Advisors say they have to increasingly shift their retirement planning to adjust for clients who continue to earn income after they enter their golden years.
“Many retirees who, contrary to the title, still work and save for retirement,” said Josh Hanover, managing director at CBIZ Marks Paneth’s Boca Raton, Fla., office.
“For the ultra-high-net-worth [client], taxes are still an issue even after retirement and can become an even bigger issue depending on the type of assets that are generating the tax activity,” said John Pantekidis, managing partner at TwinFocus in Boston.
“If a retiree has a huge portfolio of alternative investments in [limited partnership] structures such as hedge funds, private equity, ventures and so on, the retiree could have a huge tax bill without the necessary liquidity because of the phantom income inherent in K-1s,” Pantekidis said.
For retirees more than for workers, “saving” becomes more a recipe of continuing to put away money while whittling taxes, often by keeping taxable income as low as possible, advisors say.
Pantekidis said that the best tax strategies for retirees, especially wealthy ones, who continue to save during retirement and who need liquidity from investment portfolios to meet living expenses, include maintaining tax efficient investment vehicles, favoring ETFs and index funds and tax harvesting throughout the year, particularly during volatile markets.
“Most wealthy individuals who are retired tend to spend less than the value of their investable assets,” said Dan Sudit, partner at Crewe Advisors in Salt Lake City. He added that retired clients should, before they take Social Security or required minimum distributions (RMDs), consider tax-efficient moves such as partial Roth IRA conversions.
Qualified charitable contributions can help clients of RMD age lower their taxable adjusted gross income, advisors said. Though not relegated to retirees only, Sudit said, gifting appreciated stock also lowers taxable income, avoids capital gains on the appreciation and frees otherwise-donated cash to repurchase the stock and reset the basis, reducing future capital gains.
RMDs start at age 73 for most retirees. Clients who are still working and have a retirement plan with their employer, however, may not be required to take RMDs as long as they remain employed by and own less than 5% of the company, Hanover said, adding that many such retirees can also continue contributing to retirement accounts.
“Many people assume that their tax rate and obligation may be the same in retirement,” Sudit said. “But in retirement, your income is primarily passive income such as interest, dividends and capital gains. Your tax planning typically becomes vastly different than it was. Long-term capital gains tax rates and qualified dividend tax rates are lower than earned income tax rates.”
Clients can save taxes by converting retirement money to a Roth IRA, said Leah Schwarz, managing director and wealth manager at Perspective Wealth of Steward Partners in San Antonio. A Roth could allow a client to pay taxes on $10,000 at today’s tax rate and let that amount grow in a Roth IRA—eventually meaning an equal amount could be withdrawn free of tax. Two reasons this can be a plus in retirement, she said, is that it can keep Medicare premiums from increasing and it will incur less tax on Social Security.
Schwarz also recommended that retired clients start allocating a portion of their investments to tax-free municipal bonds for savings during retirement and to tax-free health savings accounts, which also provide health insurance right when retirees are likely to have such costs. “Again, this alleviates the need [for a client] to draw on a taxable bucket that snowballs the MAGI,” Schwarz said.
Retirees need to fundamentally change their lifelong attitude about saving, advisors said.
Shifting from contributing and growing a portfolio to pulling money from it and generating income “typically results in reducing risk and focusing on generating income,” Sudit said.