To avoid being surprised by how much you have to pay in tax when you retire, remember that the tax strategy for your investment accounts is just as important as the investments in those accounts. The type of strategy I’m thinking about impacts your retirement in a big way. It’s how the withdrawal strategy is included in the tax strategy. 

It is common to take the balance of your nest egg and then estimate a rule-of-thumb distribution percentage number. While this is reasonable and sustainable, most people don’t think about an important fact when you start withdrawing your money from retirement accounts. And that is, in year one, you’re covering your expenses with no problems. But within a few years, your expenses are going to be increasing due to inflation, so you’ll be taking out more from your investment accounts. And if tax brackets stay where they are today, you may be in a higher tax bracket a few years into retirement because of the extra money that you’ll need to take out to cover your expenses. 

In this post I’ll discuss four types of money that are not taxed in retirement. 

Type 1

First, are the capital gains from the proceeds of a house sale. A lot of retirees downsize or move in retirement and making sure that you’re planning for how this house sale impacts your retirement is really important.

The capital gain on the sale should not be taxable if:

• it’s your primary residence,
• you’ve lived there for two of the last five years,
• the gain is under $500,000, and
• you’re married and filing jointly.

For example: you bought a house for $500,000, then you sold it for $900,000, years later. As long as it was your primary residence, then that $400,000 difference should not be taxable if you’re married, filing jointly. (It’s under $250,000 if you’re a single filer.)

Type 2

This second one is a common type of non-taxable account: your ROTH IRA. Don’t worry if you don’t have as much as you hoped you’d have in your ROTH IRA. I’ll share some ways that retirees are funding this account after they retire, but first a quick review.

If you have a ROTH IRA and you make a qualified distribution, then that withdrawal should not be taxable. It’s a qualified withdrawal. For it to be a qualified withdrawal, you have to meet a couple different rules:

• you have to be older than 59 and a half, and
• you have to have had the ROTH for more than five years. 

And there are a few exceptions if you don’t meet those two rules. 

So, here’s how retirees are putting more into their Roth after they retire, after they stop earning an income. If they work with us, we can look to see how taxes may impact their plan a few years out. And then we’ll look at the benefit of converting their traditional IRA to ROTH over the period of a few years. It can make a lot of sense, especially if they stopped receiving a wage from work but haven’t started Social Security. That’s kind of a magic, optimal time to convert for many people. Click here to learn more about this conversion sweet spot. 

Type 3

There’s other non-taxable money that’s related to this sweet spot of after working and before Social Security. Let’s call this the bonus method. That sweet spot age could also work for non-retirement accounts where you wouldn’t have to pay tax on gains.

If you have a non-retirement investment account such as an individual account, a TOD, or a trust investment account, and you have investments with big gains, for example, you bought it for $1 and now it’s worth $10. If you have a few years of low income after you work, you may be able to sell those big-gainer investments and pay zero tax on the gain during that time. There’s a long-term capital gains tax rate that says that if you’re married and you have a taxable income that’s under $80,000, the long-term capital gains that you recognize could be taxed at 0%. That is really amazing. And if you’re a single filer and if your taxable income is under about $40,000, then you should be able to qualify for some of that long-term gains preferential tax treatment. 

Be sure to talk with your wealth manager or CPA before doing anything, because sometimes these rules change. Plan it out before you make any decisions. If you’d like to talk with me, click here to schedule a free private retirement planning session. 

Type 4

The last type of money that’s not taxed in retirement is one that most people don’t think about. And that’s your HSA, your health savings account. If you have money in your HSA and you’re under 65, you use that money for medical expenses and not pay tax on the distributions. The nice things about HSA are:

• you were able to deduct the money that you put into an HSA,
• it grew tax deferred (hopefully), and
• if you use it for medical expenses, it’s not taxed.

Some people are worried that if they have money left in their HSA when they turn 65, that it’s wasted or it’s taxable at that time, but that’s not true. You should be able to take the HSA monies and roll it in a non-taxable way into your IRA. 

So to recap, in this post we discussed: house proceeds, ROTH IRAs and conversions potential, 0% tax on investment gains, and health savings accounts. If you have any questions, please reach out.