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Ready For Retirement
Maximize Your Retirement Tax Savings: How to Maximize Tax-Saving for Each Account
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James Knoll
Believe it or not, one of the biggest things you can actually control in retirement is your tax rate. This has nothing to do with controlling what tax rates are as a whole. It has everything to do with controlling the way you pull income out of your portfolio in retirement. But to do that, you need to have a good understanding of how are different types of accounts taxed, how are different income sources taxed so that you can combine these accounts, you can combine these withdrawals in a way that's the most tax optimized for you, leading to the lowest possible tax impact throughout your retirement. So what we're going to do today is we're going to explore the different types of accounts you can invest in and explain to you the tax impact not just when you put money in, but the way that will be taxed in retirement so that you can put money in the right places and ultimately pull money out from the right places later on in retirement. This is another episode of Ready for Retirement. I'm your host, James Knoll, and I'm here to teach you how to get the most out of life with your money. And now onto the episode. So let's jump right in. And the first type of an account, probably the one that gets the least amount of love in some ways, is a standard brokerage account. This could be an individual account, it could be a joint account, it could be a revocable trust account. Anything where it's not a qualified retirement account. Here's the thing, you don't get any tax benefits for putting money in. But what people aren't aware of is There is a 0% tax bracket for the gains in the qualified dividends that you could potentially receive from that account. Here's how that works for 2025. If you are married filing jointly, when you file your taxes, if your taxable income is less than $96,700, then any long term gain that you realize or any qualified dividend that you realize up until that threshold is taxed at a 0% tax rate at the federal level. So once again, that number is $96,700. And that's taxable income. Taxable income, more or less, is going to be your adjusted gross income minus any deductions. So if you're married filing jointly and you just take the standard deduction, $96,700 of taxable income means your actual adjusted gross income was $126,700. Add on $30,000, because that's going to be removed when you factor in the standard deduction. So let's use a very basic example. You and a spouse, you're married finally, and jointly, you earn a combined $100,000 of income from your job. And you don't have any income sources outside of that. If you go to file your taxes, $100,000 is your adjusted gross income. You take your standard deduction of 30,000, now you're down to a taxable income of $70,000. If you have a brokerage account that has some stocks or some investments with unrealized gains, assuming those gains are long term, meaning they've been over a year, you've owned that investment for over a year, you can realize up to $26,700 of those gains and not pay any taxes at the federal level for doing so. This is really important to know because you might say, well James, I don't need to live on that money yet, so why would I sell that investment? Well, what if you sold just $26,700 to realize the 0% federal long term capital gain rate and then just reinvested it? What you're doing is every single year you're stepping up the basis on that investment so that down the road when you do sell it, it's not the original cost basis that you have to pay the difference on taxes on, it's the stepped up cost basis where every time you sell and repurchase, by the way, there's no wash sale rule on realizing gains. And then reinvesting back in that same security, you are increasing the cost basis which is reducing your long term tax liability when you do ultimately sell that investment again in the future to live on it. So that's incredibly important to know. I see far too many people who are simply holding onto these gains where they could be realizing these gains at a 0% bracket at the federal level. Now, of course you need to be mindful of whatever state tax consequences there are, and that's going to depend upon what state you live on. But at the federal level, there's a 0% tax bracket. For single filers, that number is exactly half, $48,350. So until your taxable income exceeds $48,350 again, these are 20, 25 numbers. You will pay 0% taxes on any long term capital gains as well as any qualified dividends. Now I say long term because any short term gains that you have, those are taxed at ordinary income rates. There's a big difference between the taxation of long term gains versus short term gains. So be very mindful of that in this applies specifically or not specifically, but maybe more often to people who are in retirement. When people who are in retirement have their income under certain thresholds, it's much more common for people to be in the 0% long term gain bracket in their retirement years than during their working years. So be mindful of this so you can start to realize when can you realize some of these gains at zero tax consequence, so that down the road it doesn't cost you even more in taxes as those gains continue to build. The next account is your standard 401k. Now, the thing to know about 401k plans is many employers offer both a pre tax 401k as well as a Roth 401k. The decision of where do you put funds comes down to what is your tax bracket, what is the marginal tax bracket that you're in when you're contributing those funds compared to what would be that same tax bracket when you're pulling those funds out in retirement? Obviously impossible to know exactly where things might be down the road, but you should have at least somewhat of an idea of where are you today. You should have a very specific idea of where you are today. It may be a good guess, a best estimate of where you might be in retirement. Here's the thing about 401 s. When you make a Roth 401 contribution, your employer, if there's an employer match, your employer match will be pre tax. Now, there is actually a newer rule where sometimes companies will allow for that employer match to be made to a Roth account that would be taxable to you. But keep in mind that for most plans, any employer contribution that is made, that contribution is going to be pre tax. So if you are making $100,000 per year and you contribute 10% to your Roth 401, your employer, let's say, is a 5% matching contribution you put $10,000 in that would go to the Roth 401K, that 5% or that 5,000 contributed the same 401K part of the same balance. But they would be tracking things on the back end. And that $5,000 is pre tax, meaning when you pulled out in retirement, that is fully subject to federal and state taxes. One important thing I'll note with 401 s with traditional IRAs is in retirement, if you're going to do any level of charitable giving, or oftentimes it makes most sense to do a qualified charitable distribution, what that means is you get to do that charitable contribution directly from the pre tax IRA and gift it to the Charity of your choice, you do that. So instead of pulling the money out of your ira, paying taxes, and then gifting the money, you simply gift the money right from your ira. There's limits on how much you can do, but that limit is six figures for most people. They're not going to hit it. It's a great way to reduce taxes while still doing the charitable giving that you want to do. The next account that we'll discuss is the Health Savings Account. Now, this can be a wonderful tool to help you plan for your retirement. To be eligible for Health Savings Account, you have to be enrolled in what's called a high deductible health plan, an hdhp. This could be either an HMO or ppo, but high deductible. And typically you would know because typically in the title of your plan it's going to say something like HSA eligible or High deductible health plan. Your deductible is going to be higher, but in exchange for that, you get to put money in. You have the option of putting money in to a health savings Account. Here's the beauty of a health savings account. Money that you put in is a tax deduction today at the federal level and at the state level in 48 states. California and New Jersey do not recognize Health Savings Accounts or HSAs. So if you live in one of those two states, you're not getting the state tax benefit, but you are still getting the federal tax benefit. And if you're in one of the other 48 states, if it's a state that has income taxes, you are getting the deduction there as well. So tax deduction on the way in. Now, with HSAs, most of the time you have to keep some nominal balance in cash, maybe $1,000, maybe $2,000. That's how a lot of these HSAs make their money. And it's a way of keeping that money liquid. But any amount above that, you have the option of investing. As you invest that money, it grows tax free, so you're not paying taxes on the gains. Again, with the exception of California and New Jersey, where they're not going to recognize HSA status. So tax benefits don't pertain there on the growth. But in all other cases, your HSA contributions can grow tax free. And then the beautiful thing is if you pull money out and it' for qualified medical expenses, that money is also tax free. Tax free on the way in, tax free growth, tax free on the way out, triple tax savings. That's the only account that you're really Going to get that. That can be an incredible tool for your retirement planning. And here's one of the beautiful things. You don't have to pull the funds out of your HSA in the year in which a medical expense was incurred. So, for example, let's assume I put $5,000 per year into my HSA for the next 10 years. For the sake of simplicity, let's just assume this doesn't even grow. I just put the $5,000 in and it stays in cash. After 10 years, I would have $50,000 in my HSA. Let's also assume that on average, over the next 10 years, I have $2,000 in qualified medical expenses. Well, I'm keeping my receipts, but I'm paying for those expenses out of pocket. What happens is 10 years from now I have my HSA and it's $50,000. I have had a combined $20,000 of qualified medical expenses. I have the option in year 10 of pulling $20,000 out completely tax free. Even if I didn't have any medical expenses in that year, I can pull that out because retroactively I have kept my receipts, I've kept track of what expenses I did have, and it gives me a ton of flexibility in the future to make that tax free withdrawal. So that can be a great strategy for a lot of people. In the years where you have the cash flow to pay out of pocket for some of these qualified medical expenses, maybe it makes sense to do so. In the meantime, keep growing your HSA balance. Knowing that almost becomes like a partial Roth IRA in some ways. It doesn't, of course, legally become a Roth IRA in the eyes of the irs, it's still an hsa, but like a Roth IRA in the sense that you're starting to build this balance that you can pull from tax free. So you got the tax deduction on the way in, ideally. And back to my example, I'm not just letting that money sit in cash for 10 years. I'm investing those contributions that go in. So instead of $50,000 in 10 years, maybe it's $70,000, maybe it's $80,000. It's a larger number. And I can retroactively pull money out and have that money be tax free. One more benefit of HSAs is after the age of 65, you can actually use those funds for anything. Now you don't get the tax free withdrawal, but this kind of becomes like an IRA in this way, you got the tax deduction for putting the money in. There was tax free growth, while that money was Invested and growing. If you realize I have way more money in my HSA than I need to fund my medical expenses throughout retirement or maybe have a great health care plan through my previous employer. And I don't have many expenses for health care throughout retirement. You can use money from your HSA to buy groceries, to buy gas, to buy whatever it is taxable. But you could think of it as being like an IRA in that sense of putting money into an account to get the tax deduction and paying money on the back end so it doesn't just have to be used for qualified health care or qualified medical expenses. That's the way that you get the triple tax savings. But. But you still get dual tax savings even if you were to use those funds for other expenses. You do have to wait until age 65 and beyond though to do that. So that's some important information to know about various types of investment accounts you can put money into so you can understand how that money can be utilized in retirement. What about other things? What about inheritances? This is a big thing. If you inherit $100,000, if you inherit $500,000, if you inherit $1 million, how is that taxed? Is that going to push you into a much higher tax bracket or what is that going to look like for you? Well, it depends. If you inherit a non retirement account, this can be a stock, this can be a home, this can be a business interest. You receive what's called a step up in basis when you inherit those funds. So for example, your parents bought a home for $50,000 50 years ago. That $50,000 home has now turned into a $2 million home. Well, if they were to sell it, they would have a big capital gain. There would be a $1,950,000 capital gain on that home. Now they get to exclude some of it because you get to exclude up to $250,000 for each spouse. When you do sell a home that you've lived in for a certain period of time, but there would still be a lot of gains that they would pay if instead though, they lived in that house until they passed away. That home, when you inherit it, it has a step up in basis, meaning the basis is no longer the $50,000 that they paid for it, it's $2 million on the date of their passing. So the value on the date that they passed. Now if you sell that home, that $2 million is completely tax free because of that step up in basis. Same thing for a stock. If you inherit a stock that was bought for a dollar, and now it's worth a million dollars. Hypothetically, that stock has a step up in basis, so you're not paying any of the taxes on that gain. So when you would receive that, once you actually sell the asset, whether it's a home or a business interest or a stock, it's just like having cash. It's tax free to you. Now, if you inherit the home when it's worth $2 million and you keep it for another five years or 10 years, and it grows to a $3 million valuation, you would pay taxes on the million dollars of gains between the two and the three. But on the date that you inherit it, again, business interest, stock, property, whatever it is, if it's a non retirement asset, there is a step up in basis to the value, the fair market value as of that day. This is different than if you inherit a retirement account. If you inherit a traditional IRA, if you inherit a 401k, you have 10 years to fully distribute that account. Now, there are actually quite a few nuances with this, so make sure you're talking to your tax preparer, make sure that you're talking to your financial advisor to get some of these details. But if you inherit a traditional IRA, for example, from your parents who passed, you have 10 years to fully distribute that account. This actually has some pretty significant retirement implications for you. Let's walk through an example. Let's assume that you need $60,000 per year to live on throughout your retirement. Let's also assume that you just inherited $500,000 from a parent who passed away. In an IRA, you must fully distribute that $500,000 over the course of the next 10 years. Well, you could do some simple Math and say $500,000 divided by 10, that's $50,000 I need to take out. That is true. If you keep that $500,000 sitting in cash and it doesn't grow at all. If it's growing though, you need to account for that. So let's assume for a second that we think that $500,000 will grow by 5% per year over the next 10 years. Based upon that projected growth, you would actually need to take out $65,000 per year to be on track to fully over 10 years. What you want to avoid is you want to avoid a situation where you're not taking enough out in those early years and then it pushes you into a very high tax bracket in the latter years. Now, I should say there's some nuance to this because you want to look at your income sources and your projected tax liabilities over the next 10 years to see are there years where you should maybe take more or less from your IRA that you're inheriting to try to smooth out the tax liability that you're going to face and not have any year when you're pushed up into a much higher tax bracket? But back to the retirement implications for you. This isn't just about the tax piece. This also is going to tie into your overall investment strategy. Again, I'm going back to what if you need $60,000 per year to live on, and we just ran this analysis to say this inherited IRA, we should be taking $65,000 per year out each year so that we fully distribute it in 10 years. You're probably going to want to look at that tool as the thing that's going to fund the first 10 years of your lifestyle. And you look at the rest of your investments and say, even if I'm retired, it might have somewhat of a moderate, moderate growth portfolio. I'm not actually going to touch my portfolio, everything excluding the inherited IRA for 10 years or more. So I might actually shift my investment strategy. I might shift my tax strategy in those accounts to account for this new inherited asset I have that has to be fully distributed in 10 years. So, yes, there's a tax component to this, but this tax component is also going to impact the way you invest the rest of your funds and your overall retirement plan. And then the final thing I want to talk about today is Social Security. No, this isn't truly a retirement asset per se, but it's a retirement income source. Retirement income source almost everybody in retirement is going to have. The important thing to know about Social Security is at the state level. Most states do not tax Social Security. I don't know what state you're in, so make sure to check for your specific state. But most states do not tax Social Security, which means it's tax free at the state level. In many instances at the federal level, somewhere between 0% and 85% of your Social Security benefit is going to be taxable. Doesn't mean it's subject to an 85% tax. It means that up to 85% of it will be taxable, meaning the income from it will be included in your calculations for what you owe taxes on. That number between 0 and 85% comes down to what's called your provisional income. Provisional income says that if your income, if your provisional income is under certain thresholds, none of your Social Security is taxable. If it's between certain thresholds, 50% of the benefit is included in your taxable income. If it's above certain thresholds, 85% of it is taxable. That provisional income. I've made a lot of other videos about how that works, and I'll link to one at the end here. But just understand that there's some tax efficiencies to the way your Social Security is taxed. So your decision of do you collect early, do you collect later? Part of that is driven by maximizing income, but another part of that is driven by maximizing the tax savings that you're going to have over the course of your retirement. So keeping all this in mind, how are brokerage accounts taxed? 401 s Roth 401 s HSAs? Inheritances? Social Security? When you know these details, you can start to put together the right portfolio withdrawal strategy, the right retirement plan that's going to help you maximize the income you have while minimizing your tax liability over the course of your retirement. Now I mentioned provisional income is a big one. Here's a link to a video I did right here. And in this video I walk you through exactly how Social Security is taxed so that you can see, based on your situation, what might you need to plan for when it comes to Social Security taxes, Root Financial has not provided any compensation for and has not influenced the content of any testimonials and endorsements shown. Any testimonials and endorsements shown have been invited, have been shared with each individual's permission, and are not necessarily representative of the experience of other clients. To our knowledge, no other conflicts of interest exist regarding these testimonials and endorsements. Hey everyone, it's me again. For the disclaimer, please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal, or other financial advice. It is for informational purposes only. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed discuss in this podcast. Then go to rootfinancialpartners.com and click Start Here, where you can schedule a call with one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss on this podcast is intended to serve as advice. You should always consult a financial, legal, or tax professional who's familiar with your unique circumstances before making any financial decisions. It.