Transcription
Most retirees are overpaying in taxes, not because they're doing something wrong, but because retirement changes the rules. The planning that worked while you were working doesn't translate once you retire. Now you're under a different set of variables. Social Security, Medicare, required minimum distributions, all while trying to find the right mix of where to take income from your investments.
Joe and Marie were in that exact spot. They had saved well. They were already retired, living comfortably, collecting social security, and didn't have any debt. By all accounts, they were doing everything right, but they were still losing thousands of dollars every year in unnecessary taxes. And here's the crazy part. Their plan didn't need a complete overhaul. It just needed a smarter tax strategy.
So, in this video, I'll walk you through how we helped Joe and Marie make a simple changes to take back control. Changes that gave them more flexibility today and saved them real money for the long term. We'll go step by step, but first let me quickly show you the most important tax strategies that every retiree should know about. The power isn't just in knowing what these tax strategies are. It's in how they work together.
So, first, Roth conversions. Converting money from a traditional IRA into a Roth IRA allows you the pleasure of paying tax now so you can avoid taxes later. And coordinating it with these other tactics is what makes it really work.
Tax loss harvesting. Selling investments at a loss may not sound helpful, but volatility in your investments can actually work to your advantage if you're proactive. Harvested losses can offset gains and give you more flexibility when layering in other strategies.
Asset location. This isn't about what you invest in, it's about which account you hold your investments in. For example, interest from bonds or high dividend stocks and a taxable account can quietly inflate your taxable income. But repositioning can aim to reduce taxable income without changing your overall portfolio strategy.
Qualified charitable distributions or QCDs. Once you're 70 and a half, you can give directly from your IRA to charity. It counts towards your RMD, but doesn't show up as income on your tax return. It's one of the cleanest ways to give and reduce taxes at the same time.
Giving appreciated investment shares. Even if you're not 70 and a half yet, you can still make charitable giving more efficient by donating appreciated investments instead of cash. you avoid the capital gains tax and can still qualify for a full deduction depending on your situation. And to make it even better, I'll show you in a bit how we use this approach for Joe and Marie to supersize their deduction.
Social Security taxation, that dreaded torpedo. As your income increases, more of your social security becomes taxable up to 85%. It phases in quickly and stacks with other income, which makes careful planning essential.
And then Medicare premium planning or Irma. Just like we want to watch income tax brackets, we also want to watch Irma brackets. Medicare premiums are based on your income from two years ago. And even a small increase can bump your monthly cost by hundreds per year.
Each of these strategies can be valuable on its own, but that's where most people tend to stop. The real magic happens when you line them up in the right sequence and make small adjustments yearbyear to stay ahead. That level of coordination is what Joe and Marie needed help with.
So, let's take a look at their finances. Okay, Joe and Marie are both 67 years old and recently retired. They live in Southern California, have no debt, and have done a great job building their retirement foundation. Okay, so they're already collecting social security about 63,500 per year combined. And Joe's benefit is a bit higher. It might have made sense for him to delay his benefit. And I'll show you why in a minute. They also receive about 38,400 from a pension and another 22,900 from rental income and then $43,000 from their investments. Their investment portfolio, it includes 900,000 in a joint trust account, roughly half of which is appreciated, a Roth IRA with $200,000 for Joe. Traditional IAS totaling about $860,000 between the two of them. They have $100,000 in cash savings and a fully paidoff home worth about 1.1 million. Their monthly core expenses are around 12,500 per month and they're comfortably meeting their needs.
Currently, they're drawing about $34,000 from their IRAs each year uh to supplement other income sources. So, that gives them a mix of withdrawals from tax deferred and taxable accounts, what we're more likely to call a pro rata strategy. And that approach isn't wrong. In fact, sometimes it does work well, but it's not optimized for Joe and Marie, as we'll see. They're paying more in tax than they need to and missing the chance to be more strategic before required minimum distributions kick in at age 73.
So, here's what we did. We evaluated multiple withdrawal strategies from Pratta to drawing only from taxable accounts to partial or full Roth conversions at various thresholds. So by the numbers, the best outcome came from doing Roth conversions up to Irma bracket number two. However, the benefit over converting up to Irma bracket number one was minimal. And in those situations where you'd have to pay a lot more in taxes now just to gain a little bit later, I'll often lean toward the more conservative Roth conversion. So in this case, just up to Irma bracket number one is what we're going for. So that's our general direction. The problem, as we'll see, is they're already pushing the limit of Irma bracket number one. We want to reduce some of the inefficiencies in how they're currently taking income, which can then create room to do Roth conversions now, so they're in a stronger position later when those required distributions begin.
Here's what we found. Compared to their current path, this strategy would save them $343,000 in future taxes. It would increase their net legacy by 274K and it would lower their future average tax rate by 3.9%. Looking at it in present-day dollars, that's about $109,000 in tax savings and an increase of $130,000 in net legacy with a 2.6% average reduction on their tax rate. So, this can give them more control over how and when they pay the taxes and helps them avoid a bigger tax spike down the road.
Now, we don't want to just layer Roth conversions on top of what they're already doing. that can push them into higher brackets and trigger unnecessary Medicare costs. They're already up against that limit. What we want to do is first reduce their current taxable income and that's what creates the space to make a Roth conversion actually beneficial. So, let's take a look at how we did that step by step. The challenge with retirement tax planning is none of these strategies operate in a vacuum. They all interact. Pull one lever like reducing taxable dividends or changing where you give and it affects your ability to do something else like in this case a Roth conversion. But I should say that while we're solving for Joe and Marie's Roth conversion strategy, it may be a different objective for you entirely. That's what makes this so powerful, but also why most people miss the opportunity.
So, let's walk through the changes we made side by side, starting with their actual 2024 tax return and then comparing it to a more strategic plan for 2025. Okay, so here's their actual 2024 tax figures and we'll use that as the base case to build off when planning for 2025. And here you can see their where their current income came from. Social security 63,500 pension 38,400 34,000 in IRA withdrawals. Uh they have rental income of 22,900. In addition, their trust account, investment account produced 24,800 in uh dividends. 16,000 came from bond funds, fully taxable non-qualified dividends. And then the remaining 8,800 or so came from stock investments. most of which were uh qualified. They also had about 27,700 in long-term capital gains and that included 3,200 in mutual fund distributions that were forced out. They also had about 4,300 in short-term uh capital gains taxed at ordinary rates. Also, you'll see that they itemized their deductions, which totaled up to 33,700. 22,000 of that was from charitable giving. But if you look closer, they were getting very little added benefit over the standard deduction, which for them in 2024 would have been 32,300. So the goal for 2025 was to reposition to lower their taxable income and allow for a more optimized withdrawal strategy and then include a Roth conversion up to the first Irma threshold.
Okay, so step one, Joe and Marie had about 360,000 in bonds held in their trust account. And the first issue is that this generated about $16,000 in non-qualified dividends from the funds that they owed fully taxable and pushing up their taxable income. Now, we didn't want to change their overall portfolio allocation. So, instead of selling off bonds entirely, we reallocated where they were withheld. So, we shifted 180,000 about half of those bonds in the trust account to purchase $180,000 in broadly diversified stocks. We then increased the bond allocation inside their IRAs by that $180,000. This adjustment lowered their taxable dividends by roughly $8,000. But then we also needed to account for the dividends produced by those new stock holdings. But this was much more tax efficient. So combined this mix of US stocks and international stocks, it still generated about 3,200 in new dividends. But because of the fund structure, about 2900 or 90% were qualified dividends, which are taxed at a lower rate than the bond income they replaced. So by simply shifting where investments were held, Joe and Marie reduced their taxable income while maintaining the same portfolio risk. Overall, we reduced taxable bond dividends by about $8,000 and then added back in $3,200 in a more tax efficient stock dividends. That gave us a net reduction in taxable income of $4,800.
Step two, for 2025, we also changed where Joe and Marie took their income from. Instead of pulling $34,000 from IAS like they did in 2024, we shifted all investment withdrawals to their trust account and paused IRA distributions for the year. Now, for calculator purposes, we also accounted for a slight increase in income from cost of living adjustments, about $800 boost from Joe's pension, and another $1600 from Social Security. So, while we eliminated $34,000 in IRA income, we're also adding back $2,400 from COLA's, making the net reduction about $31,800.
Step three, they still needed to draw $43,000 from their investments to meet spending needs. So, here's how we covered it. They were already producing about $20,000 in dividends and another $3,000 in mutual fund distributions. That income was already going to show up on their tax return. So, we used it to generate cash flow. That left $20,000 still needed, which we plan to raise by selling investment shares. But instead of repeating 2024 strategy where they realized 4,300 in short-term capital gains, we plan to sell from long-term capital gain positions, which are much more tax efficient. And then that avoided that short-term tax hit. Selling $20,000 in appreciated investments could potentially create about $10,000 in long-term capital gains since half is appreciation. But we're also able to harvest $10,000 in losses, fully offsetting those gains with market volatility. Of course, results may vary based on market conditions and portfolio management, but this gave us a very efficient starting point.
Step four, Joe and Marie had been giving about $20,000 per year to charity, but in 2024, their total itemized deductions came to $33,700, barely above that $32,300 standard deduction for a married couple. Their generosity was essentially getting them very little tax benefit. So, in 2025, we took a different approach. We actually doubled up and gave $44,000 of giving through a donor adise fund. They could then parcel it out to the end charities on their own timing. And here's what made that possible. They gave appreciated investments instead of cash. That's what gave them the flexibility to give that higher amount without taking extra money out of their checking account. And by doing so, they also avoided capital gains tax on those donated shares. And here's how they worked it out. Next year, they'll simply take the standard deduction. And the cash they would have given away, well, that can then stay in their account. They can use it to either reduce how much they withdraw from their investments in 2026 or they can reinvest the cash at a higher cost basis. So giving is not reducing their overall investments. It's essentially a net wash from an investment standpoint but with better tax efficiency. And when you average the deductions over those two years, it results in a much greater benefit than giving the same amount every year under their old strategy. By stacking their giving into one year, they increased their deductions by $22,000 this year alone.
Step five. Now, by the time we reached this point, after adjusting investment income, eliminating IRA withdrawals, and stacking their charitable giving, we had brought Joe and Marie's taxable income down from nearly 172,000 to 109K. That gave us what we needed. We now have the space to plug in a $40,000 Roth conversion and still stay below that first Irma threshold, meaning we can avoid triggering those higher Medicare premiums. And here's the important distinction. While we reduce taxable income by over $60,000, Irma thresholds are based on income before deductions. So, we ended up with just over $40,000 of space to work with the Roth conversion without crossing into that next Medicare bracket. But because we reduced so much ordinary income ahead of time, that $60,000, a larger portion of the Roth conversion stayed within the 12% tax bracket, which makes the trade-off far more efficient. So to recap the key point, rather than adding the Roth conversion on top of already high income, we created space first so that way the conversion could happen on their terms without unnecessary taxes or Medicare costs.
Now, this next part is important because it's kind of the nuance that causes a lot of people to second-guess Roth conversions. You might be thinking, if they didn't do the Roth conversion, couldn't they have just kept their taxable income even lower and maybe even avoided capital gains tax altogether? It's a fair question, and the answer is yes. Now, if your personal goal is just to reduce this year's taxes as much as possible without doing a Roth conversion, then everything we've done up to this point still works. These strategies can stand on their own and significantly lower your current tax bill. But in Joe and Marie's case, they were already paying the capital gains tax in their 2024 baseline. We didn't add something new. We simply replace part of that income with the Roth conversion, a strategic trade-off to build long-term flexibility. For them, it made sense because here's what happens if they avoid the Roth conversion. Today, their IRA continues to grow. Required minimum distributions begin at 73, even higher amounts. And those withdrawals will stack on top of social security and capital gains, leaving them with less room to maneuver and higher taxes later. By doing the Roth conversion now on their terms, they're flattening the tax curve and avoiding a bigger tax spike later on. And most people miss that part. Minimizing taxes this year isn't always the goal. Minimizing taxes over a lifetime and keeping control is the goal. Joe and Marie didn't need a total overhaul, just a smarter tax plan. And if you want to dig in further, you have to watch this video next. Alex, my business partner, shows how some retirees take $100,000 of income and pay zero tax. Thanks for watching. And if you'd like to talk to me and my team about coordinating your retirement plan, you can schedule a brief call using the link in the description. We'll catch you on the next one.