Tax-Centric Financial Planning Strategies: Retiring soon? In this video and the article below, Patrick Kuster CFP, of Buckingham Strategic Wealth describes tax-centric financial planning strategies soon-to-be retirees should consider.

Article: Retiring Soon? Consider These Tax-centric Financial Planning Strategies

What are the top strategies soon-to-be-retirees should consider?

By Patrick Kuster, CFP

Today we’re going to discuss strategies to consider if you’re retiring this year — the things you may want to do that you may not have an opportunity to do again, or things you may have to do if you’re leaving the workforce before year-end. We’ll focus on the moving parts specific to retiring in 2022 and leave broader topics — like Social Security claiming strategies and withdrawal rate rules of thumb — for another time.

Here are some Tax-Centric Financial Planning Strategies every soon-to-be retiree can take.

Contribute the Maximum Amount to Retirement Accounts

Those retiring may want to consider making additional retirement plan contributions or adjusting their deferral rate to maximize their savings. You can make 401(k), 403(b), 457 and TSP contributions of up to $20,500 in 2022.

If you will be 50 or older this year, you can contribute an additional $6,500 for a total of up to $27,000.

Pay Attention to Your HSA

If you are currently enrolled in a high-deductible, HSA-eligible health plan, you may be eligible to make contributions to a health savings account (HSA). For 2022, individuals can contribute up to $3,650 and individuals with family coverage can contribute up to $7,300. For employees age 55 and older at the end of the tax year, contribution limits increase by an additional $1,000.

Retiring during the year can make HSA contribution limits a bit tricky, especially when you’re retiring and enrolling in Medicare Part B. Pay extra attention here in case your Medicare effective date is backdated (sometimes two months). For example, if you retired in July and enrolled in Medicare, your contribution limit would be cut in half for 2022, as you were only enrolled in an eligible plan for half the year.

Similar to retirement plan contributions, evaluate whether maximizing HSA contributions prior to retiring makes sense, but be careful not to go over limits.

If you have an HSA, consider using other funds for medical and dental purposes until at least 65. After 65, funds in the account, including any growth, can be taken out without penalty, and if they’re used for qualifying medical expenses, they are also income tax-free.

Retiring with Highly Appreciated Company Stock in Your Retirement Plan?

If you own company stock within a tax-deferred retirement plan, such as a 401(k), and that stock has seen substantial growth while you’ve owned it, look into net unrealized appreciation (NUA) strategies. NUA strategies may allow you to take out all of your company stock from the company plan while only paying ordinary income taxes on your cost of the shares today. Upon selling shares, any appreciation from the original cost (cost basis) is taxed at more favorable long-term capital gains rates.

While NUA transactions are not for everyone, those who just retired with significant gains in their company stock holdings, and especially those who may need short-term funds until turning on Social Security or receiving other retirement income, should speak with their financial advisor and tax professional. It’s worth noting that NUA transactions have special rules and requirements, such as the need to distribute all funds from the plan within one calendar year, so executing any NUA strategy requires careful attention.

Weigh the Benefits of Harvesting Losses

For non-retirement accounts, Uncle Sam doesn’t know that your investments are up or down until you sell. The goal of tax-loss harvesting is to generate a tax loss when investment values are down to offset future gains and seek to purchase back a similar (same asset class) but different (not substantially identical, per wash sale rules) investment.

As this strategy is essentially a tax deferral, it is especially beneficial when losses are generated at higher tax rates and offset by future gains at lower tax rates. If you think that you might have a heavy capital gains tax burden this year, or expect to stay at a similar or lower tax rate in retirement, talk with your ﬁnancial and tax professionals. They can help you identify whether loss harvesting may be a sound strategy for you.

Tax-Centric Financial Planning Strategies:

Contribute the Maximum Amount to Retirement Accounts

Pay Attention to Your HSA

Retiring with Highly Appreciated Company Stock in Your Retirement Plan?

Weigh the Benefits of Harvesting Losses

Pay Attention to Sequence of Returns Risk

Consider Which Investments to Own and Where

Review Beneficiaries

Age-Dependent Actions

Got Questions About Your Taxes, Personal Finances and Investments? Get Answers!

Pay Attention to Sequence of Returns Risk

How would down markets today impact your long-term retirement plan? Once you enter the phase of withdrawing from your portfolio, significant losses in the early years of retirement can greatly increase the odds of outliving your assets. As you approach retirement, understanding how much risk is within your portfolio is just as important as understanding assumptions surrounding expected returns. In fact, the beginning of retirement is an important time to focus on this risk, which only increases for those who may not be collecting Social Security or other income for some years yet.

So, what can we do?

Evaluate how much of your portfolio you will be withdrawing within the next few years and how this compares to down the road. Needing 10% of your portfolio in 2023 would obviously carry higher risk than needing 1%. You may want to consider being more conservative on the “extra” portfolio dollars you plan to use over the next few years and further diversify your investments. With potential interest rate increases on the horizon, this may mean evaluating CD or bond ladders for short-term anticipated income.

Another option is to plan on borrowing money during significant market downturns while you wait for market recovery. While this strategy still generally carries interest charges and there is no guarantee of a speedy market recovery, borrowing from home equity or a life insurance policy may turn out optimal if the only other option is selling while markets are down.

It’s also important to reflect on how you are feeling. Too often investors believe they are capable of stomaching more losses during downturns than they have an appetite for. You may want to take that into account in the future when you’re evaluating the risk in your portfolio and whether reducing it is prudent. This is especially true during the transition from contributing funds to withdrawing them.

Consider Which Investments to Own and Where

It’s generally optimal to prioritize tax-inefficient investments in tax-deferred accounts. This is to say that investments that produce dividends at ordinary income tax rates, such as income produced by bonds, are generally best prioritized to traditional IRAs or pre-tax retirement plan accounts, leaving most tax-efficient investments to non-deferred accounts, such as an individual brokerage account. Keep in mind that you need to consider how investment location impacts after-tax investment risk; owning the same dollar amount of an investment within a traditional IRA does not carry the same amount of after-tax risk as owning it within a Roth IRA or non-retirement account.

Ultimately, location optimization is about knowing how to prioritize which investments go to which accounts, primarily weighting after-tax expected returns, and understanding its implications when rebalancing. Specific to down markets, this means evaluating whether an opportunity exists to swap highest-expected-return, tax-efficient investments from tax-inefficient accounts (such as a traditional IRA or non-qualified deferred annuity) to a non-retirement brokerage account or Roth IRA.

Understand that selling for a loss within a non-retirement account can still potentially trigger wash sale rules when assets are purchased back in other accounts.

Review Beneficiaries

There is never a wrong time to revisit beneficiary designations to ensure they are up to date across financial accounts, insurance policies, and revocable trusts. This is especially true after a major life event, such as retirement. It’s important to consider the tax implications of how different assets might transfer among beneficiaries. For example, it may be better to leave a Roth IRA to the beneficiary in the highest tax bracket or to prioritize IRAs over other assets for “eligible designated beneficiaries” still able to “stretch” distributions over their lifetimes.

Age-Dependent Actions

There is nothing like retirement to remind someone that they’re getting older. Medicare benefits at 65, Social Security benefits somewhere between 62 and 70, required minimums distributions (RMDs) at age 72, and the list goes on. Because so many planning decisions are tied to age, we’ll approach retirement decisions through that lens.

Retiring Before Age 59½

Retiring before 59½ can create complications for those who aren’t retiring from public service or with retirement plans that allow penalty-free distributions before this age. And with early retirement, that also generally means no Social Security benefits or other income sources, making access to retirement savings dollars potentially even more important.

If you need income from retirement accounts that don’t qualify for an exemption to penalties before age 59½, consider substantially equal periodic payments. While there are efficient ways to implement such a strategy, this may work well if you plan to need at least five years of income from retirement dollars and the amount of income works in your financial plan.

If you are a participant in a retirement plan that allows distributions without penalty before age 59½, such as a 457 plan, be careful before rolling such plan assets into an IRA. While there are other potential benefits and disadvantages of rolling over such a plan, the ability to take out funds without penalty before 59½ if something comes up is a nice advantage.

Your 60s

These may just be the lowest income-tax years of your life, and potentially the years where you withdraw the largest portions of your portfolio. If you find that you will be in a lower tax bracket this year or within the next few years compared to down the road, it may be the right time to execute Roth conversions to take money out of your IRA before RMDs kick in or even to purposely generate capital gains if you are in lower gains rates.

While you can convert at any age and there is no income limit on Roth conversion eligibility, converting before Social Security and RMD income is generally optimal. Work with your financial advisor and tax professional to evaluate if converting funds from your pre-tax retirement accounts to a Roth IRA illustrates tax savings and would be in line with your financial goals. If you don’t rely on your RMDs to pay the bills or don’t think you will in the future, converting and pre-paying the tax now before balances grow may lead to lower taxes down the road. Whether you plan to convert is helpful to know earlier in the year for income planning purposes.

Also, take the time to evaluate Medicare premiums and keep an eye on costs. Speak to your financial advisor or tax professional about Social Security form SA-44 (Medicare Income-Related Monthly Adjustment Amount – Life-Changing Event) to see if you may be eligible to reduce your Medicare premiums as a result of retirement.

You’ll also want to keep an eye on modified adjusted gross income (tax number on your tax return used to determine your Medicare premiums two years down the road). Going over a Medicare premium tier by $1 can be expensive, so being proactive may help mitigate thousands of dollars in costs.

Your 70s

Don’t miss your RMDs. Once you turn 72, you must take RMDs from your traditional IRAs. If you turn 72 in 2022, you must take your RMD for 2022 by April 1, 2023, but every year thereafter you must take your RMD by Dec. 31. Therefore, if you wait past Dec. 31, 2022, to take your first RMD (perhaps waiting until as late as April 1, 2023), you’ll also have to take the second payment in 2023 by Dec. 31, 2023. The amount you must withdraw depends on your age, life expectancy, and account balance.

If you happen to be in a situation where you’ll end up with two RMDs within a single year, and if you are charitably inclined, consider a qualified charitable distribution (QCD) to satisfy all or part of the RMD while avoiding the increased Medicare costs and taxes.

If you turn 72 in 2022, you may also need to take an RMD from retirement plans. Similar to IRAs, the rule is that you have until April 1, 2023, to satisfy the initial RMD. It’s important to note that any “still working” exemptions to avoid a 2022 RMD are based on still being employed on Dec. 31. In other words, if you’re thinking of retiring close to the end of the year, you may want to consider officially retiring on Jan. 1, 2023.

Retiring can be a complicated process with many moving parts. But keeping these and other planning elements in mind as you map your way forward can smooth your transition and offer financial peace of mind as you begin life after work.

About the author: Patrick Kuster, CFP®

As a Wealth Advisor with Buckingham Strategic Partners, Patrick Kuster, CFP®, AIF®, knows that even the most thorough and well-conceived financial life plan is only as good as its implementation. He works closely with clients to help them solve their financial puzzle – pulling apart plans, rebuilding them, then seeing them through – and achieve their most important retirement goals.

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