Retirement tax optimization strategy


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Optimal asset “tax location” strategies and drawing down traditional tax-advantaged assets, while delaying Social Security retirement payments

Investment tax location and Social Security tax optimization strategies could improve your lifetime financial plan. To understand how VeriPlan manages the automatic: A) reinvestment of positive annual cash flows from net earned income and other non-asset cash flows and B) withdrawal of assets in years with negative cash flows please refer to the “Transactions timing and priorities for traditional & Roth tax-advantaged accounts” section of the tax-advantaged worksheet.

In general, across your lifetime projections VeriPlan will assume that cash, bond, and stock financial asset withdrawals will be taken first from taxable accounts, then from traditional “avoid-initial-taxes-but-pay-taxes-in-retirement” tax- advantaged accounts, and then finally from Roth “tax-initially-but-not-later” tax-advantaged accounts. This topic is not at all simple, but in general, VeriPlan automates the lifetime asset transactions process for you, while allowing you to evaluate and obtain the benefit of tax-deferral and tax avoidance provided by traditional and Roth tax-advantaged retirement accounts.

Because the computations regarding a series of forward-chained lifetime projections can be very complex for all of what VeriPlan already automates in your projections, there are certain tax optimization strategies worth noting that could not also be implemented practically within VeriPlan projections. Therefore, the information in this section will simply point out that some investors may have the opportunity to improve upon their lifetime financial plans in practice:

1) by implementing optimal tax location strategies and
2) by drawing down tax-advantaged assets to delay their initial receipt of Social Security retirement payments.

Concerning implementing optimal tax location strategies, see: Asset Allocation, Investment Asset Tax Location, and Emergency Cash Management

It can be advantageous for certain people to withdraw tax-advantaged account assets between age 62 and age 70, while not taking Social Security payments until a later age

Regarding drawing down traditional tax-advantaged account assets while delaying the age that Social Security payments are first taken, it can be advantageous for certain people to withdraw tax-advantaged account assets at some points between age 62 and age 70, while not taking Social Security payments until a later age. In particular, when some people do this, they can avoid paying unnecessary income taxes on earlier Social Security retirement payments and instead pay income taxes on withdrawals from their tax-advantaged retirement accounts to meet cash flow short-falls.




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By doing this they draw down their traditional tax-advantaged retirement account assets and lower future taxes that would be due on Required Minimum Distributions (RMDs) after age 70 and 1/2. Meanwhile, by delaying their Social Security payments to a later age of first payment, they can increase their payment levels throughout retirement, and receive favorable tax treatment on those payments.

The years when this tactic would tend to most useful are the years after retirement when earned income falls off and total income tax rates decline before age 70. Retirees can weigh the benefits of pursuing this tax optimization strategy, when they get to that point in their lives and before they decide to accept initial Social Security retirement payments. This decision will require some careful thought.

First, an optimal lifetime “tax location” strategy can influence the relative balances of taxable and tax-advantaged account assets that would be held at this early point in retirement — and thus taxes due associated with RMDs. Second, one’s asset allocation strategy will influence whether this strategy is more advantageous, since people who hold an asset allocation skewed more heavily toward cash and bonds would be likely to receive more benefit.

Third, getting this decision right before accepting initial Social Security retirement payments has become even more critical, since in December of 2010. That is when the Social Security Administration effectively eliminated the “do-over” strategies of repaying all Social Security payments and restarting payments at a higher level. In December 2010, the Social Security Administration began to restrict do-overs to one time during one 12-month period with no repeats.

To understand more about this tax optimization strategy of accelerated tax-advantaged account withdrawals versus delayed Social Security retirement payments decisions, Dr. Shelby Smith has written a detailed white paper that discusses this strategy. Reading this white paper can be a bit of tough sledding, but for those nearing retirement the potential financial advantages could make reading this paper quite profitable.

Find a link to Shelby Smith’s “Guide to Social Security”

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