Taxes in Retirement

They are probably selling annuities.

Since the presenter is from an insurance company they are probably selling annuities of one kind or another, but that comes later. What they are doing up front is collecting names and phone numbers to that they can call you and make a harder sales pitch.

You will also hear that if you keep the combination of 1/2 your social security income and the rest of your income under $25K ($32K if married and filing jointly) then none of your social security income is taxable.

If you have sales resistance you might even get a free meal out of the deal.

The general rule is that there is nothing good to be gained from "free seminars" of any kind.

I don't know what specifically they'd be talking about, but I do retiree tax returns and here are some of the very common tax issues:

1. Social Security becomes partially taxable once your income reaches a certain level; below that, no tax. Understand the rules for that so you see whether you're just on the cusp of it, or so far beyond it that it really isn't a factor in your planning. Check also to see how your state taxes retirement income - many have exemptions for some pension income for example.
2. Currently the capital gains rate (federal) is 0% if you're in the 15% or below tax brackets for taxable income. This can motivate some long-term investors to realize capital gains, just so they report them on a tax return where they're not taxed. It's the opposite of normal tax planning. A retiree can have pretty high AGI with little or no tax, for this reason.
3. IRA distributions and pension income can lead to higher taxes, in part because of their effect on Social Security. So putting that off as long as possible can lead to benefits. Or, use the "IRA to charity" approach if you do a lot of charitable contributions & that remains in the tax code. On the flip side, I also see IRA distributions where there's no tax because overall income is low anyway.
4. Another factor that relates to total income (AGI) is medical expense deductions - they're deductible (as itemized deductions) only to the extent they exceed 7.5% of AGI. For those paying large sums for insurance, care, medications, etc. this can knock down taxable income to the point where no tax is owed. With a high AGI, often there's no deduction.

If I could figure out how to email you some rubber chicken, I'd do it.

-Tad

Andy comments:

I've been to several of these and can, therefore, disagree with Avrum.

There ain't no sich thang as a "free meal".........

Andy in Eureka, Texas

Don't forget to also FAX me a beer...

In the area where I live, those seminars are frequent and are also used to sell mutual funds, unit trusts, and limited partnerships, as well as insurance products. The most extreme form I have heard of is a free trip to Florida or Arizona, where you are pressured to invest in a time-share or condo. Personally, I would lump all such events together under the heading "scams."

In recent months the most prevalent type of seminar has been one in which seniors are advised on ways of getting higher returns on their savings in a time of low interest rates. I would guess they have something to do with annuities. The ones selling mutual funds and trusts come during periods when the stock market is booming and there a lot of financial sales people hanging around. Those are infrequent nowadays.

Never "learn" from selling you a product. Educate yourself first then go shopping.

Only an annuity can pay an income that can be guaranteed to last as long as you live.

An indexed annuity is a fixed annuity, either immediate or deferred, that earns interest or provides benefits that are linked to an external equity reference or an equity index.

When you buy an indexed annuity you own an insurance contract. You are not buying shares of any stock or index.

Jeff McLeod

Thanks, but that doesn't seem to have anything to do with my original question. I was asking about what they were talking about when they said I could "avoid taxes on social security benefits and IRA withdrawals". How would having an annuity help me avoid taxes on my social security benefits and IRA withdrawals?

This can help some. Put your RMD withdrals into a deferred annuity. The build up of triple compounding is not reported on your tax return. You will not receive a 1099. Possibly reducing your SS taxes.

This can work best. If you have non-qualified dollars that have to be reported on your tax return, then move those over to a fixed annuity. This will reduce your reportable income.

Or into any tax-efficient investment vehicle. If you're taking RMDs, paying huge annual annuity fees to buy some tax deferral at that stage is a very expensive thing to do.

"Triple" compounding is marketing-speak for normal, old fashioned tax-deferred compounding.

It is true, however, that there are some things that can be done inside an annuity that are hard to do out of one. For example, municipal bond interest - generally free of federal income taxes - can have a negative impact on the taxation of your social security benefits and so they may not be as good as a tax-deferred account.

If you're taking RMDs, though, the only way putting them into a tax-efficient vehicle makes sense is if you are getting enough income *outside* the RMDs to live off of. If the RMDs are *entirely* excess income, chances are pretty good that your income is high enough that muni bonds may still makes sense - your income is probably high enough that all (well, 85%) of your SS income is going to be taxed anyway.

If you have any earned income, I'd certainly like to see you max out a Roth before considering anything like an annuity.

Lastly, if you are considering deferred variable annuities specifically as a place to put your RMDs so that that money may continue to grow tax-efficiently, consider only no-load, no-surrender period ones with very low-expense investment options. The vast majority of VAs have absurdly high fees and long surrender charge periods and very expensive and mediocre investment options inside of them. Watch out for fees.

(a) moving the dollars - after reporting and paying taxes on them - into an annuity of any kind does not lower your current taxes at all. (b) a fixed annuity paid for with non-qualified dollars generates both taxable income and non-taxable "return of capital". Not paying taxes on the portion of it which is return of capital is not a huge tax advantage. Buy a fixed annuity if you need guaranteed payments for life, not because of supposed tax advantages.

Folks, be wary. There are some situations where annuities (of all the various sorts) may make sense. But they are not all that common.

Here's one scenario that might be brought up on the rubber chicken circuit: imagine you have a sizable amount invested in CDs or bonds/bond mutual funds. Those, by nature, generate ordinary income every year, from the taxable interest. And keep in mind the general rule on Social Security taxation - once your total income hits a certain level, SS is partially taxed. Similarly, a higher income means your IRA distributions may be taxed in a higher tax bracket.

By taking some or all of that CD/bond money and putting it into an annuity, you might lower your taxable income enough to avoid SS tax and/or lower the tax bracket applied to your IRA distributions. This is by nature of the taxation of annuities - they have a tax-deferred aspect to them. But of course you'd need to balance that against the costs and restrictions of the annuity wrapper, which might be worse for you than just paying the tax.

This is where you can insert the diatribe about equity-index annuities with 15-year surrender periods being sold to low-bracket 78 year old retirees, on the basis of their tax-saving features.

-Tad

Other options that help with taxes include Government Savings Bonds, growth stocks and stock funds, municipal bonds (including tax-exempt money market funds), raw land, 401k, IRA, etc. Of course, my favorite is to just spend the extra tax-producing money - for example, take a Caribbean cruise and consume lots of good food and adult beverage.

-HW "Skip" Weldon Columbia, SC

SNIPPED.

First the disclosure, I LIKE annuities - A LOT. I think they can be a great investment - FOR THE RIGHT PERSON UNDER THE RIGHT CIRCUMSTANCES, BUT THEY ARE NOT FOR EVERYBODY.

Now, to try to address your specific question -

The sales pitch for using annuities to avoid taxes on social security works like this - You have $500K sitting in CDs earning 5% interest, or about $25K a year in interest income. You are also getting a pension of $32K a year, plus social security of $24K a year. You do NOT need or use the interest income from your CDs - you simply let it accumulate and roll over from year to year. You are able to live comfortably on your pension and social security and your intention is to let the CD money accumulate and pass on to your heirs. BUT the interest income from the CDs is fully taxable to you whether you take it or not AND it is enough to cause 85% of your social security to be taxable.

So you put the $500K into a deferred annuity that gets similar returns. Because the annuity is tax deferred the earning are not taxable to you until you take the money out. Since you're letting THAT money accumulate anyway, you've now pulled $25K a year off your tax return AND doing that means that none of your Social Security would be taxable. Additionally, since interest income is taxed as ordinary income, moving the money from a CD to an annuity doesn't cost any more in tax when you do take the money out.

That is the sales pitch - it has some validity BUT you shouldn't do anything just because of the tax implications. The goal is to be better off AFTER TAX. You also need to fully understand your investments (which, as a side note, is part of the reason everyone is so upset with their investments right now. The market doing what it did wasn't nearly as much to blame, in my opinion, as people who THINK they know what their doing but who really have an insufficient amount of information about what they are invested it) and annuities (of all types) have lots of moving parts.

An annuity can be the right investment, for the right person under the right circumstances.

Hope this helps, Gene E. Utterback, EA, RFC, ABA

Actually, I snipped too much. Your reply was good, but getting away from the SS taxability, please elaborate on your statement above. I have never had any annuities, but who knows, they might be right for me.

Andy asks:

So, ... when the company issuing the annuity goes bankrupt..... ...... how much do you get after that ?????

Limited protections is provided by the guarantee association in each state. The amount varies. It's the same problem as when a life insurance company goes bankrupt.

Brian