Did you know that taxes are likely the largest expense you will have throughout your entire life?

While that may be hard to believe, consider all the different types of taxes that exist: income taxes, payroll taxes, sales taxes, property taxes – the list goes on and on.

Having a tax-smart retirement plan is essential to prolonging your investments and financial security.

One of the first steps to building a successful plan is to understand the tax consequences of the various assets used to supplement your retirement income.

The following strategies can help you build a tax-smart retirement plan.

Take Your Required Minimum Distributions

If you own any tax-deferred retirement accounts, look here first to help supplement your income needs.  

Once you attain a certain age, the government requires that you begin taking distributions from certain tax-deferred retirement accounts, such as a traditional IRA or 401(k). These withdrawals are known as Required Minimum Distributions, or RMDs, and are calculated based on your life expectancy.

The chart below details the age that these distributions must begin, which depends on when you were born. These ages recently changed under the SECURE Act 2.0, so be sure to familiarize yourself with your RMD age.

What’s Your RMD Age?
Born in 1950 or earlierAge 72
Born in 1951-1959Age 73
Born in 1960 or laterAge 75
Source: IRS.gov

If your RMD is still not sufficient for your cash needs, consider looking into your other assets before continuing to draw down on your tax-deferred retirement accounts. That’s because these distributions are taxed as ordinary income and the more that’s withdrawn, the more taxes you’ll owe.

Use Your Health Savings Account

If you have a Health Savings Account (HSA), you’re allowed to take out tax-free distributions to pay for qualified medical expenses. Qualified medical expenses include doctors’ bills, prescriptions, dental care, and much more. In fact, certain Medicare insurance premiums can even be paid tax-free with HSA funds.

Once you attain age 65, you’re eligible to take penalty-free distributions from your HSA for any reason. However, these distributions are still subject to ordinary income taxes if they are not used for qualified medical purposes.

Furthermore, if you’ve incurred medical expenses in a previous year, you’re allowed to take a tax-free distribution in the current year to pay for those expenses as long as the HSA was established at the time the expense was incurred. Look to see if you have any out-of-pocket medical expenses from prior years that you can ‘repay’ yourself with now, completely tax-free.

Turn to Your Taxable Investment Accounts

If you have a taxable brokerage account, it’s likely you are receiving some investment income on the assets held inside that account.

These investment earnings are generally considered taxable income when paid, whether they are re-invested or not. While interest income is taxed at ordinary tax rates, certain dividends and capital gains may be taxed at lower, more favorable rates.

If you have been automatically reinvesting your interest and dividends over the years, consider turning this feature off and using the investment income to supplement your cash needs. By only withdrawing the investment earnings, you still allow the principal investment to continue to grow.

If you’re still looking for additional cash flow, look to see if there are any assets you can sell in your portfolio.

Before selling any securities, it’s important to be mindful of any potential capital gain consequences. Any appreciation over the original investment could be subject to capital gains taxes upon disposition. If you’ve held an asset longer than a year, the gains will likely be subject to the more favorable capital gains rate, which tends to be lower than short-term ordinary rates.

If you have any unrealized losses in your account, consider using the strategy of tax-loss harvesting. This is the practice of selling securities in your portfolio that are currently valued at a loss and using those funds to purchase a similar security. This way, you get to claim a tax loss but still stay invested in the market. Be careful though! If you repurchase the same security or one that is substantially identical, the Internal Revenue Service may disallow that loss, defeating the purpose of the transaction.

Selling assets in your portfolio can be a great time to rebalance so that you can maintain your target asset allocation. However, it’s important to think about how these transactions affect your tax situation. Recognizing gains has the potential to not only increase your tax bracket, but also your Medicare premiums if you’re age 65 or older.

Don’t Forget About Your Roth Account

If you have a Roth retirement account, it’s generally best to save that for last.

That’s because Roth accounts are made up of after-tax dollars, so any distributions that you take may be completely free of income tax. This tax-free distribution also applies to any heirs who eventually inherit the account. And unlike traditional IRAs, Roth IRAs aren’t subject to RMD rules until after the death of the account owner.

While these accounts have clear tax advantages, there are some special rules when it comes to taking distributions. For the withdrawal to be tax- and penalty-free, the owner must be at least age 59.5 and have owned the account for at least five years.

Successfully Implementing Your Plan

Retirement is meant to be a relaxing time after years of hard work. Careful, tax-smart retirement planning can help protect your assets from unnecessary taxes and help set your mind at ease.

But establishing a tax-smart retirement plan isn’t just a “set it and forget it” kind of thing. Tax laws change every year, and some years more than others. It’s important to stay informed to help ensure your tax-smart retirement plan will be successful for you.

This is intended for informational purposes only and should not be construed as personalized investment or tax advice. Please consult your investment and tax professional(s) regarding your unique situation.

Author Joseph P. Marmorato Private Client Group Planner

Joe has been involved in the financial services industry since 2012. He is a member of the New Jersey Society of Certified Public Accountants and the American Institute of Certified Public Accountants, Tax Section.

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