Please view Part 1 and Part 2 of this 4 part series before viewing.
As I mentioned before in this Retirement Blog, another great way to save taxes is to convert your qualified retirement money to a Roth IRA. There is an income test to qualify – currently you can convert to a Roth IRA if your total taxable annual income is not more than $100,000 annually. This limit is being suspended in 2010, so if you don’t qualify now you will want to re-visit Roth IRA conversion in 2010. You pay the income taxes when you convert and then from that point forward you’ll pay no income taxes on earnings or the principal. So if taxes go up, as I suspect they will, you’ll be paying zero income taxes on money withdrawn from a Roth IRA. What’s more, at the current time the Roth income is not counted in the formula that determines the taxes on your Social Security benefits. Also, unlike a regular IRA there are no required minimum withdrawal requirements as long as your spouse or are alive. The beneficiaries who inherit the money will also not have to pay taxes on the principal or earnings but they will have to make minimum withdrawals they can stretch over the reminder of their life. There are several other great benefits of using Roth IRAs for your retirement money and you’ll want to thoroughly investigate these with your financial advisor. This is another reason to have a financial advisor, so if you haven’t already start your search today.
Getting Social Security Right
Most Americans take Social Security for granted and don’t realize it can serve as a valuable tax and income planning tool in retirement. Did you know that about two-thirds of retirees start their SS benefits before normal retirement age? Many times they started without giving any thought to the tax or income wisdom of doing so. Social Security benefits grow annually by 8% plus a Cost of Living Adjustment (measure of inflation) for each year they are postponed after age 62. This means that by postponing you could approximately double your benefits if delayed until age 70. But why would you want to do that?
First, where can you find an investment that annually grows 8% plus inflation and has the backing of a government promise plus is always tax-favored when received? Second, it could mean your spouse will get a big increase in SS benefits when you die because the surviving spouse is entitled to the greater of what they were receiving of what the deceased spouse was getting. Postponing until age 70 roughly doubles the SS benefits, meaning the surviving spouse will have more income for life once you’re gone. Third, you never pay taxes on 100% of your Social Security benefits; therefore, you want as much of this tax-favored income as you can get. By postponing SS benefits, a relatively larger portion of your income in retirement will be tax-favored and you will pay fewer taxes over your lifetime. Fourth, by using your fully-taxable money first (IRA, 401k, 403b, etc.) you exhaust it first and once the delayed SS benefits are received you’ll pay fewer taxes on them. Also, if taxes rise as I suspect, paying taxes later on retirement accounts could cost you relatively more. Most retirees are worried about SS being done away with, but a short reflection will verify that such would be political suicide. At the current time there are 50 million Americans drawing SS benefits and another 78 million boomers that started turning 62 at the beginning of 2008. This “voting majority” would throw out of office any politician that attempted to stop SS benefits. The only risk of delaying SS benefits is that neither you nor your spouse will be around long enough to recover in higher benefits the lower benefits lost while delaying. But, one peek at the mortality tables will tell you that the odds are substantially in your favor.
Shelby J. Smith, Ph.D.
Related Resource: You, Taxes and Retirement (Video Seminar 10 minutes)
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