Tax reduction strategies in ER

[Meadbh]

What do you do if you are fortunate enough to have a sufficiently high income in ER that you end up in the higher tax brackets? This applies to people who have a lot of tax deferred savings and are subject to RMDs. As discussed in the thread on FireCalc and Taxes, a new thread has been started to discuss this issue specifically.

Two ideas that I may use are whole life insurance purchased within my professional corporation, and inter vivos charitable giving.

Over to you for more ideas and a lively debate!

 

[kaneohe]

Not sure what you are thinking about when you mention inter vivos charitable giving (perhaps a donor advised account like this Individual Donors | Schwab Charitable - Your Partner in Tax-Smart Philanthropy that Nords and others have written about).

You might also consider a QCD (qualified charitable distribution)
Charitable Donations from IRAs for 2012 and 2013
although you have to be over 70.5 yrs. old and this was only renewed for 2013
(one yr).

 

[Meadbh]

Not sure what you are thinking about when you mention inter vivos charitable giving (perhaps a donor advised account like this Individual Donors | Schwab Charitable - Your Partner in Tax-Smart Philanthropy that Nords and others have written about).

You might also consider a QCD (qualified charitable distribution)
Charitable Donations from IRAs for 2012 and 2013
although you have to be over 70.5 yrs. old and this was only renewed for 2013
(one yr).

Thanks. I already have a donor advised fund set up, but have not put any money in it. I live in Canada so am dealing with different rules. I could theoretically donate up to 75% of taxable income in any one year and receive a tax credit.

TaxTips.ca - Donations Tax Credit

 

[Animorph]

Mostly just trying to Roth convert/withdraw tIRA funds in a way that maximizes my after-tax spending. That includes managing to stay below a target AGI or MAGI, several different tax brackets, or the AMT in different years.

 

[pb4uski]

What do you do if you are fortunate enough to have a sufficiently high income in ER that you end up in the higher tax brackets? ...

Lament that you worked so much longer than you really needed to?

 

[Sesq]

I am ten years out. If it still exists the 0% cap gain rate for those in the 15% bracket is appealing. Although at this point 95% of my investments are in tax favored accounts (401(k), Roth IRA's, 529's).

I expect to build the taxable accounts once the mortgage is paid off.

 

[donheff]

I pay the taxes. Most schemes I read about either don't fit or don't make sense to me.

 

[yakers]

I'm pretty much all taxable; pension, taxable investments & IRAs. Only thing I am doing to lessen taxes is small conversions from traditional to Roth IRAs. Also have some ibonds which serve like cash and may help with taxes a bit. Not fun paying taxes but better than not having an income to pay taxes on.

 

[johnrlawjr]

I am on a pension and SS. I guess I could look into purchasing a rental since I don't own any real estate. Don't know if I want that hassle. Considering the alternative, I try not obsess too much over my tax bill. I consider myself lucky and extremely grateful.

 

[Lakedog]

I pay the taxes. Most schemes I read about either don't fit or don't make sense to me.

+1

I do have an HSA and take cap losses as they are available to offset a small amount of income.

 

[scrabbler1]

Actually, I have done some of the opposite. Because I had a fairly large holding in my muni bond funds, the equivalent taxable yield dropped when I ERed and moved into a lower marginal tax bracket (15%). So it became a better deal to sell some of that and buy more in my corporate bond funds even though they are taxable. I pay a little more in taxes but my monthly after-tax dividends are higher.

 

[allanlevy]

I struggled with the Roth conversion item. It was not clear to me converting "now" would be good, in the hopes/event that I would be at a lower rate later, though I do get the sense that passing the Roth to heirs for tax free continued growth of the estate after death is a good thing

 

[JakeBrake]

My strategy is to defer taxes as long as possible. I withdraw cash from my cash accounts within my rollover IRA's to pay bills 30 days in advance. No Roth conversions for me.

 

[kramer]

I am an early retiree in my late 40s and so I still have time to plan for Social Security and RMDs.

I have been taking full advantage of the 0% bracket for capital gains and dividends each year. I don't know how long this will last.

Since I live abroad without USA health insurance, I am in a situation where I pay no State income tax and will experience no PPACA subsidy-reduction by showing income.

I think I may start doing IRA to ROTH IRA conversion only for the portion where I would pay 0% (probably only about $4000 per year). I am not convinced yet that paying 10% now is a good deal for me.

Another strategy may be to start taking small amounts from the IRA in my 60s in order to reduce my RMDs in my 70s and beyond. Only about 1/3 of my portfolio is in tax deferred accounts. I will probably delay Social Security until age 70 unless my health is not good. I will have some big I-bonds maturing in my mid-60s and will have to pay income taxes on those.

Another strategy is that I have never withdrawn from my HSA. I just save healthcare receipts and plan to just leave the HSA alone for a long time.

 

[zedd]

Try running your numbers thru ORP ->Retirement Calculator - Parameter Form

Zedd

 

[allanlevy]

Here is the pitiful max i know/am following on this subject. Sure wish I knew more hence seek your suggestions:

1. Distrust the $10M exception on estate tax. [mod edit]

2. Given (1) gift the max to each kid from each spouse, currently $14k/spouse/kid. do same when grandkids popup. If I could gift a non-conceived future grandchild, I would. Would even gift a placenta, if tac code allowed. Place in a trust til kids are wise/old enough to use it (protecting them from themselves). Gifting reduces your estate towards/to less than the exemption amount (estates above this exemption get whacked for the above exemption amount). Actually, I am confused about something--is there ANY way to makeup for past years where I did not gift (like a one time lifetime gift amount)?

3. I recently heard something about an ILIT (life insurance trust). I need to look into that. Fidelity mentioned this is useful in conjunction with (2). You buy insurance on your life with the gifted $. Then your kids get the insurance death benefit, my understanding is tax free upon your death, which is substantially larger than the gifted amount, tax free (is all that right?, what kind of insurance do you buy in an ILIT? )

4. Set up will/trusts to bequest your estate to your spouse and vice versa. This allows your estate to pass to your spouse tax free. I was told this effectively doubles the exemption, but I am not sure how since when 2nd to die passes, then the tax over their single exemption is taxed, unless they spend the estate down to under the exemption (so doesn't this just defer the estate tax vs double the exemption?--perhaps someone can explain the characteristic benefits of this strategy to me/others?)

5. Don't die in Maryland. Die in NV or FLd or some low tax state. MD state tax exemption is $1M. [mod edit]

6.Tax free munis seem smart, though Buffet declares bonds to be a terrible investment at present (he is right, yet my personal psychic drifts me back to bonds when the market is, as now, frothy, and a correction is likely soon when the fed begins to unwind--heck look the markets dropped circa 300 points in 24 hours and tanked 7% in Japan, the moment the fed/Bernake even started discussing beginning to taper. But that's a different thread. Obviously, munis are a tax minimization investment for income tool.

6. Obviously max out sep, ira, etc--though this is tax deferral. I have always wanted to understand the benefits of deferral. I have always used the conservative assumption that there is some very small benefit, but when you pull it out of the tax sheltered account, since it is taxed then, the "benefit" of the deferring is not particularly material (can someone refute this for me?). Further, there is a school of thought that says tax qualified accounts are not a good idea as there is a chance that Fed will raise taxes (to bail out entitlement programs) in the future, so you put money into qualified accounts now at lower tax rates to take it out later taxed on higher tax rates.

7. Be careful on the order of what you spend; spend tax non qualified accounts first.
before tax qualified accounts

8. Invest in equities vs income instruments because capital gains tax is less than income tax--obvious but arguably adds risk/volatility to portfolio.

9. If you are into charitable giving do that to get tax deductions..

10. Re tax free munis--I recently read about these can be NOT tax free if the AMT kicks in for you. I did get subject to AMT last couple years. Not really sure if I will in future years, and it scares me to think what I bought as a tax free investment turns out not to be if AMT kicks in. That is, I have bought a lower bond yield than , corporates offer to get the higher yield of munis when tax advantages are considered, only to find out the AMT robs me of the tax advantages and leaves me with the lower than corp, muni yield. Any ideas on how I should think about this/act?

I think that exhausts my current knowledge. I know (sense) it is pitiful. And I beg illumination from you wise ones in this community.
[mod edit]

Help!!

-Allan

 

[Alan]

I struggled with the Roth conversion item. It was not clear to me converting "now" would be good, in the hopes/event that I would be at a lower rate later, though I do get the sense that passing the Roth to heirs for tax free continued growth of the estate after death is a good thing

You have that backwards. You should only convert now if you expect to be in a higher tax bracket later.


For example, if RMD's at age 70.5 are going to push you into a higher tax bracket then you can lower the value of your IRA's by converting some to ROTH now in order to lower the RMD's.

 

[Aiming_4_55]

Thanks for the timely post Meadbh.

I started thinking about this in 2 areas - traditional IRA/401ks and rental assets. For me, I might have a good 15 years of ER along with 2 younger kids (deductions), so I plan to get a better idea of options within the next few years.

I think I'll be targeting the traditional IRA conversions while staying in the lowest tax bracket. Also, I'm beginning to wonder what is the best way to exit my rental properties and moving into mutual funds/index/dividend investing for the lower capital gain taxes.

Anyone have a good strategy they can share?

 

[kramer]

I think I'll be targeting the traditional IRA conversions while staying in the lowest tax bracket. Also, I'm beginning to wonder what is the best way to exit my rental properties and moving into mutual funds/index/dividend investing for the lower capital gain taxes.

Anyone have a good strategy they can share?

One problem with exiting rental properties (e.g., selling them) is that you must recapture all the depreciation you have taken on them. I believe it is recaptured at a 25% rate. Ouch.

 

[Aiming_4_55]

Ouch is right. I got a good taste of it with my 2012 return, but avoided it with a 1031 exchange. I'm thinking I might have to roll into a larger property and keep more that I want and/or moving and making a new primary residence every few years to take advantage of that.

One problem with exiting rental properties (e.g., selling them) is that you must recapture all the depreciation you have taken on them. I believe it is recaptured at a 25% rate. Ouch.

 

[GrayHare]

4. Set up will/trusts to bequest your estate to your spouse and vice versa. This allows your estate to pass to your spouse tax free. I was told this effectively doubles the exemption, but I am not sure how since when 2nd to die passes, then the tax over their single exemption is taxed, unless they spend the estate down to under the exemption (so doesn't this just defer the estate tax vs double the exemption?--perhaps someone can explain the characteristic benefits of this strategy to me/others?)

Sounds like you are describing a spousal A/B trust. The easiest way to think of it is such a trust persists after the first person of the couple dies. The survivor does not own the deceased spouse's trust, he/she is only the trustee of it, and thus when the survivor also dies that trust is not considered part of his/her taxable estate.

It would be fantastic if tax law simply allowed spousal estates to be treated separately in this manner, thus removing the need for all the paperwork associated with forming and maintaining a trust.

 

[tightasadrum]

Or you can keep your real estate rentals and let those who inherit them after you're gone deal with it. The tax basis resets, so there's no depreciation to recover.

But the issue for all of us with investment property is dealing with it becomes more like w*rk as time goes by. One possibility is to form or join a partnership where all the sale proceeds could be transferred via 1031 exchange into a large purchase. Then the partnership hires a management company to deal with the day to day problems. When you die, your heir(s) simply sells at a new tax basis and avoids the depreciation recovery.

 

[kaneohe]

10. Re tax free munis--I recently read about these can be NOT tax free if the AMT kicks in for you. I did get subject to AMT last couple years. Not really sure if I will in future years, and it scares me to think what I bought as a tax free investment turns out not to be if AMT kicks in. That is, I have bought a lower bond yield than , corporates offer to get the higher yield of munis when tax advantages are considered, only to find out the AMT robs me of the tax advantages and leaves me with the lower than corp, muni yield. Any ideas on how I should think about this/act?
-Allan

I don't believe that's quite how it works.......I think muni interest may(or may not) have an AMT component to it. If you are not in AMT, there is no problem. If you are in AMT, that AMT component is taxed (not the rest of it). To minimize your pain, look for munis w/ small or no AMT components
(assuming you're in a fund w/ a mix of stuff; if you own single bonds, it might be all subject to AMT (or not).

 

[kaneohe]

Sounds like you are describing a spousal A/B trust. The easiest way to think of it is such a trust persists after the first person of the couple dies. The survivor does not own the deceased spouse's trust, he/she is only the trustee of it, and thus when the survivor also dies that trust is not considered part of his/her taxable estate.

It would be fantastic if tax law simply allowed spousal estates to be treated separately in this manner, thus removing the need for all the paperwork associated with forming and maintaining a trust.

For the last few yrs, the new law has basically allowed your fantasy.....and more..........the survivor gets to control the whole thing if desired and gets to use the whole double exemption (what's left of it)
see portability here Federal Gift and Estate Law in 2013 and Beyond | Nolo.com

Note the critical part is that survivor must file estate tax return even if nothing is due.

 

[scrabbler1]

I don't believe that's quite how it works.......I think muni interest may(or may not) have an AMT component to it. If you are not in AMT, there is no problem. If you are in AMT, that AMT component is taxed (not the rest of it). To minimize your pain, look for munis w/ small or no AMT components
(assuming you're in a fund w/ a mix of stuff; if you own single bonds, it might be all subject to AMT (or not).

I agree. This is what happened to me in 2008 when I received a large company stock payout as part of my ER. On my statements of tax-exempt income (for the muni bond funds), there was always an amount of income subject to the AMT, amounts I had always ignored prior to 2008. But that year I had to include them when I completed the AMT form. The amounts were not very large as a percentage of the overall tax-exempt income but it did erode the overall after-tax return of the muni bond fund a little bit.