By Greg Lohr, MBA and Ethan Lohr, CFP®
Most of our clients spend decades accumulating assets and saving for retirement. But putting money away is only half the battle. There are many income tax implications depending on when and the order in which retirement funds are used. Because each income source will have a different tax liability, creating an income plan is a crucial part of maintaining a tax-efficient retirement strategy and keeping as much money as possible in your pocket. The first step in creating such a plan is to identify and understand the various sources of post-retirement income. Here are five streams of income to consider as you plan for retirement.
Social Security is a significant retirement asset for many Americans, and deciding when to receive benefits is one of the biggest questions our clients face. You can elect to receive benefits as early as age 62, but your benefit amount will be reduced. To receive the maximum benefit amount, you must delay your benefits until you reach full retirement age as determined by the IRS. (1)
Social Security is a tax-free benefit as long as your combined income stays within certain limits. If those limits are exceeded, income tax will be charged on 85% of your benefit amount. (2) This is a very important point to consider because other streams of retirement income can impact your tax liability if you’re not careful.
Investment Accounts & Savings
This category of income involves drawing from accumulated retirement savings, which can come in many different forms, including:
- Traditional IRAs
- Roth IRAs
- 401(k) plans
- 403(b) plans
- Taxable investment accounts
A $50,000 withdrawal from a Roth IRA will have a wildly different tax impact than that same distribution from a traditional IRA or a taxable investment account.
Generally, distributions prior to age 59½ from any tax-advantaged account (traditional IRA, Roth IRA, 401(k), 403(b)) will result in a 10% penalty. All these accounts (except Roth) also implement required minimum distributions (RMDs) starting at age 72.
Taxable investment accounts do not have these limitations, but the tradeoff is that you will owe income tax and potentially capital gains tax on all distributions taken. There is also an additional 3.8% surtax on net investment income if your modified adjusted gross income is above certain limits. (3)
Pensions, also called defined benefit plans, typically offer income based on a variety of factors including how long you worked at your company, your income level, and what age you retired. Like Social Security, deciding when to take pension benefits is an important part of retirement planning.
Since most pension contributions are considered pre-tax, the amount received in retirement is usually fully taxable. With a pension, you must also decide between taking your benefits as a lump sum or annuitizing it over your lifetime. Deciding to annuitize comes with even more decisions in the form of what type of annuity to use (single life, single with period certain, joint and survivor, etc.).
Choosing between taking a lump sum or annuitizing could add thousands more to your retirement income, so it’s important to weigh the decision in the context of your full retirement plan.
Royalties & Dividends
Royalties are payments received from patents, copyrights, oil, gas, and mineral properties. Generally, these payments are considered ordinary income and will increase your combined income amount for Social Security purposes.
Dividends are a portion of a company’s profits paid directly to those who own shares of that company’s stock. Depending on the type of dividend paid, they will either be taxed as capital gains (qualified dividends) or as ordinary income (non-qualified dividends).
Inheritances & Trust Funds
Inheritances, whether cash, investments, or property, are not considered taxable income when received. However, any subsequent earnings received on the inheritance will be taxable depending on the source and structure of the earnings. (4)
Trust funds are also not taxable as long as the income and assets remain in the trust. If you are receiving annual income distributions from the trust, however, those payments will be considered taxable income. (5)
Build Your Post-Retirement Income Plan
As you can see, there are many streams of income and tax implications to consider when building your retirement plan. This can be an overwhelming and confusing process for many of our clients. At Lohr & Company, we have the tools to break down each option so you can feel well-informed and confident in your choices. If you’re ready to build your post-retirement income plan, schedule a complimentary introductory meeting online or reach out to us at 434-260-6742.
Greg Lohr founded Lohr & Company, a multi-generational financial advisory firm, in 1993 to help more people plan for a rewarding, well-deserved retirement. Before he entered the financial services industry, he worked as an electrical engineer. But after spending a few years as an engineer, he decided to follow his heart and return to school for an MBA in finance from the College of William & Mary. Although he originally entered the finance industry because he was excited about the personal opportunities, it was the satisfaction of seeing people at peace with their money that has kept him here for his entire career. He is passionate about building lifelong relationships with his clients and walking with them as they navigate financial decisions and milestones.
When he isn’t working, Greg enjoys spending time with his beautiful wife and their adult children. In addition to managing their family farms, Greg and his wife also manage a growing Airbnb venue. In the cold weather months, you can find Greg hunting whitetail deer in the breathtaking Virginia landscapes. To learn more about Greg, connect with him on LinkedIn.
Ethan Lohr always knew his dream was to follow in his father’s footsteps and carry out his same mission: to help more people find financial peace and security in retirement. Ethan started practicing for his future career quite early, at the age of 6, advising his sisters on their savings with the help of his trusty calculator. But it wasn’t until he graduated from James Madison University that he truly began developing his talent as a financial advisor at Lohr & Company. Ethan is a CERTIFIED FINANCIAL PLANNER™ professional.
Ethan is most fulfilled when he’s helping clients develop a sound plan and then executing that plan. He knows that pre-retirees often have many unanswered questions and may be feeling trepidation about retirement—and rightfully so. Retirement is one of life’s greatest transitions and Ethan knows how important it is to get everything right the first time. He works to ease his clients’ fears, provide them with confidence, and help them take the necessary actions to move forward.
When he isn’t serving clients, Ethan enjoys spending time with his wife and two sons. You can also find him practicing his swing on the golf course, exercising, and hunting with his dad. To learn more about Ethan, connect with him on LinkedIn.
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Advisor. Fixed insurance products and services offered through Lohr & Company, LLC or CES Insurance Agency.