Tax filing is seasonal, tax planning is continual
In 1789, Ben Franklin stated, “In this world, nothing is certain except death and taxes.”
This still holds true today, and at this particular time of year, you’re probably busy gathering various forms and information you’ll need to file your taxes for 2022. While you’re in the mindset of taxes, there are many other year-round considerations that you may want to keep in mind.
During preretirement, you should be saving toward that magical day when you can finally retire. If your employer offers a retirement plan (401(k)/403(b), or SEP/SIMPLE IRA), this is usually the best and easiest way to save for the future — especially if your employer offers some type of match to your contributions. Additionally, but subject to certain income limitations, you can contribute to a traditional or Roth IRA. If you have sufficient earnings for the year, there is no minimum contribution amount, but your age will determine the maximum contribution you can make.
Keep in mind, you have until the tax filing deadline to make contributions for the prior year. As a reminder, traditional contributions are pretax so they can reduce your current income. Roth contributions are after-tax, but can grow tax free into the future. You’ll need to compare your current tax rate to your future tax rate in retirement.
Your retirement years are considered the “distribution” phase of life for your investments. Even if you’ve managed your own investments during your accumulation (working) years, this phase gets much more complicated.
To achieve maximum tax efficiency in your retirement years, it’s important to coordinate which account types from which to withdraw and at what time (i.e. taxable, tradition and/or Roth). You’ll also need to consider when you (and your spouse) should begin collecting your Social Security benefit and how you should take your pension benefit if you have one.
You’ll need to strategize the impact of IRA or retirement plan withdrawals prior to and after reaching your Required Minimum Distribution (RMD) age. (As an aside, this was just pushed out to age 73 effective in 2023 for those who are not yet at RMD age.)
One consequence often overlooked is the “Widow’s Tax Penalty.” This occurs when one spouse predeceases the other, and the surviving spouse begins to file as single instead of married filing jointly, often times subjecting the survivor to higher tax brackets. In retirement, you’ll need to compare your current tax rate to your future tax rate.
If you’re trying to plan how to minimize taxes on your estate, several options can be considered now, instead of later. Most folks are familiar with the annual gifting limit that is now set at $17,000 for 2023. But there is also a lifetime exemption beyond that amount that allows a cumulative amount of almost $13 million to be gifted away without any tax consequence. This amount is subject to be cut in half in 2026.
With the passage of the SECURE Act in 2019, beneficiaries to your retirement account are now required to fully deplete the account within 10 years (except for spouses), potentially adding a significant tax burden to those heirs. For estate planning purposes, you might give thought to the usefulness of a Roth conversion, and you’ll need to compare your current tax rate to your potential heir’s tax rate.
If all that wasn’t enough to think about, there is one more major issue with our current tax code. It is set to expire at the close of 2025, and with that sunset provision comes many areas of concern from higher tax brackets to decreasing lifetime gifting and estate exclusions. It may be wise to consult with your tax preparer and financial planner on these matters.
Don’t miss opportunities by ignoring tax planning. As the saying goes, failure to plan is a plan to fail. Be smart about your tax planning so you can minimize lifetime taxes by paying at the lowest rate over time.
Wendy Bennett is a senior financial adviser at Bennett Associates Wealth Management in Butler.
