Broker Check

Retirement Basics: Understanding Tax Efficiency

February 19, 2020
Share |

One of the basics in retirement is to be as tax efficient with your income as possible. In 2019, income tax rates range from 0 to 37 percent, plus a potential 3.8 percent net investment tax. Understanding how these progressive tax rates apply to ordinary income creates a tremendous retirement planning opportunity.

The basic concept of tax efficiency
Many retirees can control their taxable income each year by the amount they work and how much they withdraw from retirement savings accounts like IRAs and 401(k)s. When your income drives you into a higher income tax rate, you will need to decide if you want to maximize the tax rate applied to this range of income.

Example: Assume you are a single taxpayer with $10,000 in retirement income from a part-time job. You also have $150,000 savings in a 401(k) retirement account. The income range and applicable tax rate for a single taxpayer in 2019 is as follows;


2019 Individual Tax Rates

Tax Rate

Taxable Income*

10%$1 – 9,700
12%$9,701 – 39,475
22%$39,476 – 84,200
24%$84,201 – 160,725
32%$160,726 – 204,100
35%$204,101 – 510,300
37%Over $510,300

 

In this example, excluding other variables, you have the opportunity to withdraw an additional $29,475 from the 401(k) at an income tax rate of 12 percent. Income beyond this amount will be taxed at 22 percent or higher.

*Note: Taxable income typically includes wages, interest, non-qualified dividends, short-term capital gains (assets owned for one year or less), taxable Social Security benefits and withdrawals from most 401(k), 403(b), and non-Roth IRAs.

Other factors add complexity
Unfortunately, planning for tax-efficient retirement is never simple. There are other things to consider:

  • Your age
  • The taxability of your Social Security benefits
  • Income phase-outs of other tax benefits
  • Required minimum distributions at age 70 1/2 or older (72 as of 2020)
  • Your state tax situation
  • Other taxes (estate taxes, inheritance taxes and capital gain taxes)


What to do?

Making tax efficiency an integral part of your retirement plan can be complicated. But the rewards can be tremendous for those willing to start early, dedicate the time to planning, and ask for assistance.


Ronald Donato Jr. CFP®, MBA may be reached at (856) 667-6228 or RDonato@asfinancialservices.com.