Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler, talking about money and investing. So one of the absolute biggest things that we have to consider in financial freedom — in getting to financial freedom and being able to retire — one of the biggest things is just investing well and investing right. So mainly on this show, that’s what we’ll be talking an awful lot about — academic research.
Investment Providers Following Research
Some of the studies that I’ve seen recently are eye-opening on how few investment providers actually follow the research that has been out there and has been worked on for 70 years in terms of what constitutes for investment of a management or management of an investment portfolio. And it’s like we see a lot of stock picking, market timing, but it’s never called that, as we’ve talked about before. It’s usually called tactical asset allocation or different terms are used, but we see people saying, “Hey, let’s just put a little bit more money in this or pull more money out of that.”
What ends up happening is that investors don’t recognize that it’s not that they lose money, it’s that they end up with relative losses.
As we see in the research, they have returns that are much lower. So that’s one of the biggest things.
But there’s another thing that gets talked about an awful lot and quite often but is not necessarily focused on enough is the tax issue. And when it gets down to it, you have to really stay on top of taxes.
We actually were playing around in the office here and we were looking at how many tax law changes have there been over the past, I forgot how many years, but our minds were blown at how many tax law changes there had been over a 20 or 30-year period. I forgot what it was, but it was eye-opening. So we did a workshop talking about taxes and things that you need to know because it’s not necessarily what you make, but it’s what you get to keep that really matters as well.
Now number one, when investing well, returns are a big deal —we talk about that a lot on the show — but what you get to keep as well is another issue.
The Torpedo Tax
So Evan Barnard and I did a workshop on this, and I’m just going to give you a few things that we talked about in this particular workshop, and it’s something that you can go to the website and check out more in-depth. But I’m going to give you a few highlights, and you may go, “Hey, that’s really good enough for me to kind of know what I need to be asking about or things that I need to be thinking about.”
We started off the workshop and we started with a brain teaser, and the question was about a guy that was retiring. He had a taxable income of just shy of $49,000. And so he was in a 22% tax bracket. Single guy, 22% tax bracket, and he had about $40,000 of IRA income because he was retired, and he was able to take money out of his IRA without penalties.
Then he had about $37,500 in social security benefits. So this guy had done some preparing for retirement. We’re looking at somewhere in the neighborhood of — good grief, if you look at those two things you got about 49 almost — it’s just shy of $90,000 of income.
Then he’s got the IRA income and then the taxable income, and he’s got the $37,000 in social security benefits, and now he wants to tap his IRA for another thousand dollars. And the question that was asked, that we asked, was how much in taxes does he owe?
And you look at it and go, well, that’s easy. He’s in a 22% tax bracket. He should owe $220, right? Well, not exactly.
He actually owes $407, and the thing that we got into talking about in the workshop is something called the torpedo tax.
In retirement, you can pull money out of an investment, and not only does it trigger taxes on the investment but it also triggers taxes on your social security benefits.
Increasing the Retirement Age
So this is where it starts to get really complicated. Now what is that? Well, back in the 1980s when Reagan was president, they were trying to figure out how to save the Social Security system. And we’re talking a lot about that right now.
There was talk of increasing the retirement age. We’ve been talking about how that was a possibility for quite a while here on the show.
Well, what’s actually being talked about is increasing the retirement age for some people on a gradual basis.
But what was happening back in the 1980s, we’re looking at it going into funding. How are we going to fund social security so that people can actually retire and not take a cut in income?
What happened was an income tax was instituted on social security benefits. Now, social security was designed not to have any kind of tax on income, but they instituted this because some people have more income than others, and so they said they don’t need their social security as much, was the idea.
And a lot of you may be rolling your eyes and going, “Hey, I paid into this doggone thing all these years and you’re going to do that.” Yeah, they’re going to do that. So they did in the 1980s.
Then in the 1990s a second tax was instituted. The first one was up to 50% of social security being included in taxable income. It’s not that they’re taking 50% of your social security, it was just going to be included in taxable income, up to that. Then they increased it to up to 85%.
Well, what happens is you hit certain thresholds that have never been changed. So if you look at a single person, $25,000 is the first threshold and $34,000 is the second threshold.
Well, it’s never been changed. It’s never been increased for the cost of living. If you look at the married thresholds, then they’ve never been changed either. I mean $32,000 and $44,000; it has never been changed.
So literally there are people paying taxes on social security that in the beginning wouldn’t have been, but inflation reduces the purchasing power of the dollar and makes it so that those levels of income are bare minimum for people for retirement. So if you have income and your social security is getting taxed, this is where you have this torpedo tax that I’m talking about.
So you can have a situation where you think you’re in a 22% tax bracket, but really your tax bracket in this particular situation was over 40%. So that’s where you start to get people’s attention.
How To Protect Yourself From Torpedo Taxes
So now this is something. How do we deal with this? Well, that’s a little bit of what I’ll talk about. How do we help ourselves and protect ourselves from this?
Part of it is going to be that if we have low-income years, we may voluntarily pay taxes to convert IRAs to Roth IRAs.
That might be one. Another might be that we actually have more non-qualified investments that are taxed at capital gains rates, and another possibility, maybe using Roth IRAs.
A lot of times during accumulation it is not necessarily the greatest because your tax bracket is very, very high. It just really depends on the differential when you pull that money out. How much in taxes am I going to save by putting the money into a pre-tax investment?
If I have a thousand dollars of income and I put it into a pre-tax investment, and my tax bracket is, let’s say, 37%, well, I’m going to save $370 in taxes. What if I pull the money back out and my marginal rate’s only, let’s say, 12% or it’s 22%? Well, then it made a lot of sense to do that, to avoid 37% and take it in the future at 22%.
So you’re looking at what the rate is currently versus what it’s likely to be in the future. And part of it’s a bit of a guessing game because you don’t really know.
So that is why we do what’s called tax diversification, which is where you have different investment vehicles that are taxed in different manners to make sure that you, no matter what’s going on, can pull money out of the better bucket from a tax standpoint to get yourself to the point where you’re playing the tax system better — more to your advantage. But that quite often means that you’ve got to have some things that are pre-tax, some things that are post-tax — like Roth IRAs — and some things that are taxed at capital gains rates such as non-qualified accounts.
Because if you’re in a 10 or a 12% tax bracket, your capital gains tax rate is zero, which is kind of nice as long as that lasts — and you don’t know how long will it last. We don’t know. I mean, there’s no way to know.
But the reality is capital gains rates have historically — not always, but in most cases — been lower than the regular federal income tax rates. So you can play those things off of each other.
Then you go to a 15% bracket, and if you’re in the really high-income tax bracket, it can be as high as 20%, and then there can be an income tax on investments as well. And so those are the things that we look at from a financial planning perspective.
Four Stages of Retirement
Now, in pre-retirement, you’ve got these four stages of retirement. One of them is going to be pre-retirement, where you’re putting money away and you’re saving a lot of money. How do you do that? Where do you put the money?
Then you have early retirement, and you have middle retirement.
Early retirement is your go-go years. And that may be where you’re spending lots of money because you’re out traveling and doing the things you’ve always wanted to do.
Middle retirement, maybe at the ages of 70 to 80 is where eh, you’re not doing as much, but then you’re preparing for late retirement where you may be spending more, and we call those your no-go years. So we have funny names for these things. The go-go years are when you’re in early retirement, the slow-go years are when you’re in middle retirement, and the no-go years are when you’re in late retirement.
So there are certain things that we talk about in the workshop, and one of them is certain surprises that you might be dealing with — inflation, longevity, how long you’re going to live. People are living a lot longer now than they did in the past.
I was talking to one person, and they were talking about how we might be in a period in history where if you live for one more year, your life expectancy goes up by more than one year because you’ll live through a period of time where new technology comes out that makes us healthier. So people could be living a lot longer than they really planned on. And it really gets down to it with AI and how that might affect medicine and how new technology coming online could affect longevity and dealing with expenses and healthcare in retirement.
So we want to know a little bit about the after-tax picture before we retire.
Because you take money and put it into a retirement plan, and you save on taxes. You might have half a million dollars and after 35% taxes, you end up with $325,000 — that’s what you really have to spend.
So these are the types of things we think about. What are the differences between how much money you actually have in retirement plans versus what you can spend?
Gains in an Investment Portfolio
But one of the things that we covered in the workshop and talked a little bit about is the difference in accumulation that can happen if you don’t pay taxes on gains in an investment portfolio.
There can be significant differences in how much you have if you don’t have to pay taxes on all of your gains every year.
That’s why qualified retirement plans — 401Ks, IRAs, those types of things — have been popular: because I’ll take an investment in something, and if I have to pay taxes on it, the net investment return drops significantly. So an example I like to give is this: Let’s say that you had a 2% difference in your return on an investment. Well, you might look at that over a 20-year period, and you might have more than 20% less money in the future just because of a 2% difference in return.
Well, if that 2% difference in return is created because of taxes that you paid on the investments unnecessarily, you might go, “Hey, maybe it’s a good idea to actually use investment vehicles where I have tax deferral, where I don’t have to pay taxes till I pull the money out, and that can help with accumulations.” So that’s why that’s so important.
That’s why 401Ks and Roth IRAs can be good if you manage a non-qualified account. As long as you’re not paying a lot of taxes every year on capital gains, then there’s some aspect of tax deferral even there, where you’re actually paying taxes at a little bit lower rate because you’re not buying and selling.
Now, what are capital gains actually triggered by? Well, this is near and dear to my heart because I’ve been teaching on this radio show for years that one of the big problems in the investment industry is too much buying and selling in investment portfolios.
If you have too much buying and selling, you’re realizing those capital gains every year and paying taxes on them right now. Well, that decreases the account value. If I have to pull the money out to pay taxes, it can decrease the account value and then I have less to earn returns for me in future years. So that’s a big deal.
Now, Social Security and Medicare have their own tax traps as I’ve just referred to. And if you look at social security and those taxes, my example that I gave is this guy that’s pulling out income. He pulls out a thousand dollars and instead of paying taxes at $220, he ends up paying taxes at over $400.
Well, what was the difference? The difference was the taxation of social security. And that can be a big deal because in that particular instance this guy was in, when he pulled out more money, he was creating taxation on not only the withdrawal, the 22% on a thousand dollars or $220, but he was also creating taxation on $850 of social security.
So those two numbers, you add those two together, and that’s where the differential comes from. So that $407 in taxes that he paid was due to not only the tax on the investment withdrawal but also the social security that ended up being taxed. So those are a couple of things right there.
Different Approaches to Retirement
Now, the other thing you think about is this, and we talked a little bit about this in the workshop, Evan and I did, but there are different approaches to retirement. Some people will actually go into retirement and they’ll just retire completely. “That’s it, I’m done. Stick a fork in me, I’m finished.”
Some people will semi-retire and they’ll just work fewer hours. That’ll be one thing that they might do. Another thing is they might semi-retire to a passion-driven job, something that they really want to do. Now, in some cases that may not make much money, but in other cases there may be some significant income because people start doing something they really wanted to do all along and they’re really good at it.
Or then people may retire and volunteer. It just depends on what it looks like.
But what happens is that a lot of people are going to be looking at social security as an income source and they’re going, “I need to have income from that.” How do they calculate that?
Well, social security is actually calculated using your highest 35 years of income.
So they’ll look at income that you earned 35 years ago. They’ll bring it up to today’s dollars and then they will go, “Okay, that’s one year.”
Then they’ll take the income that you earned 34 years ago, for example. They’ll say, “You earned $10,000 34 years ago. Well, in today’s dollars that is …” Then they’ll figure out what in today’s dollars that is.
Maybe it’s $50,000. I’ll just use that as an example. What you could buy 34 years ago for $10,000 — now it costs 50. Now we look at it in today’s dollars, and each year is looked at that way. Now, the benefit to you for social security doing it that way is that they look at all your income years and then they calculate your benefit.
Now, if you’re working after age 62 — when you’re at the earliest age you can actually start to take social security — and if you have an income that exceeds after inflation, you have those new numbers. Let’s say that you made $10,000 a year and now you made $20,000 after age 62, well, if that $10,000 of income that you earned 34 years ago is now looked at as being $50,000, even though technically you made more money — you made $20,000 today — it’s not enough to make your social security benefit better because in today’s dollars that $10,000 is 50.
I hope that makes some sense. It’s kind of complicated, but that is the idea behind it.
Understanding How Social Security Works
If your income is, let’s say, $70,000 this year where you’re taking that $10,000, which is now 50 because you’re inflation adjusting it, but now you earn an income of $70,000, you may use that new $70,000 figure and it actually replaces that $10,000 figure. Because remember, it’s back to 50,000 in today’s dollars, and you can actually increase your social security benefit.
Or if you had years where you didn’t work at all and you had zero income, you may work past age 62 and replace some of those $0 or the low earnings years. Now, this can be looked at — you can actually find out what the effective earning income is on the Social Security website.
We also do this for clients, but there are ways that you can actually do those calculations on the website and determine, “Hey, if I work longer, is it going to improve my benefit?” But that’s how social security works.
Recognize that if you retire early before your full retirement age, if you’re born in 1960, your full retirement age is 67. Well, if you retire, but you still work after that, you start taking social security before age 67, and they can take away a dollar of your benefits for every $2 that you earn over $22,320 for 2024.
Let’s say you have $10,000 of income over that threshold. Well, they can take away $5,000 of your social security benefits. Then what they’ll do is they’ll recalculate your age. And I explained that in the workshop, but I’m not going to explain it here.
But recognize that there are all kinds of things that you have to know about social security and the rules, and that’s what I really want you to get.
Taxation can be an issue and a benefit.
How they can be taxed, and also how you can end up with penalties — you just got to understand this stuff. It can be complicated.
Medicare and Taxes
Next what I’m going to do is I’m going to talk a little bit about Medicare and taxes. I’m just giving you a couple of excerpts, a couple of interesting points from a workshop that we taught on taxes. We had the benefit in that of actually having visuals, but I’m going to do my best to do that right here on the radio.
So we did a workshop. I say we — Evan Barnard and myself. Evan is an enrolled agent who works with us here.
We got a few of those around here. But anyway, tax guys.
So we talked a little bit about different types of taxes you have to be aware of, especially in retirement and things that you want to think about. I just covered some of the social security taxes that can be gotchas. And Scott in our office up in Goodlettsville is telling me that we had, if you look at the number of words in the tax code, it’s like 4 million.
Who reads all that stuff? Oh my goodness. Yeah, it’s just a tremendous amount of information.
Now, it had dropped a little bit below that, he said, but it has gotten up above it again. So we add a little, maybe a simplification where there are fewer words in the tax code, but it’s complicated stuff. Good grief.
So Medicare — Medicare is another thing we have to think about, and there is what’s called an IRMAA cliff.
The IRMAA cliff is where we have income that can actually trigger higher Medicare premiums.
So similar to the other question where it’s kind of, “Hey, how much in taxes do you owe if you do something?” And the example we used is a thousand dollars gain on a thousand dollars of income taking money out of an IRA, for the first example.
Different Income Thresholds
We have another situation that we used in the workshop where we have a couple who got Medicare Parts B and ND — the prescription is D, and then the B is the Medicare Part B. If you’re taking regular Medicare, you might have a Plan G type of Medicare supplement or something like that.
Now, you have this particular couple that did well in retirement planning. They got about $322,000 of modified adjusted gross income in 2022, and then they decided to sell a little bit of stock.
So,they’re going to sell a little bit of stock for the fun of it. They just need a little bit extra money to do whatever.
So they sell the stock, they have a thousand dollar gain, and you think, Well, okay, that’s going to be capital gains tax, so that’s going to be a different deal. Remember I said earlier that your capital gains tax rate if you’re a lower income person could be zero and it might be 15, and could be as high as 20 plus. You could also have another tax, investment surtax, of 3.8%.
So in this particular case, yep, they’ve got the capital gains tax rate at 15%. So he’s got the thousand and you think, Oh, 150 in capital gains tax, and then you got surtax, another 38 bucks.
So there you go. That’s it. $188 in taxes, right? Is that what we owe?
No, actually you can have a situation. There are different thresholds. 103,000 is one threshold for single filers, and then a second threshold starts at 129,000 of income and 161,000 to 193,000.
Well, this is married in this particular case, so their income threshold is 322 to 386,000.
This is important because it can increase your Medicare premium so you have just a little income and it drives you into a different bracket.
When you have income taxes, a common mistake people make is they think, Oh man, I could end up driving myself into a higher tax bracket. I could go into a 22% or 24% tax bracket or whatever. It’s not all of your income that’s taxed at that new rate.
So if you go from a 12% tax bracket to a 22% tax bracket, that doesn’t mean that all of your income is now taxed at 22. The income that was taxed at 12 and the income before that was taxed at 10 and the other, the lowest income, was taxed at zero. Because the way it works is you’ll have some income taxed at zero, some taxed at 12, some taxed at zero, some taxed at 10, and some taxed at 12.
And then if you go to the next bracket at 22, it doesn’t mean that they go, “Oh, the zero, 10 and 12 is all gone and you’re all taxed at 22 for everything.” That’s not the way it works.
The first income still is taxed at zero, and then the next, a little bit of income at 10, and the next a little bit at 12. It’s only that extra dollars are taxed at 22. I hope that makes sense.
IRMAA
But IRMAA doesn’t work that way.
If you have more income, all of a sudden what happens is you just went over that threshold and your Medicare premium jumps.
It jumps up pretty significantly. And the number that we basically gave in the workshop is your additional taxes, because remember, you have some of the taxes from capital gains and from the surtax on income, but you also have a combined additional premium on Medicare in this case of $3,000.20.
So in essence, what that means is that take your taxes on capital gains, plus the surtax of $188, plus the 307 of increased premiums, and you basically you owe another $3,195.20 on a thousand dollars withdrawal on your investment account. So that basically puts you at a 319.5% real tax rate, is another way of looking at that. Ouch.
That is really what we’re dealing with and why we want to be really conscious. And we use software programs at our company, Paul Winkler, to help people actually determine this: Does it make sense? Where do we take income from?
Because it’s that complicated. Our tax system is intensely complicated. I just want you to be aware that this stuff exists — the tax on social security benefits that can be triggered and the IRMAA tax.
This is something that we think about when we’re doing planning and something that you want to be thinking about because it can hit you.
They call it a torpedo tax when it comes to social security for a reason, because it comes under the bow and you don’t even see it happening until bam, you’re hit by it. So it takes some planning to get around some of this stuff, and if we’re trying to be good stewards of what we’ve got, it might make sense to do some planning when it comes to this stuff.
I’m going to talk a little bit more about some of the other tax traps that you might need to be thinking about regarding retirement planning. Some of the things that you want to know more about.
And again, this is from a workshop that we taught this past week regarding taxes. It’s at our website, paulwinkler.com. Paulwinkler.com is where you can find the whole thing where we really get into it a lot slower, with visuals, because some of this stuff can be hard to actually follow.
So I’ll only cover certain aspects of it, because the reality is that hearing it can be a little bit confusing. But I want you to get how complicated taxes can be and have an understanding of why we want to plan this.
PART 2
Paul Winkler: All right. You’re listening to “The Investor Coaching Show.” I’m Paul Winkler.
Income in Retirement
The thing that I am talking about right now is taxes — everybody’s favorite subject when it comes to financial planning. It can be fairly complicated.
Now, we taught a workshop on this, Evan Barnard and myself. Evan is a certified financial planner and enrolled agent as well. He wears both hats and he’s in the Cool Springs and the Columbia office and they’ve got an office out in Dixon as well, and he jumps between these various offices.
But he and a few of our other people are enrolled agents as well, so taxes are something that we think an awful lot about around here. So one of the things that we did is we decided to do a workshop on how taxes can affect retirement. And what we got into is the social security tax on Medicare.
Now, one of the things that we also talked about is taking an income in retirement.
It used to be so simple. Back in the early days, we would take income from the least tax-advantaged investments first.
That would be the thing to do. So you go and you look at the things that you have, your bank accounts, and you retire your non-qualified taxable investment accounts. That means that you’re paying taxes on interest and capital gains each year.
It’s not deferred. You’re paying taxes on it currently.
Those would be the things that we’d pull money out of first. Then you’d go to tax deferred money like IRAs. Then you’d go to tax-exempt money like Roth IRAs.
So usually, that was the case. It made it a lot simpler to do it that way. Well, over the years, it has gotten a lot more complicated.
There have been papers written on this. Kenneth Anderson was one person that had written a paper in The Journal of Finance. There was another one by Greg Geisler and David Hulse in the Journal of Financial Planning. There were other things written by Kirsten Cook, and it’s just a lot of things out there saying, “Hey, it’s a lot more complicated than that now.”
Spending Taxable Money
Sometimes we do still spend taxable money, and I’ll give you a couple examples here. It got a little bit more complicated in the workshop.
I may actually decide that — let’s just throw out a number — I’m going to retire at age 65, let’s say. And I want to retire, live off of some of the income, but I’ve got some money in a non-qualified account, a taxable account.
I have some money in an IRA, which is pre-tax money — it’s never been taxed before — and I have some money in a Roth IRA, let’s say something like that, and I’m looking at it and saying, “Well, man, I’m going to hold off on social security.”
Because if I hold off, I’ll get a bump of five-ninths of a percent for every month that I wait to take my benefit. And then when I hit my full retirement age, and let’s say that 67, I’ll get a bump of 8% per year. So that’s pretty good.
I’ll get a pretty big bump of 8% per year for three years and from just waiting from age 67 to age 70, I have a 24% increase per life on social security. So that might make sense to do that, but what do I live off of?
Well, just because you retired at 65 doesn’t mean that you have to take your social security at 65. You can wait until 67. Now, in some instances, I’ll have, let’s say, a husband and wife, and I might have, let’s say, the lower income earner between than two of them, whoever that happens to be, take their benefit early and defer the higher benefit all the way to age 70 and it just depends on the person’s situation.
But let’s say we have a person that does have a bunch of taxable money, they’ve got a good non-qualified account, they’ve got investments that are not in 401(k)s — in other words, in IRAs — and then they decide that they’re going to spend some of that money down, and then because they’re spending after-tax money down, what’s their tax rate? Well, it may be very, very low. Maybe not much of anything, income wise.
So they might have literally found themselves in a zero, 10, or a 12% tax bracket. Well, in that case, what I can do is voluntarily, I can actually start to pull money out of the IRAs and convert them to Roth IRAs. I can even juice it up a little bit and convert, let’s say, $10,000. Let’s say I just use $10,000 of my IRA.
And let’s say that part of it’s tax debt. Half of it’s tax debt at a 0% tax rate and half of it is at a 10% tax rate. So literally, what’s my tax rate? 5%.
Half of it at zero, half of it at 10. It’s a 5% tax rate. It’s $10,000.
I take that money out. I pay $500 in taxes. That’s it.
And I go, “Oh, okay. That’s great.” And I take that $500 and the $9,500 that’s left and I put it into a Roth IRA. So my $10,000 becomes $9,500 into the Roth IRA, and I can take the $500 in taxes and I can pay it from a non-qualified tax and non-qualified account and pay the taxes from there.
That way, what happens is I’ve basically turned taxable non-qualified money into tax-free money in the future.
So that’s a cool little trick that we often use for financial planning.
Playing Brackets Against Each Other
I’m just talking a little bit about a couple of things, not a whole lot, but if it’s something that you’re really interested in, I’m talking about taxes and retirement planning. Specifically, Evan Barnard and myself, we did a workshop this week. It’s online at paulwinkler.com — you can go there. But we talked about Social Security taxation, we talked about Medicare taxes, we talked about conversions, Roth IRA conversions.
One of the things that we did talk a little bit about is filling up buckets.
In other words, you might have a tax bracket that you’re in, and you may voluntarily pay taxes all the way up until the top of that bracket.
We do this a lot. I find myself doing a lot with people in retirement, and they’re looking like their income is going to be higher in the future. It is going to be a 24%, 32%, 35% tax bracket, or something like that. And maybe just in the short run, they’re only in a 12% tax bracket.
We may voluntarily pay taxes just up to the point where you’re going to get up into a 22% bracket and stop there, or maybe you’re in 22% and may just stop right there before you go to 24%. But the big jumps are between 24% and 32%. Those are the big jumps in tax brackets, and 12% to 22% are the two big ones.
Because it’s a big jump up, the reality is we may end up in a situation where we can actually play those brackets against each other and voluntarily pay taxes at a lower one now in order to avoid higher taxes when required distributions start happening in the future, because we had all kinds of changes in required minimum distributions. It used to be that it was at 70 1/2 you had to start taking money out of your IRA, then it moved to 72, then it moved to 73, then we have 73 and 75.
It just depends on the year that you’re born. If you’re born in the 1960s and later, it’s 75, and then you don’t have to pull money out until then. But if you’re born in the 1950s, it’s 73. For some people, it was 70 1/2 because that already started. But that’s how that works.
Basis of Assets
If we look at when it may make sense to voluntarily pay some taxes, it may be a situation where you’re a business owner and you just have a bad sales year, so your income’s going to be low, or you have really high expenses so your marginal tax rate is low as a result of that. Or maybe you have some non-recurring high medical bills and you’re still able to deduct your medical expenses.
So there are all kinds of reasons that that may be the case. And we discussed that a little bit in the workshop. So we look at that and go, “Okay, so those are some of the things that we can do.”
The other thing that you can do is for times when you might have a highly appreciated stock, maybe an investment portfolio that’s done really well and you’re in a 10 or a 12% tax bracket. Well, remember, what happens is you may have no capital gains if you’re in that particular bracket.
So it may be a good year to realize those gains and not pay any taxes and then reinvest even. And then that way, now you have a new basis.
So the basis is, what did you put in? Plus, what if you paid taxes on it already?
So let’s say I put $10,000 in an investment and I paid taxes on $2,000 in gains. Well, what’s my basis? 10 plus the two.
So I pay taxes on the gains over the years, and I take that $10,000 plus the 2,000 I paid taxes on. Now that’s my basis. And if it’s worth 20,000 and I sell it, there’s an $8,000 capital gain.
Because I have a 10 that I put in plus the two I pay taxes on, it’s gained up to 20 in my example. Now I can have a situation where if I’m in a really super low tax bracket, I may voluntarily take those gains, pay no taxes on them, and then I can reinvest it, and I can have a situation where I now have a new investment account with a basis of $20,000. Hope that makes sense.
HSAs, QCDs, and Estate Planning
We also talked a little bit about HSAs — health savings accounts. One of the things I often warn people about in retirement is making sure that if they’re contributing to an HSA, they still are working for a company that’s covering their health insurance at work and they’ve got an HSA.
Some people will go and sign up for Medicare, and it may not be a good idea to do that because then you ruin your chances to go put more money in the HSA, because if you’re in Medicare, you can’t contribute to an HSA. So that was another thing that I talked a little bit about in the workshop.
The other thing that we talked a little bit about is something that is near and dear to our hearts: charitable giving and using the ability to make donations after age 70 1/2 and be able to actually use the QCD, which is a qualified charitable distribution. Now you can put in up to a hundred thousand dollars, pull that money from an IRA, and have the check go directly to the charity.
It has to be done through the custodian, so they can rate the check out to the charity. And then what ends up happening is it’s counted for your RMD, but it’s not reported as income. So it’s kind of a way of getting your deduction for charitable contributions back.
Because in the days when you made contributions to charities and the standard deduction was lower, you would look at it and go, “I’m making contributions to charities. I’m paying interest on my house. I’ve got healthcare expenses. I’m going to itemize this year for taxes because that itemization between those things that I’m able to deduct is greater than the standard deduction that they give to everybody just for fogging a mirror in America.”
So you would do that. Well, what happened is that standard deduction went way up and you have a lot of income that you can earn, which is great.
I mean, you don’t have to pay any taxes on it. But if you’re a person who donates to charities, you don’t get the benefit of that charitable donation. Well, this is a way to get that back by doing a QCD.
You can get your charitable deduction back in a way because you’re able to pull money out of your IRA tax-free and donate it straight to the charity.
So it’s really, really good. Just keep that in mind.
It’s for people that are 70 1/2 and older. It’s not for everybody. Not everybody can do this. So I want you to understand that this is not for everybody, but it makes a big difference.
The other thing we talked a little bit about is estate planning. It used to be that you had to get really, really fancy with your estate planning and how to pass assets to heirs. Now you might have somebody that is a natural person, that might be the person that inherits your non-qualified account because they get a step-up in basis, for example.
And you may have assets that you want to send to a charity because it’s all taxable, IRAs, for example, and pre-tax IRAs, because they don’t have to pay taxes on it. So we talked a little bit about that.
But those are all things we talked about. You can check out this workshop at paulwinkler.com. It’s on tax planning. And you can learn to your heart’s content; there is a lot of information on that website, paulwinkler.com.
Advisory services offered through Paul Winkler, Inc., an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
