How much attention do you pay to this factor?
by Jason Vitucci, CFP and Gene A. Schnabel
Will you pay higher taxes in retirement? Do you have a lot of money in a 401(k) or a traditional IRA? If so, you may receive significant retirement income. Those income distributions, however, will be taxed at the usual rate. If you have saved and invested well, you may end up retiring at your current marginal tax rate or even a higher one. The jump in income alone resulting from a Required Minimum Distribution could push you into a higher tax bracket.
Prior to retirement, investors would do well to study the tax efficiency of their portfolios as some investments are not particularly tax-efficient. Both pre-tax and after-tax investments have potential advantages. (SEVEN ZERO ZERO THREE ONE ZERO ZERO)
What's a pre-tax investment? Traditional IRAs and 401(k)s are classic examples of pre-tax investments. You can put off paying taxes on the contributions you make to these accounts and the earnings these accounts generate. When you take money out of these accounts come retirement, you will pay taxes on the withdrawal.2
Pre-tax investments are also called tax-deferred investments, as the invested assets can benefit from tax-deferred growth.
What's an after-tax investment? A Roth IRA is a classic example. When you put money into a Roth IRA during the accumulation phase, contributions aren't tax-deductible. As a trade-off, you don't pay taxes on the withdrawals from that Roth IRA (providing you have followed the IRS rules for the arrangement). Thanks to these tax-free withdrawals, your total taxable retirement income is not as high as it would be otherwise.1
As everyone would like to pay less income tax in retirement, the tax-free withdrawals from Roth IRAs are very appealing. Given the huge federal deficit, the pressure is on to raise tax rates in the coming years - and in that light, after-tax investments look even more attractive.
It is also possible to convert a traditional IRA to a Roth IRA, so many investors are considering paying taxes on a Roth conversion today in order to get tax-free growth tomorrow.
Certain tax years can prove optimal for a Roth conversion and you should work with someone who has experience in both tax planning and financial planning to help guide you through the process.
Smart moves can help you reduce your taxable income and taxable estate. An emphasis on long-term capital gains may help, as they aren't taxed as severely as short-term capital gains (which are taxed at the same rate as ordinary income). Tax loss harvesting (selling the "losers" in your portfolio to offset the "winners") can bring immediate tax savings and possibly help to position you for better long-term after-tax returns.
If you're making a charitable gift, giving appreciated securities you have held for at least a year may be better than giving cash. In addition to a potential tax deduction for the fair market value of the asset, the charity can sell the stock without triggering capital gains.
The annual gift tax exclusion gives you a way to remove assets from your taxable estate. In 2015, you can gift up to $14,000 to as many individuals as you wish without paying federal gift tax. If you have 11 grandkids, you could give them $14,000 each - that's $154,000 out of your estate. The drawback is that you relinquish control over those dollars or assets.2
Are you striving for greater tax efficiency?
In retirement, it is especially important - and worth a discussion. A few financial adjustments could help you lessen your tax liabilities. The team at Retirement Solutions is here to help with that.
As a valued credit union member, you are welcome to attend any of our financial planning workshops or come in for a complimentary financial planning meeting. For more information, please call us or visit our website.
Bay Area Retirement Solutions
1330 Arnold Drive, Suite 249
Martinez, CA 94553
(925) 370-3750
Securities through First Allied Securities, a registered broker dealer, member FINRA/SIPC. Advisory services offered through First Allied Advisory Services, Inc. Registered Investment Advisor. Investments not FDIC or NCUA/NCUSIF insured, not insured by Contra Costa FCU, may lose value. Products offered are not guarantees or obligations of the Credit Union, and may involve investment risk including possible loss of principal. Contra Costa Federal Credit Union, Bay Area Retirement Solutions and First Allied Securities and all separate entities. Gene A. Schnabel CA Insurance Lic.: 0663016, Jason Vitucci CA Insurance Lic.: 0F59894
Citations:
1: denverpost.com/business/ci_27383286/ira-vs-401-k-which-is-better [1/25/15]
2: accountingweb.com/article/how-make-most-federal-annual-gift-tax-exclusion/224201 [12/18/14]
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