SITUATION: I’ve almost got my mortgage paid off and I’m just about to retire. Does it make sense to have a mortgage in my retirement?
Through your entire working career, you made the most money you could make and reduced your taxes with adjustments, exceptions, credits, and deductions such as mortgage interest. Everything changes once you enter retirement. You determine what all of the regular income sources you will receive in retirement such as pensions and social security, subtract the amount of money you need to meet your retirement lifestyle goals, determine which accounts will augment any shortfall and determine how much tax is created based on what income sources are selected.
Taxes will be increased if distributions from retirement plans such as IRAs are required to meet the retirement cash flow goals. Paying off the mortgage can substantially lower income taxes. In other words, having a mortgage in retirement may increase income taxes rather than lowering income taxes.
The tax code is roughly 100K pages of tissue thin reading pleasure with something in there for everyone. Seek the advice of a fiduciary advisor who also has experience in tax planning in order to find out if the mortgage helps reduce or increase taxes.
Is social security taxable or tax-free?
SITUATION: I talked to one person and they tell me they don’t pay taxes on social security and then I talk to someone else who tells they do pay taxes on social security. How is a person supposed to plan if they cannot get a simple answer as if my social security is taxable or not?
This is one of the most egregious parts of the income tax code. In the most basic definition, social security is a tax-free benefit. However, In 1980, congress implemented a form of means testing where the more retirement income you have, the larger the portion of social security is added as taxable income. In other words, congress decided the rich should pay tax on their social security. You might be surprised how congress defines a rich retiree.
The social security provisional income test includes all taxable income, tax-free income, and one-half of social security benefits. If this results in provisional income in excess of 25K and 32K for a single & married filing joint return. respectively, some part of social security will be added as taxable income, according to the Social Security Administration. The test has not ever been indexed for inflation. As a result, more and more retirees pay more and more taxes on their social security. Every additional dollar of retirement income including IRA distributions could create up to $1.85 of taxable income. I don’t think anyone believes that 25K of income should consider you as a rich retiree.
To reduce the taxable part of social security includes income tax planning, before the end of the year, and should be completed near the beginning of every year. With proper planning, you will be able to keep a larger portion of your retirement assets and your income for you and your family while only paying the amount of taxes required by law.
My tax bill is already low, should I bother doing any additional planning?
SITUATION: My wife says I need to do more to reduce my taxes. When I look at my tax return, I see I paid far less then when I was working. What benefit would I get from additional tax planning?
We would commonly tell callers on our radio show that income tax code is written to be passive in the favor of the government. Judge Learned Hand is a famous Judge who said, “…anyone can arrange their affairs to pay the lowest tax possible. All do right, rich and poor alike, for no one owes more than the law demands.”
Having a low tax bill does not mean that one should not stop looking for more opportunity to lower their taxes. We would challenge people with a zero tax bill to look for ways to lower their tax bill even more by accessing retirement plan distributions that might also be taxed at zero percent. We would argue that there is never a better time to distribute money than at a zero rate as the future rate of the taxpayer and their heirs would certainly not be lower.
A person who is comparing their income taxes in retirement to their tax bill while working is often satisfied at the total reduction to their income taxes. Additional planning can illustrate ways to reduce taxes by altering those expenses already made such as how and when to give to charity, elimination of debt, and the timing of tax payments can all result in a lower tax bill. To take advantage of a strategy such as those mentioned in this and the prior paragraph requires advanced planning that must be completed before December 31st.