How to Pay Taxes in Retirement - What Most People Get Wrong | Office Hours

Thank you everyone very much for joining us. We really appreciate your engagement and we really appreciate your membership here at Bolden. Welcome to our Taxes and Retirement live event. My name is Nancy Gates and I've been with Bolden since 2021. I joined the company as a coach and I'm now the lead educator here at Bolden. My mission at Bolden is to ensure that every single one of our members has the support and knowledge they need to confidently use our software to build their own customized, personalized financial plan. We've built a wonderful team of coaches here at Bolden since I joined in 2021, and tonight we are here with two of our wonderful coaches. So we have Debbie Perks joining us this evening from Texas and Jennifer Latimore as well, joining us from California. So I'm really grateful to both of you for joining me tonight to co-host this event. Thank you, Nancy. Thank you. This is a special office hours. We don't do these all the time devoted to the topic of taxes in retirement. These are the items we're going to cover this evening. After our brief welcome, we'll go into some housekeeping. We'll talk about your retirement paycheck, those sources of income that are blended together to pay your bills in retirement, how those different sources of income are taxed. How you might estimate your taxes in retirement, and then of course the tricky one, how you are going to pay those taxes in retirement. Then I have a couple of questions that I really appreciate people sharing with me beforehand. I'm going to begin with this presentation, then we'll go into the Q&A. Please do remember that these events are intended to provide general educational information around the financial planning, financial wellness, domain, so nothing discussed should be considered specific financial, investment, legal, or tax advice. As we all know, managing your financial life can be overwhelming at times, but it doesn't have to be. We here at Bolden can help with questions like: What income sources will I have in retirement? How will each source be taxed? What methods are available to manage tax payments in retirement? And more. Retirement comes with multiple changes. One of those is the end of that regular paycheck from your employer. Our retirement paycheck concept represents your method of funding the life you desire once you stop receiving those paychecks from work. Because each person's circumstances are different, each of you might have a different mix of income sources in retirement. This slide portrays the most common sources of income in retirement. The first potential source of income in retirement might be part-time or contract work or some type of passive income, for example, if you own rental properties. This might be followed by pensions, annuities, investment income such as interest and dividends, Social Security, and required minimum distributions. Required minimum distributions are the funds that the IRS is going to require you to withdraw from your tax-deferred accounts at 73 or later. You've deferred those taxes, the IRS wants them paid by the end of your lifespan, and so at 73 or later they're going to require you to distribute a certain percent of your tax-deferred accounts every single year. You don't have to spend it, but you have to distribute it and you have to pay the tax on it. While the work, passive income, pensions, etc. might be sufficient to fund your expenses, for most retirees they're not. And so when more income is needed, especially during the early years of retirement before your pensions or Social Security might begin, many people dip into retirement accounts. That's okay too, of course. That's what you've been saving for. To make matters even more complex, each of your retirement income sources is going to be subject to potentially different type of tax. The most common taxes paid by U.S. citizens are FICA, which is the payroll tax which funds Social Security and Medicare, federal income tax, state income tax, and capital gains tax. Let's look at how these apply to retirement income. Work income, maybe some consulting or part-time work after retirement, will be subject to FICA and federal and state income tax if you live in a state with income tax. Pensions are also typically subject to income tax at the federal level and quite often at the state level. Social Security, not surprisingly, has its own set of complicated tax rules. Between 0% and 85% of your Social Security might be subject to federal income tax because there's a calculation that's reliant on your total income, your income from pensions, distributions, etc. All but 9 states don't tax Social Security benefits, so for most of us, Social Security benefits are tax-free at the state level. Then we have investment income such as interest, dividends, and capital gains distributions in after-tax accounts. Taxable account earnings are taxed as earned or annually. Interest and ordinary dividends are subject to ordinary income tax. Qualified dividends and capital gains distributions as well as— sorry, are taxed at preferential or lower capital gains rates. The 3 brackets are 0%, 15%, and 20%. Tax on annuities will vary depending on the type of annuity, and Roth conversions, very popular with the Bowdoin population, are subject to income tax. We'll discuss tax on savings drawdowns in more detail on the next slide. So here's a little more granularity on the tax treatment of savings withdrawals. Withdrawals from interest-bearing accounts such as checking and savings money market accounts are not taxable. Taxes on interest is paid annually, paid as you go. Distributions from after-tax accounts holding equities may be subject to capital gains tax. Typically, you're not taxed on the basis of the account, you're taxed on the gains. Withdrawals from tax-deferred IRAs and 401(k)s, 403(b)s, 457s are subject to income tax, and qualified withdrawals from Roth, HSA, and 529—our tax-free accounts—are tax-free again, as long as they're qualified. So when you're working, your employer usually withholds taxes from your paycheck and makes those tax payments to the IRS for you on your behalf. Once you enter retirement, you're going to need to develop a tax payment strategy and ensure you're compliant with IRS regulations so that you avoid underpayment penalties and interest. The good news is the Bolden Planner can account for most common types of income and project your tax liability annually through your lifespan. This can serve as a foundation for your tax payment method or strategy. So in the next portion of the session, we're going to discuss the variety of ways you can ensure that you're complying with IRS regulations to pay the correct amount of tax at the right time. These are the two overarching rules that you want to be aware of regarding taxes. The first rule is that you want to ensure you are paying enough tax throughout the year. You're generally safe if you owe less than $1,000 in taxes at the end of the year. So after subtracting your tax liability and credits from your tax— subtracting your taxes paid from your tax liability, at the end of the year, if you're within $1,000, you should be safe from penalties and interest. You want to pay the full amount of taxes within $1,000 by the end of the year, by the due date. If you end up owing more than $1,000 when you file your tax return, you may still be in good standing if you meet what's known as the Safe Harbor provisions. The IRS Safe Harbor rule is a guideline to help you avoid underpayment penalties on taxes. It essentially provides a safe amount you need to pay even if you're outside that $1,000 band. As long as you pay at least 90% of your current year tax liability or 100% of the previous year's tax liability, you're generally in the Safe Harbor, safe from penalties. If your adjusted gross income was more than $150,000, these percentages increase, the percentage increases to 110%. So the first rule, be within $1,000 or fall within the Safe Harbor. The Safe Harbor is very helpful in retirement because our income levels are going up and down. There's a lot of inconsistency in retirement. The second overarching rule is you want to pay throughout the year. The IRS requires taxpayers to pay their federal income taxes throughout the year, either through withholding or estimated tax payments. So consider this a pay-as-you-go principle. If you don't pay enough during the year, you can face underpayment penalties and interest. As I said, you can generally avoid penalties if you owe less than $1,000 when you file or you meet one of the safe harbor rules, but you should still be paying as you go. So what does as you go mean? The IRS has 4 tax quarters, as you can see on this slide. The IRS, as a pay-as-you-go system, expects the tax liability of each quarter to be paid in that quarter. If you don't pay enough tax by the due date of each of the payment periods or quarters, you can be charged a penalty even if you're due a refund when you file your income tax at the end of the year. This is especially important in retirement. Let's say you take a large distribution or perform a large Roth conversion in January. If you wait to pay the tax until you file the next April, you could likely face a penalty. If you make a large distribution or Roth conversion in January, the tax liability from January should be paid in that first quarter of the year. If it looks like you're not within that $1,000 band and you don't qualify for a safe harbor, you need to be paying proactively during the year. And these are the four 4 primary ways to pay taxes during the year: withholding from income sources, withholding a percentage of a distribution, withholding 100% of a distribution, and making quarterly estimated tax payments. So we're going to walk through all 4 of these options. The first option available for paying tax liability is withholding. From potentially work income, pension income, Social Security payments, or other income sources, perhaps annuities. Withholding is treated as if it were paid evenly without— throughout the year, even if you increase it late in the year. So this makes withholding a really powerful planning tool. Here's an example: if you take a large distribution or perform a large Roth conversion in January, but you pay enough tax via withholding from your pension throughout the year, even if the tax liability of that large distribution or Roth conversion in January weren't paid by the end of the first quarter, because withholding is considered evenly throughout the year, you won't have a problem. So if you pay enough tax via withholding from your pension throughout the year, you may meet the pay-as-you-go principal and you won't pay— face penalties as long as your total withholding meets either that $1,000 band or the Safe Harbor provision. Option 2 is withholding from distributions. Most financial institutions allow you to elect a percentage of a distribution to be withheld for federal taxes. Let's say you're taking $2,000 a month from your 401(k) in retirement or your rollover IRA in retirement. You can elect to have taxes withheld, and your custodian will send them to the IRS, send the tax payment to the IRS for you. You do want to be mindful that financial institutions have default federal withholding rates they may be applying, if you're not making an election intentionally. The default federal withholding is 10% for IRA and pension distributions and 20% for 401(k) distributions. Like withholding from wages, taxes withheld from distributions are treated as if paid evenly throughout the year. This makes it another effective way to satisfy the IRS pay-as-you-go principle. Our third option is to actually schedule a distribution from, let's say, your rollover IRA and elect 100% withholding. How it works is that the entire distribution is withheld for taxes, leaving you with zero in cash. When you use this strategy, withholding is treated as if it were paid evenly throughout the year. So some retirees take a large distribution in December with 100% withholding to satisfy the pay-as-you-go requirement. So the key takeaway from the first 3 strategies is that these methods of withholding from income, from a partial distribution, or a 100— partially, sorry, a portion of a distribution, like I withdraw $2,000 and I withhold 20% of it, or I withdraw $100,000 and I withhold the whole thing. All three of those methods satisfy the pay-as-you-go principle, and as long as you pay enough tax during the year, the exact timing doesn't trigger penalties. Mind you that It's important to note that you're only going to use the 100% withholding when it fits your broader cash flow plan. The fourth strategy is making quarterly estimated tax payments. So if your tax withholding isn't enough, you can make quarterly estimated tax payments directly to the IRS. There are two really common methods for making the quarterly estimated tax payments. The Federal Electronic Federal Tax Payment System, EFTPS. This is a free service from the U.S. Department of Treasury. It's secure and useful for recurring payments. Or IRS Direct Pay. This allows you to pay directly from your bank account without fees. Note that payments are limited to 2 per quarter. So that's the information I wanted to cover today, and we're going to move into our Q&A portion of the event. Just some expectations and confidentialities. You know, all of our members are always incredibly gracious in our live events. Just some reminders to be respectful and supportive of fellow members. I see everybody already helping each other out in the chat there, so we always appreciate your engagement. And then of course, while open discussion is encouraged, just be mindful of what financial details you're sharing this evening. I'm going to go over a couple of questions here that were submitted previously, and then Jennifer and Debbie will be helping me take your questions from the chat. So please stop putting your questions in the chat. I'm going to open the Q&A, and the Q&A allows us to better manage your questions. So please place your questions, look for the Q&A, There we go. Jeffrey found it. Look for the Q&A on the Zoom toolbar, and we can take a couple of the questions from the chat. Jennifer and Debbie will bring them to me, but let's try to transition the Q&A to the Q&A. Um, it makes it easier actually for participants to view the responses and questions already asked and answered as well. Okay, so my first submitted question is this: Is there a way for me to reduce further RMDs without doing Roth conversions. I love this question. This is one of my favorite questions. Based on the Bolden software, I appear to be in great shape utilizing the traditional withdrawal order. My concern is withdrawal order taxes and Roth conversions. The traditional withdrawal strategy has me consuming all of my taxable funds first, and I would prefer to draw from both taxable and tax-deferred Simultaneously. So like many retirees, this individual's looking interested in a proportional withdrawal strategy, wherein let's say I need $100,000 a year. Instead of taking the $100,000 a year from the brokerage account or straight from the IRA, they'd like to do maybe 50% from each. That's a proportional withdrawal order, and it can be very tax efficient. Is there a way for me to reduce future RMDs without doing Roth conversions? I'm open to Roth conversions, but I'm getting mixed signals and want to preserve cash. So yes, one way to reduce future RMDs without performing Roth conversions is to fund retirement expenses from tax-deferred accounts, whether you're doing a proportional withdrawal strategy where you're pulling some of your expense funding from taxable and some from a pre-tax, or you're just funding all of your retirement expenses from a pre-tax account. That is one method of reducing future RMDs without performing Roth conversions. Question 2: How does Bolden create realized gains? Bolden creates realized gains on an after-tax account with the capital gains tax treatment, and there are 3 things that impact the Bolden realized gains. Number 1 is in your data entry, if you put a number in the turnover rate. Most— not most— many of our users hold index funds, which are very tax efficient. You should be putting zero in the turnover percentage rate in the software if you are one of those individuals. The turnover rate is not the same as you would see on Morningstar, for example, for turnover for your particular fund. The turnover rate in Bolden is simply a lever to increase realized gains. The second input that creates capital gains in Bolden is dividend yield. So one of the data fields for an after-tax account with the capital gains tax treatment is dividend yield. If you put a percentage in there, the software will create dividends. You'll see that on the gross taxable income by source chart, and it will be also represented in our software as a realized gain and taxed at your long-term capital gains rate. The third thing that creates realized gains in Bolden is a distribution from a taxable account with the capital gains tax treatment. In Bolden, a distribution from a capital gains account with the taxable account with the capital gains tax treatment will create a gain. The gain is the difference between the distribution and the cost basis, and the gain will be taxed at your long-term capital gains rate. By the Bolden platform as per IRS regulations. So questions 3 and 4 are a strategy which I've heard of, um, but I'm not going to confirm or affirm or deny this strategy. So can Roth conversion taxes be paid via brokerage withholding followed by within 60 days redepositing outside cash back into the Roth once again to make it whole. Question 3 and question 4, I think, are both the same question here. If so, how often can this be done per tax year? Can it be done? I don't know. So I'm sorry to say I'm not a financial advisor. This is a complex strategy. I have heard of it, but I cannot advise or provide further information about this. And I think this is the same question. I saw one example. I think we must all be watching the same YouTube video or something, but I saw an example where the person was converting but having the broker withhold state and federal taxes, and then they contributed $25,000 from an after-tax savings account to their Roth. I don't think you can contribute $25,000 from an after-tax account to your Roth. So I'm not sure who's pushing this strategy out there on, on YouTube or whatever, but I hate to say I did get 2 of these in my inbox, so it seems to be a hot topic. But I, I don't know. I, I'm sorry to say I don't know. Before we move in, um, off the screen here, I just want to let you know that we do have a coaching service here at Bolden. Jennifer, myself, and Debbie are all Bolden coaches, and so our role is to walk our users step by step through their plan, understand your situation, your circumstances, your values, your goals, help you confirm that you've entered everything accurate in your plan, help teach you more about the tool so you're leveraging it to your greatest potential so that you can make the important life decisions you want to make. We don't provide any specific recommendations or advice. If you're looking for fee-only financial advice, not AUM financial management or asset management or anything like that. Bolden Advisors has a wonderful team of advisors who will collaborate with you on your Bolden Plan, and they'll cover every aspect of your plan. They'll stress test your plan, they'll go over your investment strategy, they'll discuss a 5-year cash flow plan, double-check your tax strategy, estate planning strategy, charitable giving strategy, Social Security claiming strategy. It's a very complete, comprehensive offering. So I want to appreciate— thank everyone very much for your engagement, for your membership. Thank you, Debbie. Thank you, Jennifer, for co-hosting for us this evening and making this event a successful one. So thanks for joining us, everyone. Have a great night and happy planning.