Office Hours - Taxes in Retirement

I'm so excited that you're all here. My name is Nancy Gates. If we have not met, I'm the senior manager of services here at Bolden. That encompasses our support, including the help center and the chatbot, the coaching and the classroom and live events. Our goal here is to support, educate and empower you so that you can live your financial lives with confidence. And today's session is a special office hours. And today we have a session devoted to the topic of estimating and paying taxes in retirement. So not really so much about optimizing taxes or tax strategies. We discuss some of that in our Roth conversion office hours. Our agenda today is the welcome and housekeeping, which we've taken care of. We're going to discuss a little bit about what we call the retirement paycheck. And that's actually going to be our next special office hours, the retirement paycheck, which discusses the different sources of income each individual might have in retirement. We'll discuss those sources of taxable income, how they are treated by the irs, estimating your taxes, and then the labyrinth for paying your taxes. Once your employer is no longer doing that for you, managing your financial life can be overwhelming. But it doesn't have to be. Here at Bolden, we can help with questions like what income sources will I have in retirement? How will each source be taxed? And what methods are available to manage tax payments in retirement and more. Retirement comes with multiple changes. One of those is the transition from regular paychecks from your employer to creating your own paycheck of sorts. Because each person's circumstances are different, each individual will have a variety of different income sources in retirement. Our retirement paycheck represents a method of funding the life you desire once your direct deposits from work stop rolling in. Basically, each retiree will need to develop their own strategy to fund retirement expenses. Again, we'll discuss that in another office hours two weeks from today. This slide presents the income sources most common to retirees. Note that each of these sources of income may have an impact on your federal income taxes, state income taxes, capital gains taxes, and more. So today we're going to discuss a number of topics, hopefully help you get your arms around your retirement taxes. As I said, each individual person may have a number of different sources of income in retirement. And to make matters more complex, each of these income sources might have a different tax treatment. In order to estimate your retirement tax liability, you'll need to have a solid understanding of the tax implications of each of these income sources. The most common tax paid by US Citizens are fica, otherwise known as payroll tax, which funds Social Security and Medicare, federal income tax, state income tax, and capital gains tax. Specifically, your income from work will be subject to to FICA and federal and state income tax. If you live in a state with income tax, income from pensions, annuities, interest and traditional OR PRE tax 401k and IRA distributions will be subject to federal and state income tax. A lot of complexity around annuities, so that's a generalization when it comes to annuities. Social Security has its own fund set of complex tax rules and depending on your income, between 0% and 85% of your Social Security income may be subject to federal income tax. Social Security taxation differs per state and all but nine states don't tax your benefits and those state taxes on Social Security should be portrayed accurately in our software. Your investment income in after tax accounts will be taxable and we'll discuss those details further on the next slide. Along with the tax treatment of savings drawdowns, we do have a retirement readiness tax planning course for more information around taxes and tax planning. So now we're going to get a little more granular on the tax treatment of investment income and savings drawdowns. Investment income is a term used to describe interest dividends and capital gains distributions. Investment income in after taxes accounts is taxed as it's earned or annually, while investment income in retirement accounts is not taxed as earned but taxed upon distribution. In after tax accounts, interest and ordinary dividends are taxed are subject to federal and state income taxes. Qualified dividends and capital gains distributions are taxable annually at preferred or lower capital gains tax rates. These are the preferential 0%, 15% and 20% capital gains tax rates. While some investors prefer dividend earning investments, others invest in tax efficient mutual funds or ETFs to mitigate taxes from dividends and capital gains distributions. So your annual taxable income from dividends and capital gains distributions relies a great deal on your investment choices. Withdrawals from equities in brokerage accounts or after tax accounts are subject to capital gains tax but only upon the gains. So only gains in after tax accounts are taxed when withdrawn because the basis was taxed when you earned it prior to investing. State taxation of capital gains will differ depending on your state. Withdrawals from interest bearing after tax accounts such as checking savings money market and high yield savings accounts are not taxable. Withdrawals from pre tax traditional and IRAs and 401ks and the like. You know your 403B, your 457 your 401 are subject to federal and state income tax. If you live in a state with income tax for the most part, then you have your qualified withdrawals from Roth HSA and 529 accounts which are tax free. Any questions for me on the tax treatments of retirement income? Any comments Corrections. All right, so far so good. When you're working, you might not be highly aware of what you're withholding each year. Many of us are. But your employer is usually withholding taxes from your paycheck and making those tax payments to the IRS on your behalf. So a lot of people, as long as they're pretty dialed in when they file their tax return in April, don't pay a lot of attention to their withholding unless maybe they're large life changes. Once you do enter retirement, you will need a greater understanding of those types of taxable income and how each is taxed so that you can determine your annual tax liability. Then you'll need to develop a payment strategy because you want to ensure that you're compliant with the IRS regulations for tax payments. The IRS expects taxpayers to pay their taxes as they earn or receive income throughout the year. The good news is that our software accounts for the most common types of income and can help you project your tax liability annually through your lifespan. That can serve as a foundation for your tax payment methodology or strategy. So it's super important if in retirement, to ensure that you're paying the correct amount of tax at the correct time. In this portion of the session, I'm going to discuss the ways to ensure that you comply with the IRS requirements so that you can avoid tax penalties and paying interest to the irs. The IRS requires, as I said before, taxpayers to pay their federal income taxes throughout the year, either through withholding or estimated tax payments. I call this the pay as you go principal. The tax year consists of four quarters as seen here. The IRS expects that the tax liability of each quarter is paid in that quarter. If you don't pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you're due a refund when you file your income tax return. This is more important in retirement because if you perform a Roth conversion in January, for example, and wait until you file taxes for the next year to pay the taxes, you could face a penalty. Along with the principle of pay as you go, it's essential to ensure that you're paying enough tax throughout the year to avoid penalties and interest. You are generally safe if you owe less than $1,000 in taxes after subtracting withholdings and credits when you file your tax return in April. If you aren't within that $1,000 range, you might avoid penalties by meeting what's known as the Safe harbor requirements. The IRS Safe Harbor Rule is a guideline that helps you avoid underpayment penalties on your taxes. It essentially provides a safe amount that you need to pay to avoid penalties, even if you end up owing more. When you file your tax return, the general criteria are that you pay at least 90% of the current year's tax tax liability, that is, or 100% of the previous year's tax liability. So if you pay at least 90% of this year's tax liability or 100% of last year's tax liability, you're generally safe from penalties. If your adjusted gross income was more than 150,000, the percentage increases to 110%. So the IRS has these rules in place to ensure that you pay a sufficient amount of your tax liability through the year and don't end up owing them $10,000 in April. Any questions for me on the timeliness, the $1,000 rule or the Safe Harbor? So now you're probably wondering, gosh, how am I going to pay these taxes on time and pay the right amount so that I don't end up owing penalties and interest? This slide portrays four methods that you can take advantage of to pay your taxes. You may withhold from your income sources such as pensions, annuities, and Social Security. You may withhold a percentage of a distribution. You may withhold 100% of a distribution, or you may make those quarterly estimated tax payments. The first option available is withholding from work, pensions or other income sources. So, as I said, 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 return. However, I have the IRC section here, but I'll skip the Internal Revenue Codes section where this stated but the IRC code Internal Revenue New code states that pension withholding is treated as if it were spread evenly throughout the year, regardless of when the payments are actually made. This means that tax withholding from your pension payments is calculated to cover your estimated tax liability for the entire year, similar to how the withholding from regular work wages works. For example, if you perform a large Roth conversion in June and don't pay the tax by September 15, you could face a penalty. But if you pay enough taxes via withholding from your pension or work through the year. You won't face penalties and interest as long as the annual amount withheld meets the guidelines. So if you have pensions or annuities, you might consider this withholding strategy. When you do that, distributions and the timing of Roth conversions will matter less. Some individuals prefer to manage their annual tax liability through withholding in order to avoid making quarterly payments. Of course, it's still important to ensure your total withholding meets the safe harbor rules. The second option available for paying taxes is withholding from distributions, and most financial institutions will allow you to elect to have taxes withheld. Your financial institution may rely upon default federal withholding rates unless you elect otherwise, and the default federal withholding rate for IRA and pension distributions is 10%, whereas the default federal withholding rate for 401k and lump sum distributions is 20%. State withholding may also apply depending on your state, though to my knowledge, I'm not sure if one of you can tell me whether your financial institutions allow you to select state income tax withholding when you schedule your distributions. Yes, they do. Thank you. You can change your opt out of withholding by submitting Form W4P for periodic payments or Form 4WR for lump sums to your plan administrator. Another way to manage taxes is ensure that and ensure that your retirement tax liability covered and avoids underpayment penalties is to schedule a distribution and elect 100% withholding. Because the IRS rules treat all tax withholdings as being paid in equal amounts throughout the year, some retirers actually make large distributions with 100% withholding in December, and it retroactively covers earlier shortfalls. In effect, if you elect 100% withholding, the entire distribution is withheld for taxes, leaving you with $0. By using this strategy, you can make up for underpaid taxes from earlier quarters without making quarterly estimated payments, and you avoid tax underpayment penalties and ensure your tax liability is covered. Bear in mind that the IRA distribution itself is taxable income, so the full amount withheld will increase your taxable income from the year. It becomes one of those fun looping processes, and the fourth choice for paying taxes in retirement is making those estimated quarterly tax payments. If your tax withholding isn't enough, you can make quarterly estimated tax payments to the IRS. The due dates are April 15, June 15, September 15, and then January 15 of the subsequent year year. You'll use Form 1040ES to calculate and pay, and there are a variety of different payment methods available, such as the IRS Direct Pay, other online payments or mailing the IRS a check. So this slide summarizes some planning topics we covered today and some next steps you might want to consider as well. Identify those income sources and the tax treatment of each source leading to determining your tax liability. Then you can determine your payment strategy. And then once you working on implementing that payment strategy, you can update any withholding on distributions or income sources and then if necessary, schedule estimated tax payments. Thanks everyone very much for joining to me joining me today. It's always wonderful to see you. Hope you have a great day and we'll see you next time.