How to prepare for a less taxing retirement

by Dennis Johnson

for the Business Journal

Many people expect their income taxes to go down after they retire, but some find that the IRS isn't any easier on them in their golden years. There are ways to plan for a less taxing retirement, though. Here are some things to consider.

Retirement account distributions. It's not too early to decide what you'll do with these accounts when you leave work, and your decision may affect your taxes in retirement. Your employer's plan will probably offer three options:

?Take a lump-sum distribution;

?Leave the account with your employer and receive annuity payments; or

?Roll over the account to an IRA.

If you take the lump sum, you'll owe income tax on the entire amount leaving you with a potentially huge tax bill and probably pushing you into a higher tax bracket. Also, once you take your money out of the tax shelter, any further interest, dividends or capital gains it earns will be taxable. The option for annuity payments lets you defer income tax until you receive the money over time. A direct rollover into an IRA enables you to continue to increase your retirement funds tax-deferred and choose when you want to withdraw the money.

If you're planning to roll over your retirement funds, remember to have your employer's benefits office send the check directly to the new IRA custodian. If you take the check instead, your employer must withhold 20 percent of the amount for taxes which you'll have to replace out of pocket to make your rollover "whole" (you'll get the 20 percent back when you file your taxes).

Any part of the retirement account not rolled over will be considered a taxable distribution.

Required distribution. Even if you roll your retirement funds into a traditional IRA, you can't delay your distribution (and resulting taxes) forever. Unless your IRA is a Roth (see below), you must begin taking minimum required distributions the year after you turn 70.

The IRS allows you to calculate these required distributions based either on your life expectancy (from IRS tables) or your joint life expectancy with your spouse, or anyone you name a beneficiary of the account. By opting for the joint calculation, you may be able to reduce the distribution you have to take.

Tax benefits for the new Roth IRA. Contribute to a Roth IRA and you'll never have to pay taxes on the earnings if you hold the account at least five years and until you're 59.

In 1998, single taxpayers with adjusted gross income of $95,000 or less and joint-filing couples with income of $150,000 or less can contribute up to $2,000 per year in a Roth IRA regardless of whether they participate in a retirement plan at work.

Singles with an adjusted gross income of up to $110,000 and couples with income of up to $160,000 are allowed to make smaller contributions.

Different tax rates for different states. Planning to move to a new place when you retire? Since state tax rates differ considerably, your choice of location will affect the amount of tax you pay. Check with each state's revenue department for details on taxes.

Working in retirement. When planning whether to keep working in retirement, think about this: Not only will your wages be taxed, the income you earn may cause more of your Social Security benefits to be taxed, as well.

Under the current tax law, when your "provisional" income (adjusted gross income plus tax-exempt interest and half of your Social Security benefits) surpasses $25,000 ($32,000 for couples filing jointly), some of your benefits will be subject to income tax. If your provisional income rises above $34,000 ($44,000 for joint filers), up to 85 percent of your Social Security payments may be taxed.

As you can see, a little planning ahead may mean tax savings throughout your retirement. A knowledgeable financial adviser can help you integrate these ideas and others into a financial plan that helps you achieve all of your retirement goals.

(Dennis Johnson, CFP, is a personal financial advisor with American Express Financial Advisors.)

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