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How Tax Planning Changes Through Four Stages of Retirement Part V - Timing and Planning

How Tax Planning Changes Through Four Stages of Retirement Part V - Timing and Planning

| September 28, 2020
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If you’ve been following our series on tax planning and the four stages of retirement, you have quite a bit of knowledge under your belt at this point!

We have covered the first steps to understanding the changes that can occur, developing solutions through those changes, Social Security, and Medicare.

After learning about all the traps out there, you may be still wondering...are there more?!

That’s what brings us to our next point…

You must plan how and when you will use taxable, tax-deferred, and tax-free assets to manage your income and tax brackets efficiently.

You can’t be haphazard about tapping your tax deferred savings. Timing is everything and if you don’t plan carefully, through all stages of retirement, you’ll encounter unintended tax consequences.

Let’s take a look by first addressing a question I hear often when doing retirement planning: “Which accounts to spend first?”

Here’s a common example, Sam and Mary.

They have been good savers, as you can see, and are looking forward to spending their retirement years traveling and seeing their grandchildren. In addition to Social Security benefits, they have:

  • $450,000 each in an IRA
  • $60,000 each in a Roth IRA
  • $300,000 in a joint bank account

They want to spend about $8,500/month, or just over 100k/ year. 

Where would you take money from first?

Most people think “first take the after-tax money in the bank, then take the tax-deferred IRA money, and then take the tax-free Roth IRA money." This is “conventional wisdom.” It has been promoted by many big investment firms for some time. It’s not a bad plan, but we know conventional wisdom isn’t always the best approach.

Not surprisingly, this topic has drawn the attention of academic researchers specializing in financial planning. They’ve conducted multiple studies on how to prepare for retirement using a combination of Social Security, taxable bank accounts, tax-deferred accounts like IRAs and pensions, and tax-exempt Roth accounts. You can see some study titles there.

Their research has shown that the conventional wisdom approach probably isn’t ideal.


Here, in an alternative approach, there are two key elements in the early years: First, use the taxable bank money for expenses. But also during the same period, accelerate IRA distributions during otherwise low-income years, putting that money into Roth accounts. This is the “filling your tax bracket” approach which we’ll discuss in a second. This alternative approach gives you more flexibility to use that tax-free Roth money strategically in future years.

Does it make a big difference? I think so. In the academic studies, this approach has been shown to increase portfolio longevity, that is how long your non-Social Security assets last before being totally spent, by up to two years.

The big takeaway here, of course, is that you’ve got to plan all the way through retirement, especially around how you handle your tax-deferred assets. 

And, of course, see your tax professional for tax advice.


One way to help manage your income both before and during retirement is to utilize Roth IRA conversions. 

A Roth IRA conversion is a simple process that allows you to move money from an IRA, or other pre-tax retirement account, like a 401(k), to a Roth IRA.

In general, the amount that you convert is added to your income for the year, and will be taxed at your rate.

For example, if Jill converts $100,000 from her IRA to a Roth IRA, she will have to add $100,000 to her income. The conversion income will be taxed at Jill’s rate

For that reason, it’s recommended that prior to making any conversion, you consult with your tax professional.

A conversion doesn’t need to be all-or-nothing, though. One helpful conversion approach is called “filling up the bracket.” 

Often, you may find yourself in the middle of one of the tax brackets with room to add more income without pushing yourself into a higher bracket. For example, in 2020 the 22% tax bracket for married couples filing a joint return goes from about $80,000 to about $170,000.

If you file a joint return and your taxable income is $100,000, that means that you could add another $70,000 of income without going into the next bracket. Making a Roth IRA conversion like that could make sense. 

If you plan to convert a large IRA, this approach is often more tax efficient than converting the full amount in one year. Instead, you can make smaller Roth IRA conversions over a number of years, filling up your bracket each time. This can help reduce the average tax rate you’ll pay on your converted money and also spreads the tax bill out over a longer period.

Roth IRA conversions can be especially powerful in years when your taxable income is low, such as having a high non-recurring medical expense deduction or a low sales year for a business owner.

It’s also common for people who retire early and are not yet receiving Social Security benefits, pensions, or IRA distributions. They may have a very low tax bracket, making it a good time to complete Roth IRA conversions in those pre-RMD “gap years.”

So this is a good time to spell out the crux of things: You must know whether you’re trying to keep income below a bracket threshold to avoid bumping up to the next highest tax rate… 

Or whether you’re trying to increase income to fill up a bracket to take advantage of that tax rate.

Some tactics you could use in managing income around tax brackets might include:

  • Withdrawing tax-free money from life insurance policies to keep income low
  • Selling highly appreciated stock for low or no capital gains
  • Taking distributions from IRAs or 401(k)s to take advantage of a lower tax rate

And, as we’ve seen, you can also consider partial Roth conversions to fill up lower tax brackets.


There are also two other pre-retirement strategies to consider, but they don’t apply to all people.

The first has to do with how you use a health savings account. This would only apply to people who are covered by a high deductible health plan (HDHP). 

The second has to do with high-earning small business owners who fund company pension plans and become eligible, under the new tax law, for something known as the qualified business income, or QBI, deduction.

Both of these features of the tax code could be used to manage your tax exposure and provide significant tax-favored benefits throughout retirement. 

If either or both of these apply to you, go ahead and note that now on the questions area of your evaluation form and we can discuss it later.

We’ve seen throughout our series the critical importance of managing our tax-deferred accounts. Because once you’re over 72, you’re forced to take out required minimum distributions, or RMDs. And that can be troublesome to your tax bill.

But many people make charitable donations, supporting their favorite nonprofit with annual gifts. So let’s look at how your RMDs and charitable giving may work for you with some planning.

Meet Albert and Shirley, who are in the new 24% tax bracket. Now, the standard deduction for a married couple filing a joint return in 2020 is $24,800. But Albert and Shirley are over 65, so they each get an additional standard deduction bringing their total standard deduction for 2020 to $27,400

This means they will receive no tax benefit for any itemized deduction unless their total exceeds that $27,400 mark.

So, if Albert and Shirley have $15,000 of existing itemized deductions, say from state and local taxes, deductible medical expenses, and mortgage interest, what happens tax-wise if they donate $5,000 to charity?

They get no federal income tax benefit from making the charitable contribution because it doesn’t exceed their $27,400 standard deduction.

That’s not to say they shouldn’t do it, but they should understand it’s not helping them save on taxes.

But we all know charity starts at home. So it’s a natural question to ask, “How does retirement tax planning figure in?” 

It’s a very good question, because the government still wants its share of those tax-deferred assets when you pass away.

And like we’ve seen, how you set things up really matters. Which leads us to…


Organize your assets for your family’s benefit (estate planning still matters).

Estate planning is always a relevant topic, even though people don’t like to discuss death.

But we’re not going to discuss it in the traditional way. That’s because the new tax law excludes estates valued at up to $11.4 million from the federal estate tax, meaning only the tiniest fraction of people need to worry about estate taxes. [Note: you may still face an estate or inheritance tax at your state level.]

Still, very important tax issues remain around how your assets are received by your beneficiaries after you die. 

One example is making sure married couples plan for their available “step-up in basis.” That’s quite a tax term, right? 

Simply put, a step-up in basis is a tax rule that readjusts the value of an inherited asset so its value is NOT what your spouse or decedent paid for it initially. Instead, it’s “stepped up” to its price on the date of death. This can make a big tax difference as we’ll see.

It’s likely that most assets you own, other than your retirement accounts and annuities, will be eligible for a step up in basis.

Let’s consider Phil and Mary, who live in a separate property state.

They’re married and own a variety of taxable investments in a joint account known as “joint tenants with rights of survivorship (JTWROS).”

And the investments have long-term capital gains of $120,000.

One day, bad news arrives: Phil is diagnosed with terminal cancer. He has 18 months to live.

Scenario 1: Do nothing after diagnosis

Let’s see how this works with two scenarios. In the first, Phil and Mary make no planning changes to their assets.

When Phil dies, Mary will receive a step-up in basis on Phil’s half of the joint account, which is $60,000. She’ll still face a future $60,000 of unrealized gain on her half of the account.

Simply put, that means if Mary decides to sell all the assets, she’ll owe tax on her $60,000 of gain.

Scenario 2: After diagnosis…

Now suppose that upon Phil’s diagnosis, Mary and Phil moved all the investments into one account in Phil’s name. Then, as long as Phil lived longer than one year, Mary would receive a full step-up in basis on the entire $120,000 account.

Simply put, Mary could sell that account and pay no tax.

When you sell your investments, would you rather owe tax on $60,000 of gain or none?

And let me say, planning around death is hard. But this is where a professional can help because they are emotionally removed from the situation, and can assist you to make good decisions that may seem hard at the time.


Ok, enough about death… let’s talk about long-term care!

Believe it or not, there are a number of tax breaks associated with long-term care insurance.

For example, long-term care premiums may be a deductible medical expense at the federal level and possibly eligible for deductions or credits at the state tax level.

And on the other side, if you are receiving long-term care benefits, in many cases those benefits are tax-free. For instance benefits received from reimbursement-style policies are tax-free. In addition, cash benefit-style policies are tax-free if they don’t exceed the higher of your actual long-term care costs, or an IRS daily limit, currently $380.

Choosing HOW you pay for long-term costs can have a big impact on your estate and your heirs.


In recent years, non-traditional long-term care policies that blend together some long-term care insurance and life insurance have become popular. Often, the first inclination of the insured here is to tap the policy to pay for long-term care costs, but that’s often a tax mistake.

Let’s take a look at Florence, a widowed woman who qualifies for long-term care benefits and lives at home with in-home care. Her yearly care costs are $60,000.

Florence’s Social Security benefit is $20,000 in annually, which covers her basic expenses, but not long-term care. She also has $400,000 in an IRA, and a life insurance policy with a long-term care rider that will pay $500,000 to Florence’s children upon her death. Alternatively, Florence could use up to $10,000 per month for long-term care costs. Any amounts used for long-term care will reduce the life insurance death benefit.

Please note: this is just an example, and is not meant to represent any specific policy, but many long-term/life-insurance hybrid policies work this way.

Scenario 1: Florence uses LTC policy to pay for five years of care 

First, suppose Florence is infirmed for five years and uses her policy to pay for long-term care expenses. That's why she bought it, right?

Here, Florence pays little to no income tax during this period because she’ll have such large non-reimbursed medical expense deductions. The $500,000 policy pays out $300,000 – $60,000 per year for five years.

That means her kids will inherit tax-free life insurance of $200,000, the remainder of the $500,000 policy value. In addition, her children will receive the $400,000 in her IRA, which will be taxable to them.

Scenario 2: Florence Uses IRA to pay for care 

Now, let’s suppose Florence lives for the same five years, but uses her IRA money to pay for the long-term care expenses instead. Florence still pays minimal income tax per year because of her high medical expense deduction.

And now, the kids will inherit the $500,000 of life insurance completely tax-free, as well as roughly a $100,000 of remaining IRA money which will be taxable.

Comparing the scenarios, the ultimate net benefit is unknown because it depends on Florence’s children’s tax rates. 

But it’s hard to imagine a scenario where paying for her care with $300,000 of taxable money, with minimal cost to Florence, is not a better option than paying for her care with $300,000 of tax-free money.

In the second scenario, we’re preserving the tax-free money for the heirs and paying for the long-term care with Florence’s taxable IRA money.


We started with a clear statement about the problem: Retirees often pay more taxes than expected because a confusing system treats various income types differently and contains hidden taxes and penalties.

Let’s do a quick review of what we learned about the four stages of retirement.

Under the pre-retirement heading, we saw the importance of understanding the “after-tax” value of your retirement savings BEFORE you retire. And we also saw that in those pre-retirement years, it’s critical to consider your tax-deferred savings and start taking advantage of funding Roth accounts to fill your brackets, something you’d do through your early retirement years in low tax years.

We also looked at Social Security and taxes. And we saw Medicare has its own tax-like structure that can push you off the “IRMAA cliff,” and we saw the importance of signing up for Medicare on time, right in the middle of those early go-go years.

That’s because starting in your middle retirement years, you’ll be confronted with required distributions and we’ve seen the importance of planning your income needs before then and the tax issues involved.

And then we saw the importance of setting up your assets and managing them during the later years of retirement so that you can preserve the most for your heirs and leave them with the most tax flexibility.

All those items together lead us to this obvious solution to our original problem.

Because your tax exposure will change throughout retirement, you need a strategy that:

  • Anticipates how and when you tap assets to cover your personal expenses 
  • Understands the range of taxes you will face at various stages 
  • Manages your actions so you pay as a low a tax rate as possible


By following us through this series, you’re indicating that you’re preparing to leave the accumulation phase (saving for retirement) and moving to the distribution phase, when you start spending retirement assets.

We’ve seen that the distribution phase is more complicated than working and collecting a paycheck. Managing your tax rate through the four stages of retirement is part of the challenge of retirement planning. We’ve seen the cost of mistakes. 

Naturally, we want to be efficient with our savings and there are strategies to reduce your tax burden. But, as with many things in life, this takes education and planning and advice.

It's a lot to think about. Our tax code is complex, and the rules keep changing. But what doesn't change is that you need a plan.

We hope you have enjoyed this series. If you have any questions or would like to request a meeting with me regarding planning for your retirement, don’t hesitate to send me an email at! I hope to hear from you!

Advisory services through Capital Advisory Group Advisory Services LLC and securities through United Planners Financial Services of America, a Limited Partnership. Member FINRA and SIPC. The Capital Advisory Group Advisory Services, LLC (CAG) and United Planners Financial Services are not affiliated.

The views expressed are those of the presenter and may not reflect the views of United Planners Financial Services. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Neither United Planners nor its financial professionals render legal or tax advice. Please consult with your accountant or tax advisor for specific guidance.

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