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How to avoid a Jack-in-the-Box surprise at retirement Thumbnail

How to avoid a Jack-in-the-Box surprise at retirement

When I was thinking about writing this blog, the Jack-in-the-Box toy popped into my mind. You may have heard about this toy that was believed invented in the 14th century. Typically it’s a music box with a crank. When you turn the crank it plays music which culminates with a clown or jester popping out often unexpectedly.

Some people like surprises but a lot of people don’t. When it comes to retirement, I think most of us want to know that there will be no surprises, especially after a long career of hard work. Unfortunately, many retirees are in for a surprise around retirement.

From earning a paycheck to withdrawing funds

Financially, retirement involves big financial changes. Tapping savings, Social Security and investments is a lot different than collecting a paycheck. One of the biggest changes is your tax situation. Here are 6 big impacts to consider:

1. Collecting Social Security now or waitingCreate Post

That money’s been waiting for you for years. Finally, it’s time to get something back from all those years of paying into the system. And, better collect it now before the whole system goes bankrupt, right? –These are some of the common comments we hear about Social Security.

For healthy, higher income taxpayers, collecting as soon as you are eligible may not be the best strategy. One of the biggest miscalculations of retirement is underestimating how long you will live. While you may believe you won’t live that long, we consistently see clients who underestimate their longevity.

One way to ensure that you have the most funds to pay your basic expenses is to defer collecting Social Security as long as possible. For each year you defer beyond your normal retirement date, you will experience a permanent 8% increase in your Social Security benefit level. In addition, if you are married and you are the high income earner in the family, that deferral can result in a higher benefit for your spouse, too.

As for Social Security going bankrupt, I believe that there is too much political pressure in Washington to allow this important benefit to faulter. Unfortunately, Congress will likely wait until the very last minute to resolve Social Security’s funding problems.

2. Withdrawing funds from IRAs or non-retirement accounts

When work ends and retirement begins, you need a new paycheck and that paycheck needs to come from other sources. For upper income taxpayers, that income may come from non-retirement investments, dividend-paying stocks, holdings in company stock of a former employer, rental properties, real estate sales, IRAs, and other sources. Each one of these involves different tax consequences. Knowing which ones to hold or sell can have a big impact on the amount of taxable income reported on your tax return.

3. Deferred compensation plans are great until you leave

A significant number of our clients work for companies that offer deferred compensation plans. These plans allow the worker to defer current income into a tax-deferred account for many years. This can be especially helpful if you are a high income earner as it can allow you to avoid being pushed into a high tax bracket.

During your working years, deferred comp plans can be really helpful tax-wise along with adding to your retirement assets. However, one of the big downsides is that most plans require the account to be emptied within four or five years of leaving your current employer (even if you have not yet retired). If you saved aggressively into a deferred comp plan, say $1 million, you might have to add $200,000 per year to your income when you retire. Without careful planning, this income might be unexpected and create a big tax bill.

4. Capital gains from mutual funds – even if you are a buy & hold investor

One of the big tax surprises we’ve seen the last few years is investors who did not sell a single security but were hit with a big capital gains tax bill. If you own mutual funds, you probably know exactly what I am talking about. Mutual funds are required to distribute 95% of their gains every year in the form of capital gains distributions. Because most investors reinvest their dividends and capital gains, they may not realize that their fund(s) paid out big distributions. Even if you reinvested all of your dividends and capital gains, these distributions are all taxable.

5. RMDs can add to taxable income, too

If you reach age 73 this year, you’ll need to start taking required minimum distributions (RMDs) from your pre-tax 401(k) or IRA.1 The amount of the RMD is calculated by dividing the December 31, 2023 account balance by a factor of 26.5 to calculate your RMD. For example, if you had a $2,000,000 across all of your pre-tax 401(k)s and IRAs at the end of last year, you would need to take out 75,472. If that coincides with a required distribution from a deferred comp plan and Social Security, you might have a pretty high tax bill.

6. The Jack-in-the-Box surprise at retirement - Medicare surcharges

Once you reach age 65 you must sign up for Medicare.2 At enrollment, you’ll be required to make regular payments for Part B and Part D based on your taxable income. Because these Medicare premiums are income based, you will be required to pay a higher rate if your income exceeds $103,000 (single filer) or $206,000 (married filing jointly).3 Importantly, if you retire this year, Medicare uses your income from two years ago, e.g., from your 2022 tax return. If you are a high income retiree, that means you’ll pay a surcharge based on a tax year when you were working and likely had higher income. Medicare will adjust your premium each year based on your taxable income.

Navigating the transition to retirement can be tricky for higher income individuals and couples. Coordinating all of these potential tax impacts while ensuring that you have a steady stream of income requires planning. We can help.

If you would like more info about planning for that year when you want to retire, give me a call. There are several ways to help you make a good transition to retirement without a Jack-in-the-Box surprise. You can schedule a quick call with me by clicking HERE.

Lyman H. Jackson



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· Top 5 financial mistakes https://planwithfps.com/blog/top-5-financial-mistakes

1Starting in 2033, the RMD age is increasing to 75.

2 If you are still working at 65, you should still sign up for Medicare but you will defer enrollment until you retire.

3 This adjustment is called Income-Related Monthly Adjusted Amount or IRMAA. Limits are for 2024.

©2024 by Financial Planning Solutions, LLC (FPS), a Registered Investment Advisor. Reprinting or redistribution only by permission. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.

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