Benjamin Franklin famously said that "in this world, nothing can be said to be certain, except death and taxes." With April 15 right around the corner, let's talk about the more palatable of Franklin's two certainties.
Taxes don't disappear in retirement--and they can be an important variable in determining your standard of living. Good planning helps, so I asked several top financial planners to share their best ideas for reducing your tax burden in retirement. Here are the top five ideas I heard:
Get ready for higher taxes. Most financial pros say we'll be paying higher taxes sometime in the next few years--no matter who wins the November presidential election. A case in point: The Bush Administration's reductions in capital gains rates likely will be allowed to expire at the end of 2010. For most taxpayers, the current long-term 15 percent rate will jump back up to 20 percent. So, consider looking for sensible opportunities to sell appreciated stocks held in taxable accounts before then. Often, these are stocks that may have become overweight in your overall portfolio mix. "Use the proceeds to diversify your holdings," advises Kevin Dorwin, a portfolio manager at Bingham, Osborn and Scarborough. One good way to do that he says, is to buy a broad mix of stock and bond index funds.
Harvest your losses. The stock market may be a basket case, but Dorwin sees a silver lining in capital losses. He advises selling securities in your taxable account at a loss; the losses can be used to offset gains from other equities.
"You can also use the sales proceeds to purchase a similar--but not identical--investment to maintain your overall strategy," he says (under the federal tax code, if you buy a "substantially identical" security within 31 days of the initial sale, the loss is disallowed).
Go easy on the 401(k). Most planners recommend that you contribute the maximum allowed to your 401(k) account. After all, you're socking away untaxed dollars that will grow sheltered from taxes; and, if your company matches your contribution, that's free money. But Joe Baker, president of Alcus Financial Group, cautions that you shouldn't max out your 401(k) at the expense of more immediate financial needs.
"Perhaps you need some of that money to pay college tuition, a house or a car," he says. "You don't want to wind up pulling money out of your retirement account early, because you'll pay a financial penalty and set back your long-term retirement goals."
One extreme example of poor retirement fund allocation is the recent sharp rise in the number of Americans raiding their retirement accounts to make mortgage payments to avoid foreclosures. That's a worrisome development for American retirement security, and it's a predicament you want to avoid.
Give away your stocks. If you're holding highly appreciated stocks in a taxable account and plan to make a sizeable charitable gift anytime soon, donate the shares instead of cash. You'll be able to deduct the value donated from your income taxes, and avoid paying capital gains taxes. The charity will be protected from capital gain liability as well, due to its non-profit status. "If you're going to give anyway, this is usually a better way to do it," says Dorwin.
Gimme shelter...sometimes. Tax-sheltered retirement investing is a key part of any retirement plan. But it makes sense to keep some retirement assets in taxable accounts. If all your assets are in tax-deferred vehicles, it's all taxed as ordinary income on withdrawal--and that can have negative consequences for your overall tax situation in retirement.
"You'll find that your tax rates and brackets are fluid in retirement," says Jon Beyrer, vice president of financial planning at Blankinship and Foster. "Sometimes taking a distribution from a tax-deferred account can wind up putting you in a higher overall bracket than you want to be in." Withdrawal from a taxable account may trigger a capital gain liability, but offers a flexible choice in managing your tax bracket.
Investments that may make sense in a taxable account--all other things being equal--include municipal bonds (they're tax-free); exchange-traded funds, which offer better control of capital gain liabilities than mutual funds; and blue-chip stocks that pay qualified dividends, which carry a relatively low 15 percent federal tax rate.
Time is money. Actually, Ben Franklin said that, too. Maybe he should have been a financial planner.
For millions of Baby Boomers, retirement is an opportunity for reinvention, rather than taking it easy. Mark Miller is helping write the playbook for the new career and personal pursuits of a generation. Contact Mark with questions and comments at mark@retirementrevised.com