Exploring Taxes in Retirement

6.30.23: Audio automatically transcribed by Sonix

6.30.23: this mp3 audio file was automatically transcribed by Sonix with the best speech-to-text algorithms. This transcript may contain errors.

Val Majewski:
Well, welcome back to the Federal Retirement Show. Im your host Val Majewski with American Benefits Exchange. Really appreciate taking the time out of your schedule to view the information that we're providing. Again, we hope that this is very valuable. We hope that it is something that you feel you need. And even if you just happen to stumble upon thinking this was some other kind of video and you are a federal employee, hopefully you did learn something and maybe you didn't even know you were going to. But today, the topic I want to talk about is taxes in retirement and exploring how those work for you or going to work for you when you eventually do retire. I attended a meeting last week where the topic was about uncertainty with retirement. You know, whether or not people are going to have a confident or strong retirement. And the uncertainty revolved around taxes and how much they were actually going to keep of their hard earned money, the money that they have put aside for retirement. Now, luckily for you, a government employees, you do have a pension. You do have Social Security that should be there for you when you do retire as a lifetime payment, an annuity type of payment. And you will still see some taxes come out of that. But the bulk of where people are putting their money for retirement, their tsp. If you are not utilizing the tax free option, the Roth option, well, 100% of that money is going to be subject to tax.

Val Majewski:
So how will taxes affect your net dollar? In retirement. How what is your take home going to look like after taxes are implemented or after taxes are applied to those payments? So let's dive into the information today and we're going to discuss taxes in retirement. So first off. The question I've been asking every federal employee that I talk to on a one on one basis and a question that I'm asking the group presentations that I'm giving the crowd. Which direction do you think taxes are going to go? Do you think taxes are going to go up or down in the future? I'll give you a second to ponder this and answer yourself. But the consensus, it's not unanimous, but the majority of folks are thinking that taxes are going to go up. And why not? Because they already are going up to some extent, and they are scheduled to go up again after 2025. So whether you think they're going to go up or not, they already have gone up and they're scheduled to go up unless something does change dramatically when it comes to policy. So let's take a look here. Current tax rates right now, the Tax Cuts and Jobs Act of 2017 did lower tax rates across the board for folks. The top tax rate is currently set at 37%. Now, that is after a 7% increase that happened due to inflation. This is adjusted by the IRS.

Val Majewski:
But looking at how taxes were reduced in 2017 as a result of that piece of legislation and historically, we are at very low tax rates prior to this general tax rate that we're in. The lowest was in the 1930. So here in the year 2023, we are still at historically low tax rates compared to our tax rate history, even though we just saw an increase and we're scheduled to see another increase in a couple of years. So the top tax rate currently 37%. That's after seeing an increase. Of 7% or about 7% after taking inflation. And again, the IRS makes that adjustment. After 2025. That piece of legislation, the Tax Cuts and Jobs Act, will be set to expire and will revert back to previous tax rates, which means the top tax rate is expected to go up to now 39.6%. Now, just used the top tax rate instead of listing every single one of them. But you can see we're at 37 now after an inflation adjusted increase when we're going to be up even higher after 2025 and all the other tax brackets are going to increase by about 3 or 4% as a result of reverting back to the previous tax rates prior to the Tax Cuts and Jobs Act. Now, if you're following along, that just means we are scheduled to see increases going forward. So tax rates are going to be going up. Now, does that mean when you do retire? There might be any higher tax bracket than you are currently in.

Val Majewski:
Now, assuming you're going to retire, you know, within a couple of years, let's say after 2025. Now, here's here's why that could be. Now, granted, you might be saying, well, I'm going to be making drastically less money in retirement than I'm making now, so I'd probably would be in a lower tax bracket. And that might be true. But a lot of federal employees that we talk to, a lot of federal employees that we do reviews for, want to get to as close to their pre-retirement income in retirement. They want to get as close to that as they possibly can, meaning they want to make the same amount of money when they retire as they were making prior to retirement. Why is that? Because most want to live the same type of lifestyle. You don't want to drastically affect how they're living. So if that's the case, let's just say you're want to get it very close to your pre-retirement income in retirement, that means you're, relatively speaking, be in a very similar, if not the exact same tax bracket. So you might be paying more in taxes. Then you were while you were working, just from a percentage standpoint. So understand we are in historically low tax rates now. We just saw an increase in 2023 and we are scheduled to see another increase starting in 2026. How will taxes work in retirement? What will be taxed? What things are going to be affected by taxes once I do retire? Now, obviously, your pension is something that is going to be taxed, right? It's taxed in the extent of the government's contributions.

Val Majewski:
Now, as a traditional Fers employee, you put in 0.8% towards the Fers system. Newer hires put a little bit more in 3.1%. If you're an RA, 4.4% if you're an FRA. The government puts in the bulk of the contribution for you, the employee. And the part that's going to be taxed in retirement is the extent of the government's contribution. So the bulk of your payment will be subject to tax when it comes to your pension. If you are fortunate enough to retire with full benefits prior to being Social Security eligible, you will be entitled to the first supplement. Now, the first supplement is an entitlement. It's a free benefit. If you're not familiar with this, I'd highly. Our episodes on the first supplement, what it is and how you can. Going to be. But 100% of your first supplement benefit is going to be subject to tax. So every dollar that's coming to you as a result of the first supplement will be subject to tax. Now, once you hit age 62. Let's say you retire prior to 62 and you get the supplement at age 62, the supplement stops. If you retire at age 62 or later, well, your choice is to take Social Security or not. Social Security will be taxed to some extent.

Val Majewski:
At this.

Val Majewski:
Facts or what portion of your benefit will be subject to tax is based upon your earnings in retirement. It could be up to 50% of your benefit is subject to tax or even up to 85% of your benefit can be subject to tax depending upon which earnings bracket you fall into. When it comes to that Social Security earnings test for the purpose of taxation, now there's another earnings test to see how much of your Social Security benefit could be reduced in retirement. We're not talking about that. We're talking about an earnings test that comes to what portion of your Social Security benefit will be subject to tax. But at least something should be subject to tax. Unless you're making a very minimal amount, then maybe you'll have very minimal tax. But generally speaking, most folks that I'm talking to will have either up to 50% subject to tax or possibly even up to 85%. Their Social Security benefits subject to tax. Now, there are some states that you can live in. We've talked about that in previous episodes. Some states you can live in where you will not be subject to state income tax when your pension or Social Security. So there are some states out there that either do not charge state income tax at all or there are states that will not subject you to state income tax or pension and Social Security payments.

Val Majewski:
You can find out what states those are by reaching out to us. You can go to federal retirement. Show.com fill out our information and we can get that out to you. So you can see if you currently live in one of those states or if the state you're planning on moving to in retirement is one of those states. Tsp. Now 100% of the money that is in the traditional account. Once you withdraw, it is going to be subject to tax. 100% of the traditional account, the pre-tax bucket. The wrath bucket is not subject to tax the wrath bucket. You've paid tax on that already. It earns interest assuming you've seen growth over the rest of your career. All the dollars that come out of that bucket are going to be tax free. That's the nature of the Roth account. But all of the money's in the traditional account. Are going to be subject to tax. Now, it's important to note, if you're not familiar with this, even if you put 100% of your funds into the Roth account, all of the government matching contributions are going into the traditional account. So you will have some portion of your TSP that is subject to tax. So understanding where the taxes are going to come out of when it comes to your pension, first supplement Social Security and TSP. You could be subject to a lot of tax if you're not preparing properly.

Val Majewski:
There's two things you can avoid, right? We can't really we can't avoid taxes on our pension. We can't really avoid tax on the first supplement said 100% of that. You can't really avoid tax on Social Security unless you're earning way too little of income in retirement. But most that I talk to, you want to earn a lot of income in retirement. So now it comes to the options that you choose. With TSP, you have a choice of which bucket you can put money into. You can put money into the pre-tax bucket, the traditional bucket or the post tax bucket, the Roth bucket. A lot of people that I'm talking to now, this is not advice. This is just reporting. The news of a lot of folks that I'm talking to are moving their contributions to the Roth bucket because they'd rather prepay Uncle Sam today and make sure they get him as much out of their pocket as they can in retirement. So I mean by that. Well, if we're at historically low tax rates today and we're scheduled for tax increases going forward and you feel like, hey, I'm going to be at a very similar income level in retirement, well, they'd rather pay tax now, just common sense at a lower tax rate than it's going to be in the future unless some new legislation comes out that keeps taxes at historic lows.

Val Majewski:
I don't see that in the in the near future. That's not something that's currently been presented in the budgeting. But. If they do make changes, they will report the news when that comes. But currently we're scheduled to see another tax increase. As far as rates are concerned. In 2026. So understand your options as a federal employee to help mitigate taxes in the future. So what are your tax free options? Well, we mentioned TSP Roth. You can put money into your. Psp on the north side and that money can grow. And every dollar that you take out in the future will be tax free. Understand, you will still see a taxable portion of your TSP through the government agency matching fund. But even outside of TSB, what are your choices outside of the government to provide a tax free. Retirement strategy. The first is just Roth IRA. Now we have Roth. Roth TSP is subject to 401 K rules. So you can have both a Roth TSP and a Roth IRA. Tsp has its own limitations on how much you can put in. So do Roth IRAs. They have limitations on how much you can contribute to them. They also have limitations on how much money you can make in order to contribute to a Roth IRA. But a Roth IRA is a traditional way in which you can put money aside.

Val Majewski:
And in the future, that money will be tax free. You won't you are not able to take the money just like your until age 59.5. But that money will be tax free when it's all said and done, your your money that you put in plus any of the earnings tax free. And the second way that we look at when it comes to tax free retirement strategies is a little lesser known or let's say less mainstream, because this is not something that is normally advertised all over the place like Roth IRAs are. It's part of the tax code, section 7702. Now, what does that mean? 7702 has been around since 1984. And this is a section of the tax code that talks about the tax treatment of certain plants, specifically life insurance plans. And it outlines what a legitimate life insurance contract based upon the IRS guidelines looks like. And the fact that as long as it remains a life insurance contract, according to their guidelines, the cash value that grows within the plan. It can be utilized on a tax free basis as well as the death benefit of the life insurance plan can be utilized by the beneficiaries on a tax free basis. So it talks about the tax qualification of a properly designed. It passes all the tests. Life insurance contracts. Let me say that again. This is a life insurance contract.

Val Majewski:
But why is this awesome? Why is this another tax free retirement strategy that you should look into? Because there are no restrictions on how much money you can earn in order to contribute to this plan. There are no restrictions on how much money you can put in when contributing to this plan like there are with TSB and Roth IRAs. And there are no limitations on how old you must be or restrictions on how old you must be in order to access this money penalty free. You can access it in your 30s 40s 50s whatever it is. There is no 59.5 guideline when it comes to these types of plans. Now, what kind of plans can be utilized under section 70 702 of the tax code? Traditionally speaking and currently these are the two main players when it comes to permanent life insurance that builds cash value and if properly designed, can build significant cash value on a tax free basis. The index Universal life iul. Or a traditional whole life plan participating, whole life plan with paid up additions using dividends. So these plans, if properly designed, okay, can be a tax free alternative for you in addition to maybe your Roth and the other. Income sources is you're going to get when it comes to your pension, Social Security or the first supplement if you want to set up a or an additional.

Val Majewski:
The retirement savings plan. You want to do so on a tax free basis. These are two awesome options. I've seen them personally. I've seen them with my clients performed the way they should, and they have been a great addition to my clients or the people that I help their overall retirement strategy. Now, here's another great thing about these things. They are not subject to the ups and downs of the stock market. So not only can you take some risk within your TSP and satisfy whatever it is that you want to satisfy as far as your risk tolerance, this could be not only another tax free bucket for you, but also a risk free bucket, meaning, you know, without a shadow of a doubt that you cannot lose any money in these two types of plans due to market downfall. Now, if you do ever see the word variable in front of a universal life plan, variable universal life. That is subject to the ups and downs of the stock market. It's also probably going to contain a lot of fees and extra fees that you don't want to pay. But any time you see the word variable. Variable universal life or variable annuity, that means money is directly invested in the stock market and can be subject to loss. We're not talking about that. We're talking about fixed index accounts or guaranteed rates with the whole life plan.

Val Majewski:
And using section 70 702 in order to design plans properly so you can accumulate cash value that can be utilized on a tax free basis as well as provide a tax free death benefit should you happen to die too soon. So these are all some ways in which you can mitigate taxes in retirement. As I said earlier, it's unfortunate, but we can't do anything to mitigate the taxes out of your pension and really to mitigate taxes out of your first supplement or your Social Security payment. You can put money into the Roth portion of your TSP. But again, the government matches into the traditional portion and that money is going to be subject to tax if you want to remain tax free. And let's say you said, hey, I'm going to put the 5% in because I want to get the free money with the government in my TSP. But anything additional I don't necessarily want to put in there. Takes a risk. I want to put the additional money aside and also a tax free bucket that's not subject to risk. We can look at these options and we look at ways in which you can provide tax free retirement income or tax free retirement cash. Without the restrictions that are in the or a traditional Roth IRA. But certainly you can use any and all of these things that we're discussing.

Val Majewski:
The overall goal and the the theme of this episode is talking about taxes in retirement, exploring what those are. Where are you going to see taxes come out? What are the tax rates going to be in the future? Looks like they're going up. How do we mitigate those taxes and get Uncle Sam as much as we can out of our pocket as we possibly can? Now, whether you know it or not, Uncle Sam is your partner in retirement. Is your partner and he is counting on you. Retiree Because you're going to be paying some taxes on some things, especially the accounts that you haven't paid taxes on yet. If you've got money in the traditional account, I'd rather pay him off, get him out of my pocket as much as I can. And that way going forward, all the interest that I earn, all the money that I make will be considered tax free. Um. How do we do this? What are the ways in which we can decide what's the best strategy for me? Because everybody's different, right? I'm talking in generality today about taxes and retirement, how to mitigate those, but everybody's situation is a little different. So if you want to plan ahead, whether you just got hired yesterday and you just got out of college, high school, what have you, you just got out of the military and you're super young.

Val Majewski:
Just a baby. Just getting started. You need to know what's going on. You need to start planning for retirement today to maximize everything. Okay. So it's important that you get an analysis done. You learn all the variables and all the choices that you made when you first got hired and the effect of those and what they're going to have over the course of your working career. In a retirement review done today. In an analysis done, we can provide a couple of different reports, as you see here. And you know everything you need to know when it comes to the choices that you're going to make while you're working. Also, if you're in the middle of your career, great. Let's get a retirement checkup. You may have seen our previous episode where we talked about the check engine light. You may not realize it's on get a retirement checkup. See where you currently stand. Make sure you're trending in the right direction. And even if you're so close to retirement that you're like, Hey, I don't need this. I'm retiring tomorrow. I'm out of here. I've got my 30 plus years in, I'm done. It's great to know exactly where you stand and see some of the options that you're going to be choosing while you're filling out your retirement paperwork. So you want to make sure you're making the right choices with, say, the survivor benefits, with your insurances, with your TSP.

Val Majewski:
You want to make sure you're setting that up right, for success in retirement. So whether you got hired yesterday or you're retiring tomorrow, there's something in there for everybody. And it's necessary that you get a retirement checkup or a retirement analysis performed. It's not going to cost anything. It's complimentary. It's a service that we provide to federal employees just like you. So how do you do this? Where do you go? We'll go to federal retirement show.com. That's federal retirement show.com fill out our form request a benefits review of retirement analysis. We'll be in touch. We'll set up a time to do that. We have folks all across the country. Most of the time we're doing things virtually through Zoom or teams or just over the phone, but we can certainly meet face to face if absolutely necessary. So go to federal retirement. Show.com fill out the form. We'll be in touch to schedule a time to review your situation and provide those reports to you. So again, thank you for taking the time out of your busy schedule to view this episode. I suggest going back to view all the information in our library so that you can get us up to speed as possible on all things veteran employee benefits. Again, my name is Val Majewski with American Benefits Exchange and look forward to seeing you on a future episode.

Sonix is the world’s most advanced automated transcription, translation, and subtitling platform. Fast, accurate, and affordable.

Automatically convert your mp3 files to text (txt file), Microsoft Word (docx file), and SubRip Subtitle (srt file) in minutes.

Sonix has many features that you'd love including advanced search, world-class support, collaboration tools, secure transcription and file storage, and easily transcribe your Zoom meetings. Try Sonix for free today.