Make Strategic Tax Planning a Priority For Your Retirement Plan

Drew Forrester

If you’re like most, you approach your retirement planning with the sole focus on building your nest egg, accumulating as much as possible to get you to your goals. Yet there’s an often overlooked piece of the planning that could have an impact on your finances in retirement –strategic tax planning. What could your tax exposure be, and how can you work to minimize or effectively plan for taxes down the road? There are several strategies that can add up over the years, and could result in significant savings.

Take Steps Now to Better Control Your Tax Bracket in Retirement

There are multiple types of investment accounts with different tax benefits and consequences that are available for your consideration when planning for your retirement years.  Having differently taxed buckets of money to pull from in retirement gives you more flexibility for tax-planning purposes. These include:

  • Roth Accounts – Deposits are made with after-tax money, so you don’t get a tax break today, but you receive tax-deferred growth and you pay no income taxes in retirement when the funds are withdrawn. Examples of this type of account are Roth IRA, Roth 401(k), or Roth 403(b).
  • Pre-Tax Accounts – Deposits are made with pre-tax money. While you get the tax break today as well as tax-deferred growth, you will be required to pay income taxes on both your original contributions as well as any growth when you withdraw the funds. Examples include the Traditional IRA, 401(k), 403(b), 457(b), SIMPLE IRA, or SEP-IRA.
  • Other After-Tax Accounts – This is typically a brokerage account which holds stocks and other types of investments. You don’t get a tax break today. You will typically pay tax both on capital gains (which is often a lower rate than your income tax rate) on any gain realized when sold as well as on dividends and interest received

Take Advantage of a Health Savings Account for Health Care Costs in Retirement

Health Savings Accounts (HSAs) aren’t traditionally considered as a retirement planning tool, yet as Mike DiSalvo explained in a recent article, they could play an important role. If you contribute to your HSA throughout your career but don’t use any (or all of) the funds to pay for health expenses along the way, the money can be invested and accumulate over the years to save for medical costs in retirement in a tax-advantaged manner. This is key because these expenses are typically the biggest expenses for retirees. There are many benefits to an HSA:

  • Contributions to an HSA are not subject to federal income taxes
  • Earnings to an HSA from interest and investments are tax-free
  • Distributions from an HSA to pay for qualified medical expenses are tax-free

To qualify for an HSA, you must be enrolled in a high-deductible plan.

Adopt a Tax-Efficient Investment Strategy

A common mistake many investors make is holding certain assets in the wrong types of accounts.  It’s critical to make sure the accounts are appropriate for the investment in order to take advantage of specific tax breaks. Some examples include:

  • Municipal Bonds – These can be tax free so it is generally better to hold these in a taxable, non-qualified account.
  • Fund Turnover Ratio – How often are the actual fund managers buying and selling within the fund? Frequent buying and selling within the fund (high turnover ratio) can lead to more distributions to the investor which could result in more capital gains tax incurred if it is held within a taxable, non-qualified account.  Thus, if the turnover ratio is low, meaning the managers are buying and selling infrequently, it is more tax-efficient to hold these funds in a taxable account.
  • Tax Loss Harvesting – Evaluate your tax-loss harvesting opportunities on an annual basis, and annually consider realizing losses within a taxable, non-qualified account. Realized losses can be used to offset any gains that are realized, thus reducing the capital gains tax you pay. Also, if there is a net realized loss in the year, you can write up to $3,000 (for 2017) off your income tax that year and carry forward any losses to be used in future years to either reduce your income or offset any realized gains.

Don’t Forget about Catch-Up Contributions

Many investors forget that when you reach certain ages, you have an opportunity to increase your contributions to tax-advantaged accounts. This includes retirement accounts and HSAs, which increase to the following limits at ages 50 and 55:

  • Retirement Plan Accounts (401(k)) – The current catch-up contribution, in addition to the $18,000 annual limit, is $6,000. This means that starting at age 50, you can contribute a total of $24,000 per year to your 401(k) (for 2017).
  • IRAs – In addition to the $5,500 annual limit on your IRA, you’re allowed a catch-up contribution of $1,000 at age 50, increasing your total allowable annual IRA contribution to $6,500 (for 2017).
  • HSAs – Starting at age 55, you are allowed an additional catch-up contribution of $1,000 per year. This increases your maximum allowed contribution from $3,400 per year for individuals to $4,400, and from $6,750 per year for families to $7,750 (for 2017).

Be Smart about Your Charitable Contributions

A little-known way to make a difference to a registered charity of your choice and gain a tax advantage at the same time is through a Charitable Donor Advised Fund. Instead of using after-tax money to donate to a non-profit (i.e. writing a check), consider gifting appreciated assets that are in a taxable account to your Charitable Donor Advised Fund.  In the year that they are gifted, you not only receive the charitable deduction on your taxes, you also receive forgiveness for the capital gains tax you would have incurred. Once the securities are in your Charitable Donor Advised Fund you can schedule grants out to the non-profit charities of your choice.  Things to consider:

  • Once the investment is placed into the account, it’s permanent. You can’t take it back.
  • Only 501(c)(3) charitable organizations can receive the gift. You cannot give to an individual or an organization that isn’t registered and approved to be part of the fund.
  • If your charity of choice is not on the list but is a registered 501(c)(3), you can request that it be added.

Another strategy for individuals over the age of 70 ½ to consider is to donate money to a charity directly from an IRA.  Doing this will not only go toward satisfying your Required Minimum Distribution (RMD) for the year, it will also be excluded from income taxes.  You don’t receive a charitable deduction for the donation but often the tax savings from the income tax exclusion can be more beneficial than the charitable deduction.

Be Strategic about Your Company Stock

If you’ve been with a company for a good deal of time, chances are you may own highly appreciated company stock within your employer retirement plan. You may think that rolling it all into an IRA when you retire is your only option, but there may be a better way to approach this, and it involves a special rule called Net Unrealized Appreciation (NUA) which can result in significant tax savings. The idea is this:

  • Upon retirement, if you decide to roll your 401(k) out of the plan, you can roll the company stock into a taxable account and the rest of the assets can be rolled into an IRA.
  • You will pay ordinary income tax on your company stock basis (what you originally paid for the stock) in the year the rollover occurs. Depending on your individual situation,  it may be a good idea to roll out your company stock over the course of a few years to minimize the tax burden.
  • Here’s the benefit: When you choose to actually sell the company stock in your taxable account the gains are taxed at long-term capital gains rates (usually 15%), which is typically much lower than your income tax rate (the top tax bracket is currently at 39.6% for high income earners).
  • In contrast, if you choose to roll over your entire retirement plan balance into an IRA, all of your withdrawals, including that which comes from the profit of your company stock, will be taxed at your income tax rate.

At Krilogy, when we present these strategies to clients, they are excited about the savings they can experience if they implement one or more of them into their financial plan. They quickly see why a tax strategy is important for accomplishing their retirement goals, and appreciate having the flexibility and options available that such a strategy provides. Going through this process is yet another way that Krilogy provides value to clients. We look forward to answering any questions you may have about the information presented above, and would welcome an opportunity to perform a complementary review of your portfolio, and help you experience The Art of Accomplishment.

Krilogy Financial® is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

Krilogy Financial® does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.