As we enter the final weeks of tax season, now is a great time
to review your goals and look towards your retirement planning.
If you are closing in on retirement or many years away, what
better time to revisit your situation than tax season! You need
to collect all your tax "stuff" anyway, so add a few documents
and update your retirement planning. However, the one variable
that is hard to plan for in retirement will be taxes. We don't
know what the tax rates will be in 2013, so how can you plan for
20 years or more in the future? Will rates be higher, lower, or
will we have a flat tax? But not knowing doesn't mean that you
shouldn't be planning.
Gather the Data
Once you have completed your taxes, gather all your investment
and bank statements. Put together a net worth statement. In other
words, figure out what you own and what you owe. Then divide your
investments into two categories, taxable accounts (i.e. brokerage
accounts) and tax deferred [i.e. Individual Retirement Accounts
(IRAs), 401(k) and 403(b) plans and annuities]. Within the
taxable accounts, list what you own that may have special tax
treatment such as tax free bonds or holdings that may be subject
to a lower capital gains tax rate when they are sold.
Within the tax deferred category, look at your statements to see
if you have any after tax money that you have contributed. In a
company retirement plan, when you retire, chances are you will
roll over the assets to an IRA. The after tax contributions (not
the growth) can be taken out and not rolled over. If you have
different types of IRAs, make a list of what they are. For
example, you may have deductible IRA contributions,
non-deductible contributions and Roth IRAs. With Roth IRAs, in
retirement, you can withdraw these dollars tax free. It gets
tricky with non-deductible IRAs. When you withdraw from these
accounts, the contributions are tax free, but the growth is
taxable. It would be easy if you could take the contributions out
first, but the laws don't allow this. For every dollar you
withdraw, some will be considered "basis" and some growth. The
basis portion will be free while the growth will be taxable. What
confuses this even more is that if you have various IRAs
including a rollover from a company plan, you need to look at all
accounts when you calculate the tax free percentage. Your
non-deductible contributions should have been tracked on IRS Form
8606. If you never filed this form and made non-deductible
contributions, the IRS will assume all the money in the IRA is
tax deferred and therefore taxable upon distribution. You should
speak with your adviser or tax preparer immediately to correct
Now that you collected and organized your information, make a
list of your retirement goals in measurable terms. When will you
retire, how much will you need, where do you want to live, etc.
Will you sell your house? Even if you are many years from
retirement, start the thought process now. Each year you can
revisit your goals and make adjustments as needed.
How Do Taxes Fit In?
More often than not, retirees have more income than they thought
they would, especially when turning 70 1/2. That's the magic age
that Required Minimum Distributions (RMD'S) must start. Planning
for taxes many years down the road is difficult, but must be
considered. A slight change in tax rates can have a large impact
on your finances, especially when compounded over many retirement
years. What is often recommended is to plan based on current tax
laws. Chances are your tax deferred monies will still be taxable
under any tax law changes. Will rates be higher or lower? Will
capital gains and qualified dividends still have preferential
treatment? The answer is probably yes to all of this.
Over the next 20 or more years, we will most likely have many tax
changes that will raise tax rates in some years and lower tax
rates in others. So what to do? When planning, build in a higher
tax rate to some of your assumptions. See how that impacts your
planning. When deciding where to live, even if the plan is to
live in a state with no income tax, consider building some state
tax into your projections. States that currently have no income
tax may impose a tax rate in coming years.
You want your retirement years to be a stress free as possible,
and we all know how stressful tax time can be. So invest a little
time now to help plan for the future. If all of this is
overwhelming, reach out to a CERTIFIED FINANCIAL PLANNER™
professional who can help steer you in the right direction.
FPA member Scott M. Kahan, CFP®, is president and founder
of Financial Asset Management Corp. a fee only Wealth Management
firm in New York City.