Earlier this month, Punxsutawney Phil, our trusty weather forecasting groundhog, predicted an early spring, which is good news for those who are sick of the cold and snow. Weather aside, his Groundhog Day prediction is also a sign that tax season is officially upon us, and that April 15 will be here sooner than we realize. Now’s as good a time as any for financial advisors to make sure their clients are aware and informed about the landscape of their retirement tax situation, which has a few particulars that can sometimes be overlooked and therefore not accounted for when retirement planning.
Financial advisors can use tax season as catalyst to discuss with their clients three reminders about taxes in our older age:
1. Social Security wages may be subject to taxation.
Oftentimes clients don’t realize that they may have to pay taxes on the Social Security they collect, and that the tax percentage can be fairly substantial. Make sure you explain to your clients how these taxes work—if their combined income (or provisional income determined by adjusted gross income not including Social Security + non-taxable interest + 50% of your Social Security benefit) is greater than a certain threshold, then they may have to pay taxes. Also important for clients to note is that, as income rises, more of a retiree’s Social Security benefit may be taxable. For example, depending on combined income, up to 85% of Social Security benefits may be taxable. That amount might be more than they bargained for, literally and figuratively.
2. The threshold for taxable Social Security might be lower than expected.
Currently, the threshold for paying taxes on Social Security benefits is $25,000 (for the “single” tax filing status) or $32,000 (for “married filing jointly”). These figures seem fairly low, and they may come as a surprise to many who have worked hard and for many years in an effort to grow their wealth. Because the combined income threshold generally applicable to married couples is lower than what some retirees may realize, they may be caught off guard and find that they have not anticipated the tax impacts in retirement or how they will affect their desired retirement lifestyle.
3. Taking the RMD could increase the taxes due.
As I’ve mentioned in the past, for those who have an IRA or other employer-sponsored retirement plans, they may have to withdraw their RMD (required minimum distribution) each year starting at age 70 ½. Because RMDs may be subject to taxation, the distributions from these arrangements generally will increase the retiree’s taxable income. This may result in a higher percentage of the retiree’s Social Security benefit being taxable because the amount subject to taxation will generally increase with the addition of other sources of income. RMDs may therefore present another unaccounted for cost for retirees.
I’ve discussed previously that Social Security is changing, and so many clients might be more focused than ever on growing their Social Security income and their personal retirement savings. The problem might be, however, that they haven't considered the tax implications or factored into their retirement finances a cushion to offset the possible tax costs. Whether they are approaching retirement or are currently in retirement, financial advisors should make a point to discuss with clients these three factors and develop a game plan to ensure they are ready for all tax situations. Build into their retirement plan the potential for high taxes and make these taxes a part of the ongoing discussion. Doing so may help them be better prepared for a successful retirement in the long run.
The information presented in this communication is intended as general information only. The Hartford and its employees cannot provide tax, legal, benefits or accounting advice. As with all matters of a tax or legal nature, we encourage you and your clients to speak with a qualified tax or legal advisor concerning your client’s specific situation.