March 11

Optimizing your Retirement Income



As we head towards tax season, let’s talk about some strategies to help optimize your retirement income. In retirement your tax rate can vary widely over the years based on the timing and order in which you use different sources of money to pay for your living expenses. An intelligent distribution plan can have a significant impact on the taxes you pay thereby increasing how long your money lasts and how much you can spend. To maximize your net income you will want to apply the tax code in an organized and efficient manner. Always consult a tax professional before taking any action.

Let’s begin by looking at some Tax Traps – These traps occur when your effective marginal tax rate exceeds your stated marginal tax rate. For example a widow filing as an individual with ordinary income of $100,000 would cross into the 22% tax bracket but their blended marginal tax rate would appear to be 19.1%. The problem is that not all income is taxed the same way and so depending on the makeup of her income her effective tax rate could be significantly higher than anticipated.

The Capital Gains Bump Zone occurs when additional ordinary income pushes your capital gains into a higher bracket say from 0% to 15% or 20%. Effectively your non-capital gains income creates additional capital gains taxes. In higher income situations this can further trigger an additional 3.8% medicare surcharge.

The Social Security Tax Torpedo occurs when your “provisional income” triggers taxation or social security benefits to be taxed at 50% to 85%. In certain cases this can be as extreme as changing your effective marginal tax rate from 15% to as high as 40.7%.

The Medicare IRMAA Cliff refers to the Income Related Monthly Adjustment Amount. This occurs when your “modified adjusted gross income” exceeds the Medicare Part B and D premium tiers pushing you into the next higher premium tier. While this is not a tax in a traditional sense it is a hard cost that is tied to your income that can be managed through good planning. It’s called a cliff because if you go over the income levels by even a single dollar, you move completely into the next premium tier.

The conventional order of operations when taking retirement income is that you first spend down your taxable dollars allowing your tax deferred accounts to grow. You then spend your tax deferred accounts before tapping your tax-free sources. This conventional wisdom like most rules of thumb is generally correct but like most rules of thumb isn’t always the best approach.

There have been multiple studies showing that when paired with the tax traps above, there might be alternative approaches depending on each client’s situation.

The basic theme in tax planning is that you want to accelerate taxes when rates are low and defer them when rates are high. One alternative approach in low tax years would be to spend taxable accounts first but also do partial Roth IRA conversions from a traditional IRA. The extra taxes you pay today could be more than offset by the reduction in required minimum distributions that would be due later in retirement. This can be a very powerful strategy in earlier retirement years when combined with a charitable giving strategy like a donor advised fund.

Additional things to consider in low tax years would be take ira distributions in lieu of taxable ones or to sell highly appreciated stock when you are in a zero or low capital gains year.

In high income years you could withdraw tax-free money from a life insurance policy or tap a line of credit for extra income. If you are charitably inclined and you have required minimum distributions, you could make a qualified charitable distribution. This strategy allows you to fulfill your charitable intent and avoid recognizing the distribution as income on your tax return.

In summary, because your tax exposure will change throughout retirement, you need a strategy that is flexible and regularly evaluates and anticipates your marginal tax rate. Planning will help drive your decisions around which assets to use and when to draw from them to cover your personal expenses. Always consult with your tax advisor before implementing any changes.

Gardner Sherrill, CFP®, MBA, is an independent Wealth Advisor with Sherrill Wealth Management. To learn more visit The opinions expressed in this material are not intended to provide specific advice or recommendations for any individual. Traditional IRA account owners should consider the ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation. This information is not intended to be a substitute for specific individualized tax advice. Securities and advisory services offered through LPL Financial a registered investment advisor. Member FINRA/SIPC.


Distributions, Income, Taxes

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About the author

Gardner is a CERTIFIED FINANCIAL PLANNER and principal of Sherrill Wealth Management in Bradenton, Florida. He has spent 20+ years in the wealth management field helping families negotiate the various obstacles and opportunities that retirement provides them. Read More

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