SHOW NOTES: 2018-07-19 MiM

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Last Week’s Question of the Week: What is the name of one of the top Budgeting apps that we mentioned last week? ANSWER: According to the website, the top 6 budgeting apps in 2018 are Mint, Pocket Guard, YNAB (You Need a Budget), Wally, Mvelopes, and Good Budget.

HOST: So today, you are talking not just about retirement planning, but also taxes in retirement?

KLAAS FINANCIAL: Yes, taxes are necessary to plan for. Disclaimer: we are not accountants. Please check with your own accountant to understand how taxes will affect your own situation.

As we retire, taxes can be a factor and we do like to explain what to expect and also how to try planning for this. We don’t want people to ignore this and have a big surprise when they file their taxes and perhaps didn’t withhold enough from their various sources of income.

Remember, that although you may not be collecting wages when you retire, just know that the IRS is still waiting for their tax money to be paid from all of those deferred sources that you have been accumulating.

Retirees will likely draw their income from a variety of sources- some income may be exempt from federal taxes, some will be fully taxable, and others may be taxed in part.

First of all, what about your Social Security income? Some people don’t realize that for many people, they will likely pay taxes on up to 85% of their social security benefit. This comes as a surprise to people who remember that SS was previously not taxed. Beginning in 1984, the IRS began taxing Social Security income to help with the financing crisis of Social Security.

If your combined income as an individual is more than $34,000, up to 85% of your benefits could be subject to tax. And, if your combined income is less than $25,000, your benefits are not taxable at all. Married couples with combined income of less than $32,000 don’t pay taxes on their Social Security benefits, but between $32,000 and $44,000 you will pay income tax on more than 50% of your benefits, and more than $44,000, up to 85% of your benefits may be taxable.

However: Social security and railroad retirement benefits are not taxable for Wisconsin.

HOST: What if you have a pension in retirement?

KLAAS FINANCIAL: First of all, if you have a pension coming to you, first of all that’s great news. Make sure you sit with a professional to make sure that you elect the best choice of the choices provided as most cannot be changed after the fact.

Pension income: Most pensions are taxable, and if you are collecting a pension in Wisconsin, your pension will be both state and federally taxable; however, some types of military pensions or disability pensions may be partially or entirely tax-free. The provider of your pension will send you a 1099 form at the beginning of each year that shows you how much of your pension is taxable. If you live in Illinois, your pension is NOT taxable by the state, just federally.

Withdrawals from retirement plans: If a plan was funded with pre-tax dollars, whether by you or your employer, it will result in taxable retirement income when withdrawn. Expect pretty much all withdrawals from IRAs, 401(k)s, 403(b)s, SEPS, SIMPLES and other similar types of plans to be taxable. Generally, if you are under 59 ½, distribution of these monies from these plans will be charged a 10% penalty.

What rate will you pay taxes? Depends on how much income you are taking. The more you take, or have to take as a result of your Social Security or pension, or to live your life, will determine the tax bracket that you will be paying taxes on as this is considered ordinary income tax. (10-37%)

Distributions from Roth accounts are basically the opposite of a tax-deferred account. Assuming you paid tax when you put the money into a Roth, and you are 59 ½, and the account has been established for 5 years, you will not pay taxes on the growth when you take a distribution.

Plan to withhold taxes from your pensions, social security and other forms of retirement income.

HOST: What about investment income in non-retirement accounts?

KLAAS FINANCIAL: You can expect that various types of retirement income will either be taxable at your ordinary income tax rates (10% to 37%) or at a capital gains rate (0% to 20%).The tax code divides capital gains into long-term and short-term capital gains:

Short term capital gains tax is a tax on profits from the sale of an asset held for one year or less. These are taxed at your ordinary tax rate. Long-term capital gains tax is a tax on profits from the sale of an asset held for more than a year.

Interest, dividends and capital gains that occur in non-retirement accounts will be reported to you on a 1099 form each year and you will pay tax on most of this type of investment income as it is earned. The exception would be any capital gains that fall into the zero percent tax rate – you don’t pay tax on that portion of capital gains

The Tax Cuts and Jobs Act (TCJA) that was drafted in December 2017, is still being understood. It includes many changes that will affect individual taxpayers for 2018-2025. However, it maintains the status quo for taxes on long-term capital gains (LTCGs) and qualified dividends. The TCJA retains the 0%, 15%, and 20% rates on LTCGs and qualified dividends. However, for 2018-2025, these rates have their own brackets that are no longer tied to the ordinary income brackets. Here are the 2018 brackets for LTCGs and dividends.

Single Joint Head of household
0% tax bracket$0-38,600   $0-$77,200 $0-$51,700 
beginning of 15% tax bracket$38,601$77,201$51,701
beginning of 20% tax bracket$425,801$479,001$452,401

After 2018, these brackets will be indexed for inflation.

HOST: So, if I need money from my individual account or after-tax accounts, will I pay a penalty and taxes?

KLAAS FINANCIAL: If it is an investment account, you will pay capital gains tax if your account has grown and if you take a distribution, there will be taxable cap gains growth, but never a penalty since these are not retirement accounts unless it is an annuity. Distributions from after-tax annuities can cause a penalty if you are under 59 ½, and remember that gains can be income taxable, instead of cap gains taxable.

HOST: When I turn 70 ½ and have to begin taking my RMD’s from my retirement accounts, will I pay tax then? And how can I avoid this?

KLAAS FINANCIAL: Yes, again according to your tax bracket, and the balance of the account from the previous year end close, you will be required to begin drawing out a percentage of your pre-tax monies from your IRA’s or 401ks (unless you are still working where the 401k plan is) and graciously pay the taxes due. Avoiding pulling your RMD’s and paying these taxes legally? You can currently donate your RMD’s to a charity and avoid the taxes paid by you, and the charity pays nothing as well.

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Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.