Retirement Income Tax Strategies

There are many factors to creating a stable, secure, and sustainable¹ retirement income plan. One of the more important factors in retirement income planning is tax efficiency. Additionally, on-going retirement income should strive to cover Base Expenses only (mandatory living expenses), while other expenses are be handled through a Discretionary Fund (For more details read: Prioritizing Retirement Decisions). Through targeted retirement income planning, retirees should strive to maximize their income streams through tax efficiency. 

Optimal retirement income efficiency can be found by generating only what is required and meeting these liabilities tax efficiently.

Imagine that retirement income sources are put into three different silos: 1) income that is fully taxable, 2) income that is partially taxable/tax favored, and 3) income that is tax free. Some examples of these sources of income listed in each hypothetical silo.

Retirement Income Silos

Most retirees focus only on pre-retirement income replacement. For example, if your household currently operates on $150,000 per year, then you may assume you need $150,000 of retirement income. This overly simplistic method may be an unnecessarily costly way to create a retirement paycheck.

Rather, retirees should be concerned with matching required income with mandatory expenses and not consuming more than is actually needed. If you generate more income than is required to pay Base Expenses, you will most likely be paying more taxes than are necessary.

The key for retirees is generating actual, net retirement income dollars because not every dollar of income is equal from a tax perspective. Every $1 taken from tax free accounts is actually worth $1 in net terms; whereas $1 taken from a taxable account may only be worth $0.80 (if the assumed retiree tax rate is 20 percent). To the extent possible, a reasonable approach to generating income on a tax efficient basis is: tax free sources, followed by partially taxable, then fully taxable.  
   
This is a brief overview of income source diversification, with an eye toward tax efficiency. A retiree whose goal is to maximize net retirement income, while minimizing taxes on that income, should seek the advice of a qualified professional.

FPA member Jason Branning, CFP^®, is a fee-based investment adviser and financial planner with CS Planning Corp. in Ridgeland, Miss. He owns Branning Wealth Management LLC.

¹ The 3-SModel which is secure, stable, and sustainable is a premise of Modern Retirement Theory. “Modern Retirement Theory”, Journal of Financial Planning’s Retirement Distribution Supplement, December 2009. Copyright Jason Branning and Ray Grubbs.