Developing a Tax Strategy for a New Retiree

The most significant goal clients discuss with advisors during their professional relationship is retirement. How taxes are paid is an important component. Making a strategy for your clients will make this great change much easier.

We don’t need to get too far into the weeds of tax preparation because we’re financial counselors, not tax advisors. Rather, we want to take a strategic approach, providing value to our client’s financial life and properly guiding them.

Let’s use a fictitious customer as an example for clarity. Assume our customer is a single woman who works as a program manager for a Fortune 500 business and earns $300,000 per year. She has no other sources of income. We’ll focus on federal taxes because state taxes vary significantly across the country.

This is a significant change.

Moving from working to receiving retirement income will be the most significant in our client’s financial life. For most of her working life, she had been accustomed to getting reliable biweekly paychecks from her job. This will be a huge adjustment, regardless of the technique we employ to replace it.

Tax withholding was virtually an afterthought in those bi-weekly checks. Federal taxes were withheld from every payment, and this was practically never brought up at our semi-annual meetings.

Our client informs us during our mid-year assessment that she will retire in three months. It’s time to start devising a tax strategy that fulfills her requirements.

A new tax bracket has been created.

We must calculate her new tax bracket because she no longer earns a constant $300,000 per year pay. It’s a two-step process. We need to figure out how much money she’ll make in total, including her pension and Social Security retirement payments (this income may have different tax treatment). Then we compare that figure to what she requires in terms of spending. The larger of the two figures will be used.

Our client’s annual revenue dropped from $300,000 to $100,000 due to her expenses. According to the 2022 tax table, her federal tax bracket has dropped from a 35% to a 24% marginal rate. Her flexibility within that bracket permits her to make an additional $70,050 in ordinary income before jumping to the next bracket.

Now is the time to start having fresh conversations and strategizing new plans. We can consider Roth conversions or additional eligible withdrawals, depending on various other criteria, to help mitigate the impact of large RMDs in the future.

Putting a plan into action

We can decide how to pay taxes in advance now that we’ve done the legwork and our customer understands how their taxes will change in retirement.

The simplest option is to express the value of distribution withholdings. We’ve already discussed our client’s expected annual income, and we have a reasonable idea of where they fall in the federal tax bracket. Then we’ll be able to make an informed conclusion about the withholding. We might suggest withholding 15-20% on the federal level for our client with $100,000 in regular income in 2022.

Contact Information:
Email: [email protected]
Phone: 8889193252