Taxes after Retirement. Okay, we survived Income Tax Day 2016 and crawled over the finish line with a small refund. It puts one in the mindset to consider the impact of taxes after retirement.

Dan worryingly says, “A sure sign they’re running out of other people’s money is the politicians are shifting their sights from taxing income to taxing savings.” We’ve been relatively frugal in our working life. We’ve deferred current wants to fund future needs. We have more dollars in our retirement savings than in our house and cars.  Despite the fact Lori loves houses — especially old ones! Our “cabin” is under perpetual renovation. And Dan loves cars. Still,  our cars are all well over 100,000 miles.

taxes after retirement

Taxes after retirement — It may be old, but it’s not shiny.  Our faded and scratched 2002 Mercury Cougar has over 190,000 miles on the odometer but still gets 40 mpg on the  highway and 32 mpg combined. The dog’s enjoying it now. The first daughter may end up with it this summer.  The minivan is similarly aged. Fewer dollars spent on cars means more in retirement savings.

We tend to drive our cars into the ground or pass them down the line to family members. That sexy red Cougar? When new, it was originally Lori’s commuting car. The daughter was then fifteen. It was the car in which our daughter learned to drive a manual transmission. A long time ago. Long enough that the Mercury brand disappeared in the interim. It’s been a great car, with low maintenance and low cost to operate. It’s not that we don’t like new cars or fancy houses. We just like retirement security better.

It’s taken a lifetime of savings and deferred gratification to get to some degree of security. Are you worried about having your hard-earned savings confiscated by future taxes, even though you’ve done “the right thing” according to current public policy by saving for your retirement? It crosses our mind.

The threatened future taxes on assets or transaction fees on investments are proposed as a way to “get” the corporate titan millionaires who have plenty to spare. The danger is that such taxes will merely become a tax on age as many average workers and professionals accumulate substantial savings for retirement and have the house paid off before quitting the workforce. For some reason, whenever Washington aims at the wealthy, they hit the middle class. 

You can’t control political avarice so you do the best you can within the current rules of the game. You worry about future rule changes. But plan based upon the status quo. To that end. . . .

Taxes After Retirement – CCRC Fees and the Prepaid Medical Expenses Deduction.

One of the advantages of a Continuing Care Retirement Community (CCRC) or Life Plan Community is that portions of your initial entrance fee and monthly fees may be deductible from gross income as prepaid medical expenses. The calculation is complex.  It is done on an annual basis and reported by your CCRC to each resident.

“Seniors considering or reconsidering such a community should be aware that they may qualify for hefty tax breaks if they move into a retirement community that offers assisted living and skilled nursing support as part of what are considered lifetime care benefits. If their children or other family members provide major financial support for entrance fees and monthly expenses, they also may be eligible for tax deductions.”  — US News: Retirement Communities May Provide Big Tax Breaks – July 23, 2013

For entrance fees, only the non-returnable portion may be deducted, so there’s a trade-off in return-of-capital contract clauses and current tax impact. This can make the after-tax numbers vastly different than the back-of-the-envelope budget that ignores tax impact. It’s why you should talk with an experienced tax advisor or elder law attorney before making a decision on a CCRC. It might also help you choose between competing communities. The terms of the contract may make nominally similar communities vastly different in tax impact.

For most Type A (extensive or LifeCare contract) CCRCs, somewhere between 30%-40% of monthly fees are deductible. It’s not a credit. It’s a deduction. It reduces taxable income, so the tax savings are a factor of your actual tax rate and not a dollar-for-dollar reduction of taxes paid. Still, this is one of the reasons we like CCRCs. We’d rather pay towards our own health care than pay taxes to the government. And we don’t feel selfish in that desire. Given the risk of longevity, our limited pool of resources  may have to last a long time.

But there’s more.

There are a lot of choices and elections available in the tax code. Many times we make decisions without understanding the future tax implications. Some of these consequences are paid in unnecessary taxes after retirement. The next tax dilemma is a hidden trap.

Taxes After Retirement – Traditional vs. Roth.

Individual Retirement Accounts (IRAs) and various other tax-advantaged retirement savings devices like 401(k)s offer the option to defer taxable income into retirement (Traditional) or to pay taxes today and take savings out in retirement income tax-free (Roth). You can even convert traditional accounts into Roth accounts. has a nice checklist of considerations and a calculator to help you evaluate based upon taxes after retirement.

The choice of when to be taxed (now or post-retirement) is normally posed as, “What is your current income versus what do you expect your income to be in retirement?” Assuming that tax rates or tax brackets don’t change substantially over twenty years, guessing future income is a seemingly reasonable approach.

Our retirement planning is focused on maintaining our current standard of living and relative income level when our money is working for us after we quit working for money.

We’ve been feeling pretty good about the ability of the portfolio to support our plans at a 4% withdrawal rate. We’re approaching the 95% confidence level that we’ll have enough and we have a few years of working to go.

We’ve kind of concluded that there’s not a lot you can do against the true hell-in-a-handbasket scenario so that last 5% may just be our acceptable risk.

We’re planning to wait to collect Social Security until age 70 to maximize our defenses against outliving our assets.

Lori had to upset the apple cart by finding an article on the perverted rules of Social Security benefits income taxation. The problem? Your effective tax rate may be much higher than your nominal tax bracket based on pre-retirement income. Why? Social Security benefits are taxed differently and more than ordinary income. The government apparently doesn’t want you to live above the poverty level in retirement. Okay…that probably wasn’t really the original intent, but, as is often the case, the unintended consequences are different.

Taxes After Retirement – Social Security Taxation And Roth Conversion. presented the problem in an Advisor Perspective column by John E. Walton, Ph.D., PE on April 19, 2016.

The unique way that SS benefits are taxed dramatically changes the marginal tax on retirement income, particularly for clients with benefits enhanced by delay until age 70. At low levels of total income, SS benefits are tax free, but as income increases, up to 85% of benefits are taxable. Since an additional dollar of outside income can make more SS income taxable, the extra dollar of income requires the payment of tax on the extra dollar, plus tax on the newly taxable portion of SS. At some points in the formula, this turns the 15% tax bracket into (1 + 0.85)*.15 = 27.75% and the 25% tax bracket into 46.25%. This makes conversion to Roth substantially more beneficial, even if the client appears to be in a higher tax bracket today relative to retirement.”  — ValueWalk: Social Security Taxation Roth Conversion

Dr. Walton’s graphical illustrations of nominal versus effective tax rate or tax bracket are particularly clear and disheartening. The effect is largest for those earning $65,000 up to approximately $110,000 in combined pre-tax Social Security and ordinary income. Of course, right where we want to be. And describing exactly our plan to defer Social Security to 70.

Our prior expectation was that it probably didn’t matter much whether we did Traditional or Roth. We expected approximately equal income on both sides of retirement. Our recent contributions have been to a Roth, partly so we’d have some money on both bets. Now, seeing Dr. Walton’s explanation, we’re planning to review our conversion options for our traditional IRAs and 401(k)s.

And it still feels like a high-risk area because we can’t count on a stable tax code. Any decision could be undone by future political whims.

Taxes After Retirement – Caveat and Conclusion.

As always consult with your tax professional. This article is not tax advice. Rather it raises to your attention tax questions that may affect your planning. Tax impact is very fact specific, given the complexity of the tax code. As a society, we believe fervently in full employment for lawyers and tax accountants. Keep yours happy.

Still, we wanted to share Dr. Walton’s observations. It might help you consider your own taxes after retirement planning issues. You can’t ignore taxes and taxes because one thing is certain. We will have taxes after retirement. Uncle Sam expects payment every April (or sooner if you’re on quarterly estimates).