Tax Strategies for Retirement
Buckets Create Tax Choices
Written by Linas Sudzius, J.D.
While designed to provide valuable
information, this brochure is not intended
to oer specific tax advice. Your unique
situation will dictate whether any financial
product or strategy described in this
article is right for you. Individuals are
encouraged to consult with a qualified
professional before making any decisions
about their personal situation.
Retirees can be aected by a variety of
taxes — state income taxes, estate taxes
and Social Security taxes, to name a few.
But the most common tax — the one
that all retirees will deal with — is the
federal income tax. For this reason, we’ll
focus primarily on the federal income
tax and its eect on individuals planning
for retirement, but be aware that all
potential taxes need to be understood
and planned for by those who hope
to have a financially comfortable
The Importance of Tax Eciency
You’ve probably been advised by more
than one source that contributing
money before tax into an IRA or a
401(k) plan (a qualified account) is one
of the best ways to save eectively for
retirement. When contributing money
into an employer-sponsored retirement
plan while still working, you are usually
able to exclude contributions from your
taxable income — such contributions
are sometimes referred to as pre-tax”
dollars. Your untaxed contributions will
grow tax-deferred over time because
the growth in qualified retirement
plan accounts is not subject to federal
income taxes either.
Tax Strategies
for Retirement
Buckets Create
Tax Choices
P. 2
When do you pay income taxes on
a qualified account? Later on, when
you make withdrawals from the
account — typically during retirement
when you might expect to be in a
lower income tax bracket. At that
time, withdrawals are subject to your
ordinary income tax rate. It is this
subsequent federal income tax liability
on the distributions that should be
considered when evaluating tax
strategies for a future retirement.
For example, imagine that you are 35
years old. If your otherwise taxable
income this year is $50,000 and you
contributed $3,000 of pre-tax money
to a qualified account, you would pay
federal income tax on only $47,000
of your income. Then, say in 30
years, when you retire, if your taxable
income is $40,000 and you withdraw
$4,000 from the qualified account,
your taxable income would be
bumped up to $44,000. Even though
you may be in a lower tax bracket, the
taxable distribution from the qualified
plan would still eectively increase
your taxable income.
Tax Deferral of Qualified Accounts
is not Forever
One of the challenges with a
qualified retirement plan is that the
federal government does not allow
people to put off taking distributions
forever. The tax code requires most
people to start taking required
minimum distributions (RMDs)
beginning at age 70 ½ — even if
they already have plenty of income
to live on at the time. This can be
particularly problematic because
as people are living longer, many
are working longer as well. If you
must take an RMD while still earning
income from a job, for example,
it could bump you into a higher
income tax bracket.
IRS. Nov. 16, 2017. “Retirement Plan and IRA Required Minimum Distributions FAQs.”
Accessed Feb. 2, 2018.
RMD Penalty Tax
The penalty for not
withdrawing the RMD from
your employer-sponsored
or other qualified retirement
plan is 50 percent of the
amount not withdrawn.
For example, if your RMD
is $20,000 and you do not
withdraw anything from
your retirement plan, you
will be assessed a tax penalty
of $10,000 (50 percent of
$20,000). And, you will still
owe regular income tax on
the money when you take it
out of the plan.
P. 3
Will Taxes be Lower in the Future?
If you actually are in a lower tax
bracket during retirement compared
to when working, qualified plans are
highly tax-eective.
Conventional wisdom suggests that
your income will decline in retirement.
What you may not realize is that
for many, taxable income does not
actually decrease. Why? Some people
lose some valuable tax deductions and
credits as they age and, as a result, end
up with a higher taxable income in
retirement. Others work longer than
they expect, and still others have more
taxable investment income than they
planned for.
2010 2012 2014 2016 2018 2020 2022
$ trillion nominal
Total Government Debt
U.S. from FY 2010 to FY 2023
Actual Estimated
2 “Total US Government Debt in 2018.” Accessed Feb. 2, 2018.
Social Security Administration. July 13, 2017. “The 2016 Annual Report of the Board of Trustees of the Federal Old-Age and
Survivors Insurance and Federal Disability Insurance Trust Funds,” Pages 10-13. Accessed Feb. 2, 2018.
Congressional Budget Oce. January 2017. “The Budget and Economic Outlook: 2017 to 2027.”
publication/52370. Accessed Feb. 2, 2018.
Future retirees are also facing a whole new set of variables
that could impact both income tax rates and their level of
income in retirement:
Projected increases in the national debt,
which may
lead to increased taxes
Slower growth in the labor force paying into the income
tax system,
which could also result in higher payroll tax
Projected Social Security shortfalls in the future,
could lower monthly Social Security retirement benefit
Likelihood of increased Medicare/health care expenses
with aging population
Likelihood of increased Medicaid/long-term care
expenses with aging population
P. 4
Whether your Social Security benefits
are taxable depends on your total
taxable income, your Social Security
benefits and your marital status.
Generally speaking, if Social Security
retirement benefits are your only
income, your benefits will not be
taxable and you may not even have
to file a federal income tax return.
However, if you receive income from
other sources, your modified adjusted
gross income must be below the base
amount for your filing status to avoid
federal income taxes on your Social
Security benefits.
Base amounts (2017):
$32,000 for married couples
filing jointly
$25,000 for single, head of
household, qualifying widow/
widower with a dependent
child or married individuals
filing separately who did not
live with their spouses at any
time during the year
$0 for married persons
filing separately who lived
together during the year
To determine if some of your Social
Security benefits may be taxable, add
one-half of your total Social Security
benefits to all of your other income,
including any tax-exempt interest. If
this total is more than the allowed base
amount for your filing status, some
of your Social Security benefits may
be taxable. The IRS provides an online
tool for taxpayers to estimate the
taxable portion of their Social Security
As you can see, depending on your
particular situation, the strategy of
deferring taxes while you are working
only to pay them when
you’re retired may not always
be to your advantage.
IRS. Feb. 13, 2017. “Are Social Security Benefits Taxable?”
Accessed Feb. 2, 2018.
IRS. Dec. 23, 2017. “Are My Social Security or Railroad Retirement Tier I Benefits Taxable?”
my-social-security-or-railroad-retirement-tier-i-benefits-taxable. Accessed Feb. 2, 2018.
Will Your Social Security
Benefits be Taxable?
Recognize that the more
retirement income you
receive from tax-deferred
qualified plans, the higher
your taxable income will
be in retirement. And the
higher your income, the
more likely your Social
Security benefits will
be taxed.
P. 5
Four Buckets: The Tax Continuum
A simple way to visualize the impact of taxes on your
money is to divide your assets into four buckets.
Tax Free
Tax Free
Tax Free
The Taxable Bucket represents accounts for which you typically
receive a Form 1099 each year. Here are some examples:
Interest from certificates of deposit (CDs)
Dividends and taxable distributions from mutual funds held
in nonqualified accounts
Dividends and capital gains from stocks
Interest and capital gains from bonds
Reinvested dividends
The Tax-Deferred Bucket may include:
Traditional IRA
401(k), 403(b), 457(b)
Qualified and nonqualified annuities
Appreciation of unsold mutual funds and securities
Savings bonds
The Income Tax Free / Estate Taxable Bucket includes:
Roth IRA
Municipal bonds
Appreciation of capital assets held until death
Life insurance (if properly structured)
The Income Tax Free / Estate Tax Free Bucket includes
items found in Bucket 3 used to fund:
Irrevocable life insurance trusts (ILIT)
Charitable trusts
1 2 3 4
P. 6
1 2 3 4
 IRS. Oct. 20, 2017. “Retirement Topics - IRA Contribution Limits.”
Accessed Feb. 2, 2018.
P. 7
Tax Strategies
To help minimize taxes in the
future, you should consider
taking action today. In fact, the
more wealth you have, the more
advantageous it might be to move
assets from left to right on the
tax bucket continuum. When the
goal is to reduce the total amount
of taxes you will pay in a future
retirement, you may have to take
on a greater income tax bill today
— by strategically repositioning
assets from Buckets 1 and 2 to
Buckets 3 and 4.
Tax Diversification
If all of your retirement assets are
in qualified plans, you may have a
significant tax liability on distributions
when you retire. But, if all of your
accounts incur tax liabilities for
you before retirement, the erosion
of your assets due to taxes may
limit the growth potential of those
assets throughout your career. Tax
diversification is the strategy of
spreading your assets across a mix
of taxable, tax-deferred and tax-free
accounts, in order to avoid both of
these scenarios.
For example, consider
adding up to $6,500 ($5,500
if you’re younger than 50)
in a Roth IRA (if you are
eligible) to your existing mix
of retirement accounts.
You will not receive
an immediate income
tax deduction for your
contributions to a Roth IRA,
but your money will have
the opportunity to grow tax-
free and you may withdraw
contributions you made to
your Roth IRA tax-free at
any time. After age 59 ½ and
after the account has been
open for at least five years,
withdrawals — including
earnings — will not be taxed
at all. In fact, the Roth IRA
can be an ideal complement
to an employer-sponsored
retirement plan, because
participation in a pension
plan at work may preclude
tax-deductible contributions
to a traditional IRA.
Roth IRA Conversion
You can reposition traditional IRA
and qualified plan assets from Bucket
2 (tax-deferred) to Bucket 3 (tax-
free) by converting them to a Roth
IRA. Conversions are considered
distributions for tax purposes, so
you’ll have to pay income taxes on
the amount converted in the year of
conversion. Note also that if you pay
taxes on a Roth IRA conversion with
proceeds from the qualified plan,
the money used to pay the taxes is
deemed an additional distribution
and is subject to taxes and any
additional IRS penalties for premature
distributions. Therefore, it’s usually
recommended that you pay the taxes
due upon Roth conversion from
other assets.
While the taxes you pay on a Roth IRA
conversion could put a dent in your
current retirement savings, if you think
your income tax rates will be higher in
the future than they are now, it’s still a
strategy you should consider.
Because converting a traditional IRA
or other qualified assets to a Roth IRA
is a taxable event and could result in
additional impact to your personal tax
situation, including (but not limited to)
a need for additional tax withholding
or estimated tax payments, the
loss of certain tax deductions and
credits, higher taxes on Social
Security benefits and higher Medicare
premiums, you should be sure to
consult with a qualified tax advisor
before making any decisions regarding
a potential Roth conversion.
Converting qualified account balances
to a Roth IRA is not an all-or-nothing
proposition. You can strategically
convert limited amounts each year
to control your income tax result. As
you convert assets each year, you’ll
pay only the taxes on the amount
converted, in addition to your regular
income taxes. This way, you might be
able to pay the additional tax liability
associated with conversion using
income earned from other sources,
such as your job.
What if You’re not Allowed to
Contribute to a Roth IRA?
Single or head of household
taxpayers who earn more than
$135,000 a year ($199,000 for married
spouses filing jointly or qualifying
widowers) may not currently
contribute to a Roth IRA.
what they may be able to do is
contribute to a traditional IRA each
year and then convert their IRA to a
Roth IRA. There is no income limit
on taxpayers who wish to convert
traditional IRA balances to Roth IRAs.
Please remember, however, that
converting your traditional IRA or
other qualified assets to a Roth IRA
is a taxable event and could result in
additional impacts to your personal
tax situation as described in the prior
section on Roth conversions.
IRS. Oct.. 20, 2017. “Amount of Roth IRA Contributions That You Can Make for 2018.”
for-2018. Accessed Feb. 2, 2018.
2 3
P. 8
Advantages of a Roth IRA
The following are some
potential advantages of
converting employer-
sponsored retirement
plan assets to a Roth IRA:
Tax-free Roth IRA
withdrawals do not impact
the taxable status of your
Social Security benefits.
retirement plan investment
options may be more
limited than those oered
by Roth IRAs.
Roth IRAs have no RMD
obligations during the
taxpayers lifetime.
Be aware that any
money in a Roth IRA
will be considered
part of your estate
for estate tax purposes
— placing it firmly
in Bucket 3.
Reliable Income with
Partial Taxation
There is also a strategy to reposition
taxable assets from Bucket 1
(taxable) to Bucket 2 for tax-deferred
growth opportunity and partially
taxable distributions. One example
of that strategy is to use a taxable
investment, such as a CD, to purchase
a nonqualified annuity. This is another
way to deploy a tax diversification
strategy to help avoid having all of your
income be taxable during the run-up
to retirement.
An annuity is a contract between you
and an insurance company under which
you make a lump-sum or a series of
deposits into the contract and, in return,
the insurer agrees to pay interest on the
deposits and make periodic payments
to you immediately or at some point in
the future. Annuities oer tax-deferred
growth potential, a death benefit during
the accumulation phase and, when
you’re ready, income payout options
that are backed by the financial strength
and claims-paying ability of the issuing
insurance company.
Most annuities have provisions that
allow you to withdraw a percentage
of the value of the contract each
year, up to a certain limit, without
any contractual penalty. Of course,
withdrawals will reduce the contract
value and the value of any protection
benefits. Withdrawals above the
contract’s limit typically incur early
withdrawal penalties (referred to as
surrender charges). The length of
1 2
P. 9
time surrender charges apply varies
by contract. Because annuities are
designed as long-term retirement
vehicles, annuity withdrawals are
subject to ordinary income tax. Federal
tax law says that withdrawals are taxed
based on the gain in the contract first,
and, if taken before age 59 ½, taxable
distributions are subject to an additional
10 percent federal tax.
Fully Taxable — But Reliable Income
Although buying an annuity probably
won’t reduce your tax bill at retirement,
it can help secure a reliable income
stream. By rolling over assets from a
401(k) or other qualified retirement
plan to an annuity-based IRA, you can
create guaranteed income options.*
Reliable lifetime income is becoming
increasingly more important because
retirees are living longer, and they need
their retirement income streams to
likewise last longer. Some annuities will
also allow their owners to reduce their
overall market risk.
Estate Planning –
Using Bucket 4
For the purposes of estate planning,
federal gift taxes and estate taxes
are now integrated into one unified
tax credit, which means that any gift
tax exemptions you use during your
lifetime will reduce the estate tax
exemption available upon your death.
The top estate tax rate is 40 percent on
assets over $10 million in 2018, before
taking into account the necessary
inflation adjustment. Currently, you
may make a gift of up to $15,000
to an individual family member
each year without triggering gift tax
ILIT Trust Strategy
An irrevocable life insurance trust
(ILIT) can be used to reposition assets
from Bucket 1 (taxable) to Bucket 4
(income and estate tax free). As part
of your annual gift exclusion, you
can transfer assets to the ILIT that
will be used to pay the premiums for
a life insurance policy. If structured
IRS. Jan. 12, 2018. “What’s New - Estate and Gift Tax.”
whats-new-estate-and-gift-tax. Accessed Feb. 2, 2018.
P. 10
properly, the life insurance death
proceeds will be both income and
estate tax free. Proper use of an
ILIT and gifting would allow you
to leverage annual $15,000 gifts to
generate substantial estate tax free
proceeds for your beneficiaries
upon your death.
With an ILIT, the trust is the owner of
the insurance policy, thus excluding
the life insurance policys cash values
and death benefits from your taxable
estate. If the trust is drafted and
funded properly, your loved ones
should receive all of your life insurance
proceeds undiminished by both
income and estate taxes. Because an
ILIT must be irrevocable, once you
sign the trust agreement, you can’t end
the trust or change its terms. You must
give up control of the ILIT assets, as
you must choose someone other than
yourself as a trustee, and you cannot
be a beneficiary of the trust. Your
spouse and your children may
be (and usually are) beneficiaries
of an ILIT. Contributions to the
ILIT represent gifts that you cannot get
back. Because you cannot
reclaim your contributions or receive
any benefit from the trust, it would
be inappropriate to have the trust
own policies the cash value of
which you had planned to use
for retirement income.
It’s especially advisable to consult with
a qualified estate planning attorney,
as well as an insurance professional,
when considering the implementation
of an ILIT.
P. 11
Dierent investments have dierent
tax characteristics. The tax
characteristics of certain financial
products may make a big dierence in
determining whether such investments
fit your specific circumstances.
In general, the more taxes you are
required to pay in retirement, the more
income you’ll need to generate in
order to both pay those taxes and live
comfortably. Making financial plans
early for retirement, and considering
diversifying your tax buckets so that you
can optimize tax results both during
the accumulation phase of your life and
again after retirement, can help you
pursue the retirement you desire.
It’s important to work with an
experienced financial professional
and your tax advisor to help you
develop and implement a tax strategy
for retirement that is appropriate for
your financial situation.
* Annuities are long-term, tax-deferred insurance products intended for retirement purposes.
Any withdrawals may be subject to income taxes and, prior to age 59 1/2, a 10-percent federal
penalty tax and state penalty taxes may apply to the taxable amount. Withdrawals from
annuities will affect both the cash value and the death benet.
Investing involves risk, including the potential loss of principal. Any references to protection benets
or lifetime income generally refer to xed insurance products, never securities or investment
products. Insurance and annuity product guarantees are backed by the nancial strength and
claims-paying ability of the issuing insurance company.
We are an independent nancial services rm helping individuals create retirement strategies using
a variety of investment and insurance products to custom suit their needs and objectives.
Investment advisory services offered through Kingdom Financial Group, LLC, an SEC Registered
Investment Advisor. We are an independent rm helping individuals make retirement income
planning more successful by using a variety of strategies to custom suit their needs and objectives.
By contacting us you may be provided information about insurance products and investment
opportunities. Annuity product guarantees are subject to the claims-paying ability of the issuing
company, and are not offered by Kingdom Financial Group, LLC.
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