerations. Preferably, you should do this tax planning ahead of inking your deal. There are ways to structure a sale agreement that minimize your taxes that you can only do before the closing.

There may be debts to address, potential stock details, and so on. You’re likely going to need help from a professional wealth manager. Act sooner rather than later on this, but choose carefully who you bring on your team. There have been brilliant technologists and business people of all kinds who have been taken advantage of by investment “professionals.” Choose wisely.

2.) Trust and estate

This step cannot be emphasized enough. Very few people want to think about their will and estate plans because let’s face it, thinking about death is depressing. But with wealth comes responsibility. If you don’t deal with it, it can cause issues for loved ones down the road.

The facts are, your estate plan including your will and insurance, probably do not match your new level of wealth. Don’t worry about getting too deep into the weeds right away, just cover the basics. A good place to start is with an Accredited Estate Planner (www.naepc.org).

3.) Don’t blow it

Coming into money does weird things to people. There are crazy stats about folks who just aren’t prepared and spend it all. Lottery winners and professional sports players are prime examples. On average, 70 percent of lottery winners go through their winnings in several years.1 And a good number end up in bankruptcy.

Similar results occur with professional athletes. Sports Illustrated recently estimated that 80% of retired NFL players go broke in their first three years out of the League.2

Hey, you aren’t a lottery winner and you may not be a famous sports figure, but blowing through a pile of cash in a few years can happen. This is where a an experienced fiduciary wealth manager who is a Certified Financial Planner TM professional can help. With purposeful planning, you can drill down and figure what kind of cash flow you’ll need to sustain your dreams. So before you get caught up in “lifestyle inflation” you’ll want to know if you have enough cash coming in from your big pay day so that you can live the way you want to for as long as you want to.

4.) Family and friends get weird

It happens. You and a bunch of friends are at dinner, do they expect you to buy? Maybe a family member wants a loan to get a business started. Do you give one? If you do, will it set a precedent? Or what if they don’t want to pay it back because, “you have enough.”

Also, it can change how new acquaintances view you. Do they like you just for your money? As one tech millionaire states, “If you aren’t married yet, good luck trying to figure out (and/or always having self-doubt) about whether a partner is into you or your money.”3

5.) Adrift

After working so long and hard on your business, there can be a loss of purpose after it’s sold. Markus Persson, the 36-year old who sold Minecraft for $2.5 billion tweeted about it. He wrote, “The problem with getting everything, is you run out of reasons to keep trying, and human interaction becomes impossible due to imbalance.”4 Feeling adrift is often part of the process, give yourself time to fall into a new routine and find a new purpose. Playing golf may only fill up so much time and then what?

This is where you may need help in charting a new course and reinventing your “retirement”. You can find comprehensive programs and tools that help you identify in a holistic way the kinds of opportunities and options that will bring you purpose and significance while connecting you to something bigger. (Check out the Successful Transition Planning Institute)

Takeaway After You Sold Your Business

Everyone focuses on the big exit. The day when cold, hard cash starts raining from the skies and you go yacht shopping. Just don’t forget the other side of the equation, that there are realities of sudden wealth, both financial and emotional. The sooner you can make a plan and get some help, the easier it’ll be to relax and take advantage of everything you’ve work so hard to accomplish.

1 http://time.com/4176128/powerball-jackpot-lottery-winners/

2 https://www.forbes.com/sites/leighsteinberg/2015/02/09/5-reasons-why-80-of-retired-nfl-players-go-broke/#41faa7bf78cc

3 http://www.businessinsider.com/i-made-15-million-before-i-was-30-and-being-rich-wasnt-as-awesome-as-youd-think-2014-7

4 https://hbr.org/2015/09/dealing-with-the-emotional-fallout-of-selling-your-business

Can I Still Deduct an IRA When Contributing to 401k Plan?

2017-03-19

Here’s the latest question to the Tax Corner: Can I still deduct an IRA when contributing to a 401k plan?

Does any participation in an employer sponsored plan make one ineligible to participate in a self-directed IRA?

Question: I have two part-time jobs. 95% of my wages are generated at job #1 where no 401K plan is offered. I work infrequently at part-time job #2 where a 401K plan is offered and I have participated in the plan. I will only accumulate a couple hundred dollars in taxable wages in 2017 from job #2, and will therefore contribute less than $50 to the 401K plan. Given that, I would like to opt out of the 401K plan and contribute to a self-directed IRA based on the sum of my wages from both jobs. THE PROBLEM. In 2017 I have worked at job #2 and had tax deductible contributions allocated to the employer sponsored 401K plan (the amount is less than $20). Since I have already participated in this plan in 2017 is there a way to have my employer or sponsor ‘recall’ those funds from the employer based 401K account? Then I will not have participated in any employer sponsored plan in 2017 making me eligible to participate in a self-directed IRA.?

Answer from our Boston Tax Planner:

Based on my tax research resources, the short answer is participation in an employer plan will make you ineligible for a tax-deductible IRA in the same year.

An employee is covered by an employer retirement plan for a tax year if the employer has a:

Defined contribution plan (profit-sharing, 401(k), stock bonus, or money purchase pension plan) and any contributions or forfeitures are allocated to the employee’s account for the tax year.
IRA-based plan (SEP, SARSEP, or SIMPLE IRA) and the employee has an amount contributed to the IRA for the tax year. • Defined benefit plan (403(b) annuity, cash balance, or plans for federal, state, or local government employees, other than section 457(b) plans) and the employee is eligible to participate within the tax year. An employee is covered even if he or she declines to participate, does not make a required contribution, or does not perform the minimum service required to accrue a benefit for the year.

No vested interest: If any amount is allocated to or a benefit accrues to an employee’s account, the employee is covered by that plan even if he or she has no vested interest in (legal right to) the account.

If it’s early in the year, you may be able to talk with your employer about withdrawing from the plan, taking the deferred contribution as income and adjusting your payroll records so that Box 13 on your 2017 W2 will not be checked. That is an operations issue you’ll need to refer to the payroll and 401k administrator. (I personally doubt that an employer would allow such a ‘recall’).

On the other hand, you may still consider a contribution to a non-deductible traditional IRA. It would need to be coded this way with the custodian and reported on your taxes to account for basis (and future tax issues). So if you can’t successfully ‘recall’ funds, consider the non-deductible route.

And depending on your income, you may want to consider a Roth IRA contribution instead. This will provide for ‘tax diversification’ in the future since the funds can be withdrawn without having to pay any income taxes on accrued gains, dividends and interest.

401k Hardship Distribution for Medical Expenses

2017-03-19

Ask the Money Coach:

My mother got into a car accident and can not make decisions on her own. I am currently her power of attorney. How can I cash out her 401K to pay for her expenses?

She has been out for over a week and doctors expect her to be disabled for quite some time. I need help to pay for everything so how can I get access to her 401k?

Response from Boston Money Coach:

For the immediate issue, you can contact your mom’s employer and speak with the HR department or the company’s 401k administrator about their specific requirements. Employer plans may offer the option allowing employees to withdraw from the balance contributed by the employee but not all employers offer the option. If the employer’s plan does allow for “hardship distributions,” you’ll be provided with the details on limits and procedures by them. You’ll need to provide documentation to them of your power of attorney.

Amounts Eligible for Distribution

Depending on what the plan allows, you may be eligible to tap from the balances accumulated from the employee elective deferrals, the employer profit-sharing contribution and any regular employer matching contributions. Generally, the amount earned on elective deferrals is not available for a hardship distribution.

Criteria for a Hardship Distribution

To be eligible for a hardship distribution, from a participant’s account you need to show that the distribution is:

Because of an Immediate and Heavy Financial Need, and
Limited to the Amount Necessary to Satisfy That Financial Need.

There are several “safe harbor” provisions available. Medical expenses for an employee, employee’s spouse or children or beneficiary are at the top of the list. Other eligible situations include costs incurred for the purchase or repair of the employee’s primary residence, education or funerals.

Tax Treatment of Distributions

Under IRS rules, you may withdraw money from the employer-sponsored plan but you will still have to pay income tax on the amounts and if your mom is under age 59 1/2 there will be a 10% penalty.

A Teachable Moment in Tax Planning

Tax and financial planning cannot prevent such crises but proper planning can help deal with them with less stress. Life is filled with risks. At any time we can be literally and figuratively hit by something unexpected. The goal of financial planning is to find ways to mitigate these risks.

Companies are supposed to have “disaster plans” in place. We owe it to ourselves and our loved ones to do the same.

This is why I suggest to families that they review their auto and property insurance regularly to make sure that they have proper coverage in place for things like medical expenses. I also suggest long-term and short-term disability insurance to help ensure that there will still be income coming in even if you are still in the hospital. I’m also a fan of supplemental benefits coverage (think AFLAC) to provide cash that may be a resource to cover bills above and beyond medical care.

But the best and most effective part of any safety net is having an emergency cash fund – liquid, safe and readily accessible. Another important element is proper legal documents in place. As in this case, a family member of trusted friend having a power of attorney will help by allowing someone the authority to represent you and conduct your financial affairs in your absence.

But none of this works if you don’t plan ahead for the worst even when we all hope for the best.

8 Ways to Minimize Your Taxes

2017-02-04

It’s tax time again. While taxes are the price for a civilized society, there’s nothing in the law that says you can’t lower your own tax bill. So at this time of year, I do get questions about taxes. Most folks are looking for ways to minimize taxes. Here are 8 ways to minimize taxes. You may find one or two that work for you.

You can minimize tax liability in more ways than can be counted here. You are limited only by your imagination, the creativity of your professional team and your willingness to go right up to whatever lines the IRS has.

Tax Minimization versus Tax Evasion

As noted once in a US Supreme Court opinion, tax avoidance is not illegal. Tax evasion is. Being on the right side of the line is key. There are lots of legal ways to minimize your taxes.

For some who have deep pockets and can afford to hire teams of high-priced tax attorneys and accountants, the number of creative ways found to avoid taxes can almost be limitless. But like investing, these kinds of options also come with high risks if the IRS deems the strategies to be illegal or abusive.

For most people without an entourage of professionals, there are still some conventional ways to minimize your tax liability.

Options for Self-Employed or Rental Property Owners

The best options usually involve being self-employed or owning rental real estate. For these folks there is the opportunity to use depreciation, a calculated non-cash expense, to lower one’s taxable profits from a business or rental property. Likewise, you can find ways to legally shift income.

One way is to hire family members like a spouse or minor children which shifts net profit from your tax bracket to someone who may be in a no-tax bracket. This works especially well if you help the minor child use his income to fund a Roth IRA which gives him a head start on retirement savings and is a neat way to save for college, too.

Another option is to supplement medical expenses through a Medical Expense Reimbursement Plan (MERP) sponsored by your enterprise. Let’s face it. You were going to incur and pay those expenses anyway but through these methods you can now get a legal tax subsidy.

Ways to Minimize Taxes When Receiving a W2

For those who are W2 earners, the best options relate to employer-sponsored benefits. Take advantage of any benefit that shifts income to a tax-deferred vehicle. These include employer-sponsored retirement plans, flexible spending accounts for health or dependent care.

If you don’t work outside the home but you have a spouse who does, then be sure to fund your own IRA to the max. This will help your own retirement but also reduce your current year taxable income.

Investing Strategies that Lower Taxes

If you have deeper financial pockets, you can consider investing in municipal bonds which produce tax-exempt income or in partnerships like oil and gas exploration which produce depreciation and losses that can be used to offset your other income.

Lower Taxes in Retirement: Think Roth IRA

While lowering taxes in the current year are what most people are now asking about, it’s also advisable to plan ahead for taxes in retirement. As you put aside money in your IRAs and company 401(k)s, you’re lowering your current tax bill. But you’ll find that Uncle Sam will be waiting to take his toll when you start taking distributions in retirement.

One way to lower your future tax bill will be diversifying where your retirement money is held. By funding or converting other IRA funds to a Roth IRA, you’ll have the option to withdraw funds tax-free in retirement or allow them to continue to grow because you won’t have to take a minimum distribution from these accounts.

Because of income threshold limits, you may not directly qualify for opening or funding a Roth IRA. But with a little bit of help, you can navigate the rules to fund a ‘backdoor Roth IRA’ which will save you money on taxes in retirement.

Next Steps

To really figure out your best options, you should have a plan. So, you should reach out to a qualified financial professional who knows how to integrate tax planning for your personal situation.

Must I Pay Social Security Taxes on Earnings After Full Retirement Age?

2017-02-14

Taxes are always a hot topic and especially for those in retirement. If you’re working in retirement, you may have found yourself asking this question as well: Must I pay Social Security taxes on earnings after I reach Full Retirement Age?

There are two parts to this question as I understand it: Social Security withholdings on earned income and taxation of Social Security benefits.

Social Security Taxes on Earnings After Full Retirement Age

As is the case with most things in life, it depends. In this case, it depends on which question you’re asking. For completeness, I’ll cover both.

If you’re still working, whether in a self-employed capacity or for an employer, then the answer is a very simple ‘yes’. As long as you are working and earning an income, then you’ll be required to contribute to Social Security. Your continued earnings history may also be used to increase your benefits when Social Security reviews your benefits calculation.

Taxes on Social Security Benefits

For the other side of this question, you may or may not need to pay taxes on your Social Security benefits. This depends on whether or not your Modified Adjusted Gross Income (MAGI) is above a certain threshold that depends on your filing status (i.e. single or married filing jointly, for instance).

Up to 85% of a taxpayer’s Social Security benefits may be taxable. This will depend on your MAGI and filing status: above $32,000 and filing jointly, or above $25,000 and filing single, head of household, or filing separately.

To calculate your MAGI,

Take One-half the Total of Your Social Security or Railroad Retirement Benefits From Your Ssa-1099 or Rrb-1099 (These Are Reported on Form 1040, Line 20a);
Add Earnings From W2s (Form 1040, Line 7);
Add Taxable Interest From 1099-ints (Form 1040, Line 8a);
Add Ordinary Dividends From 1099-div (Form 1040, Line 9a);
Add Other Gains From Form 4797 (Form 1040, Line 14);
Add Ira Distributions From 1099-r (Form 1040, Line 15b);
Add Taxable Pensions From 1099-r (Form 1040, Line 16b);
Add Schedule E Income (Rental Real Estate, Royalties, Partnerships, Etc.);
Add Farm Income (Form 1040, Line 18);
Add Unemployment Compensation (Form 1040, Line 19)
Add Any Other Income That is Reported on Form 1040, Line 21;

In addition to these forms of income, you also need to add back any tax-exempt interest from investments like municipal bonds (reported on Form 1040, line 8b).

Next Steps

Whether or not you’re now retired, you should have a plan that integrates your retirement lifestyle and income sources with a view towards your taxes in retirement. Reach out to speak with a qualified tax planner who can bring all the pieces of your income, benefits and expense puzzle together to find a plan that’s right for you.

Tax Strategies for Retirees

2017-01-17

Ah, retirement! No more worries, right? But when your paycheck stops, you now have to figure out not only how to turn your nest egg into a ‘pay check’ but how to handle income taxes, too. Here are some tax strategies for retirees to consider. While income taxes can be complex, you may be able to lower your tax burden with good planning and some professional help.

Nothing in life is certain except death and taxes – Benjamin Franklin

Next to being shot at and missed, nothing is really quite as satisfying as an income tax refund. – F. J. Raymond, American Humorist

It’s not so much about how much you have but how much you keep. And retirees that have a tax-efficient investing and distribution plan in place may be able to keep more of their hard-earned wealth for themselves or their heirs. Consider the following tips to help you make smarter money management moves in retirement.

Less Taxing Investments

Retirees may want to consider a healthy dose of municipal bonds (also known as “munis”) in their taxable accounts. These types of investments have a long tradition helping investors save on taxes and offset stock market volatility. Interest paid on municipal bonds is exempt from federal taxes. And for residents in states with income taxes, you’ll also save on state income taxes by buying bonds issued by your tax-home state. And the higher your income tax bracket means the more you can potentially benefit from investing in munis.

The Tax-Exempt Advantage: When Less May Yield More

Would a tax-free bond be a better investment for you than a taxable bond? Compare the yields to see. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.

Federal Tax Rate	15%	25%	28%	33%	35%	39.6%
Tax-Exempt Rate	Taxable-Equivalent Yield
4%	4.71%	5.33%	5.56%	5.97%	6.15%	6.62%
5%	5.88%	6.67%	6.94%	7.46%	7.69%	8.28%
6%	7.06%	8%	8.33%	8.96%	9.23%	9.93%
7%	8.24%	9.33%	9.72%	10.45%	10.77%	11.59%
8%	9.41%	10.67%	11.11%	11.94%	12.31%	13.25%

The yields shown above are for illustrative purposes only and are not intended to reflect the actual yields of any investment.

Courtesy of DST Systems, Inc.

Tax-managed mutual funds or investment platforms that offer tax-loss harvesting (like Betterment for Advisors) are other options. Managers of these funds as well as the algorithms used by the platforms focus on tax efficiency through many means. They may limit the ‘turnover’ or number of times they trade investments. Or they match capital gains with offsetting losses to minimize total taxable gains. At the very least, you should carefully look at a fund’s prospectus to determine its average ‘turnover’ ratio. The lower, the better as this will help limit trading fees and potential gains. Tax-managed funds are most appropriate for your taxable accounts though you may want to also consider them for your IRA accounts as well.

Asset Location

As important as diversification is to investing, you also need to consider where you should keep certain investments to ‘yield’ the optimum tax-efficient return.

Some types of investments are better suited for taxable accounts and others are more optimal when part of a tax-deferred account. Why? Blame the tax code. Certain investments are better suited for retirement account while others have better tax treatment in taxable accounts. This is why many financial and tax experts (including me) recommend keeping real estate investment trusts (REITs), high-yield bonds, and high-turnover stock mutual funds or ETFs in tax-deferred accounts. You won’t get hit with a tax bill from the dividends or gains as you would if these were in a taxable account. On the other hand, low-turnover stock funds (like index funds), municipal bonds and growth or value stocks may be more suited for taxable accounts.

The Tax Trap

The maximum federal tax rate on certain dividend-producing investments and long-term capital gains is 20%. And if your income is above a certain threshold, you may also be subject to an additional 3.8% Medicare tax. This applies to single-filer taxpayers with modified adjusted gross income (MAGI) over $200,000 and over $250,000 for joint filers. Without proper planning ahead of time, taking withdrawals from the ‘wrong’ buckets or having investments throw off too much taxable income into those buckets and you’ll get a surprise at tax time. (And another thing to consider is the potential impact that all this income may have on your Medicare premiums. If you have investments throwing off lots of capital gains, dividends and income, you may find that your MAGI is high enough to put you in a different tier where you may be paying the maximum amount for your Medicare Part B premium).

Taxes are never a favorite topic and less so for retirees. But with a little planning and guidance you may be able to keep more in your wallet. Skip the planning and you may just want to go straight for the aspirin … and your check book.

To see if you have the right investments that match up with your tax plan, call Steve Stanganelli at 617-398-7494.