Retirement – Excelsis Accounting Group

Retirement Tax Planning: Why It Matters as Much as Ever

For most of us, retirement planning revolves around saving and investing enough to enjoy a comfortable, worry-free life once we stop working. But many retirees overlook a key piece of the puzzle: tax planning. Even after retirement, tax management plays a crucial role in stretching your savings and making the most of your retirement income. Ignoring taxes during your golden years can significantly erode your savings and affect your lifestyle.

Here’s why tax planning in retirement is just as important as when you were working:

1. Taxes Don’t Retire When You Do

Retirement doesn’t mean an end to tax obligations. In fact, many of your retirement income sources—including traditional IRAs, 401(k)s, and pensions—are taxed as regular income when withdrawn. If you don’t have a tax-efficient strategy, you could be hit with higher taxes than expected. For example, withdrawing large amounts from tax-deferred accounts could push you into a higher tax bracket, leading to unexpected tax bills.

2. Social Security Benefits May Be Taxed

Many retirees don’t realize that up to 85% of their Social Security benefits may be taxable, depending on their income level. If you have other substantial sources of income—such as from part-time work, pensions, or retirement accounts—your Social Security benefits could be taxed, reducing your overall income.

3. Required Minimum Distributions (RMDs)

Once you reach age 73 (as of 2023), you are required to take minimum distributions from traditional IRAs and 401(k)s, which are taxed as ordinary income. Failing to plan ahead for RMDs could mean higher tax liabilities down the line, especially if these distributions push you into a higher tax bracket.

4. Healthcare Costs and Medicare Premiums

Your taxable income in retirement can affect more than just your taxes. Higher income levels can lead to increased Medicare Part B and Part D premiums, often called “income-related monthly adjustment amounts” (IRMAA). This is another reason to manage your taxable income strategically to avoid unexpected healthcare cost increases.

5. Estate and Inheritance Taxes

If you’re thinking about passing on wealth to your heirs, tax planning can help minimize estate taxes and ensure your loved ones receive more of your assets. Without proper planning, estate taxes could eat up a significant portion of what you leave behind, especially for high-net-worth individuals.

How to Effectively Manage Taxes in Retirement

Here are a few strategies to help manage taxes effectively in retirement:

Diversify Retirement Accounts: By having a mix of tax-deferred accounts (like traditional IRAs and 401(k)s), Roth accounts (which offer tax-free withdrawals), and taxable investment accounts, you can have more control over your tax liabilities each year.
Strategic Withdrawals: Consider drawing from Roth IRAs or taxable accounts first to manage your tax bracket, leaving your tax-deferred accounts for later years.
Tax-Loss Harvesting: If you have taxable investments, you can sell losing investments to offset capital gains and reduce your overall tax liability.
Work with a Financial Advisor: Tax laws are complicated, and even more so during retirement. A financial advisor specializing in tax-efficient retirement planning can help you navigate these complexities and create a plan that reduces your tax burden.

Just because you’re no longer working doesn’t mean you should stop planning for taxes. Without careful tax management, your savings could diminish faster than expected, leaving you with fewer resources in your later years. By integrating tax planning into your retirement strategy, you can protect your financial future and ensure that your golden years are as financially stress-free as possible.

An HSA Can Also Be Used to Save for Retirement

Health savings accounts (HSAs) were created as a savings vehicle to help people pay out-of-pocket medical expenses. If qualified, you can establish an HSA in much the same way you establish a traditional savings account or an individual retirement account. You can open one with a lump-sum payment or through regular contributions, usually through paycheck deductions.

What makes HSAs appealing is that they offer several valuable tax-saving features. For example, your contributions are excluded from deductible income, all account earnings accumulate tax free, and, as long as the medical expenses paid with HSA savings are “qualified” expenses for you, your spouse, or your dependents, withdrawals from HSAs are tax free also. It is these tax savings features plus the ability to invest contributions in longer term assets that can make HSAs viable as alternative retirement savings vehicles.

Before looking into how HSAs can be used to save for retirement, it can be helpful to explain how they actually work.

The Rules on Contributions

The maximum family contribution for 2024 is $8,300 plus a $1,000 maximum catch-up contribution for participants who are age 55 or more. For self-only coverage, the maximum contribution for 2024 is $4,150 plus a $1,000 catch-up contribution for those participants age 55 or more. The limits will be adjusted for inflation in future years. An individual’s employer or family member may contribute as long as the total contribution amount does not exceed the annual limit.

Investing Contributions

As a participant in an HSA, you have the choice of keeping contributions in cash or investing them in other assets, such as stock and bond mutual funds.* Money not spent on qualified expenses during the year is rolled over for subsequent years. If you are in fairly good health and underutilize medical and health services, you could potentially build up a relatively large balance in the HSA account over several years.

Making HSAs Work as Retirement Savings Vehicles

If you currently maximize contributions to all tax-favored retirement accounts and also save in taxable accounts, you could treat the HSA as one more option to increase your savings and do so in a tax-favored way. Essentially, you would treat the HSA as a retirement savings account and allow the assets in the account to accumulate for as long as possible while paying out-of-pocket medical costs with taxable funds. Of course, this approach does not work if you cannot fully fund all your tax-advantaged retirement savings vehicles.

Remember, each person’s situation is different and you will benefit from discussing this option — and other retirement savings options — with an experienced financial professional

A Checklist for Plan Sponsors

Once a retirement savings plan has been approved and is in place, it’s tempting to sit back and adopt an “I’m done,” hands-off attitude. However, to ensure that a plan will continue to operate effectively, employers should periodically review plan provisions and features. Here are some points to check.

How the plan is presented. The more convinced employees are of the wisdom of saving for retirement, the greater the level of employee participation. The greater the participation, the more the plan can benefit all employees — including highly compensated ones. Regular meetings, newsletters, and handouts are effective means of communicating plan advantages. Check to make sure printed materials are up to date and easy to understand, and distribute them frequently.
Plan investments. Employers that sponsor participant-directed plans can limit potential legal liability for losses caused by employees’ investment decisions if plan investment choices meet certain requirements under Section 404(c). Very generally, where 404(c) protection is sought, a plan should offer at least three “core” investment choices, allow employees to switch investments at least once each quarter, and provide participants with adequate disclosure of specified investment information.
Administration. Participants and beneficiaries must be given a copy of the Summary Plan Description (SPD) within 120 days after a plan is adopted or within 90 days after becoming eligible to participate in the plan or receive benefits. Review the SPD to make sure it accurately describes the provisions of your plan. If changes have been made to the plan document — which is likely, given the recent tax law changes — then all participants must receive a notification of these changes within 210 days after the end of the plan year in which the changes were adopted. Generally, all participants must receive a copy of the SPD every five years.
Summary annual reports (SARs). Summary annual reports must be distributed to participants within nine months after the close of the plan year. If a plan receives an extension to file its annual report (Form 5500) with the IRS, then the SAR must be distributed within two months after the end of the extension.
Plan rollovers. Qualified plans must allow a participant to elect direct rollover of any eligible distribution to an IRA or another employer-sponsored retirement plan. Your plan should have procedures in place to handle direct rollovers.
Bonding. Generally, plan fiduciaries and others who handle the assets of a plan must be bonded. The bond must be equal to at least 10% of the funds handled by the bonded individual, but cannot be for less than $1,000 and need not be for more than $500,000.
Loans to participants. Loans that are not properly administered may be treated as constructive distributions resulting in taxable income to the recipients. Review loans to make sure that loan balances do not exceed the maximum limitations. Unless used to finance the purchase of a principal residence, all loans must be repaid within five years. A plan may impose more stringent conditions on loans than the law requires.
Plan forms. All forms should meet current requirements. Forms that may need updating include beneficiary designation forms, benefit election forms, and the notice of distribution options.