Ready For Retirement
Ready For Retirement
Tax Planning for Widowed Retirees: How to Optimize Your Tax Strategy
Jennifer, 54, plans to retire soon. Her husband, 70, is retired, on Social Security, and dealing with some severe health issues. Jennifer worries about possibly becoming single in retirement, which could result in a higher tax bracket for her.
Jennifer is considering whether to convert her traditional accounts to Roth to lower future taxes or to change her contributions to Roth 403b, even if it means paying more taxes now. James walks us through several factors for her to consider and demonstrates why her future tax situation is likely not as dire as she thinks.
Questions Answered:
How should Jennifer maximize her retirement savings in light of her current financial situation and future tax implications?
What factors must Jennifer consider when deciding whether to convert her traditional retirement accounts to Roth or change her contributions to Roth 403b?
Timestamps:
0:00 - Jennifer’s question
4:46 - Retire early for tax benefits?
6:05 - Roth conversion strategy
8:43 - Consider future expenses
12:38 - Assess SS strategies
13:56 - Consider living situation
15:54 - The conversion question
17:54 - Main takeaways
Create Your Custom Strategy ⬇️
Today we're going to dive into the situation of a listener named Jennifer, who has a very specific set of circumstances that will require a bit of careful and strategic planning. The reason for that is Jennifer's 54, and she wants to retire within the next few years. The challenge she's up against is that, while she's in her peak earning years and wants to contribute to pre-tax accounts, her husband is 70, and he's already retired and he's on social security. On top of that, he has some pretty serious health concerns. So, jennifer, her main concern beyond, of course, her husband's health concern is that she may spend a significant part of her retirement single, which would put her into a higher tax bracket. So what should she do today? Should she contribute to Roth accounts? Should she do Roth conversions? Should she retire early to expedite that process? All that and more is coming up on today's episode of Ready for Retirement. This is another episode of Ready for Retirement. I'm your host, james Canole, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. Let's jump right in by going over Jennifer's question. Here's the question that Jennifer submitted Hi, James, I love your show.
Speaker 1:I'm 54 years old and I'm hoping to retire by 60. My husband is 70, retired and has several major health problems. He's also already on social security. I have $2 million in a traditional 403B, $200,000 in a traditional IRA, $50,000 in a Roth IRA and $50,000 in a 457B. We have been living on about $13,000 per month, which is my take-home pay plus his social security. Because of my husband's age and health status, it is likely that I will spend a significant number of years single after he passes. This will put me into a much higher tax bracket. My 403B plan does not allow in-plan Roth conversions, so the only thing I can convert before I retire is a $200,000 traditional IRA. I can send my 403b contributions to a Roth moving forward, but I can't convert the $2 million that's in traditional as long as I'm working. Should I retire sooner so I can roll over the 403b into the IRA and start aggressively doing Roth conversions? Should I change my future contributions to the Roth 403b, even if that means paying more in taxes now, at the height of my career, or am I totally screwed?
Speaker 1:Thank you for your help, jennifer. All right, jennifer. Well, thank you very much for that question. To jump right into it, no, you're definitely not totally screwed. There are, of course, some planning strategies or some planning things you're going to need to look at, because you are absolutely right.
Speaker 1:If we look beyond, of course, health concerns and all that, there is a good chance that you are going to spend a good chunk of your retirement, even just with the age difference itself, in the single tax bracket. In retirement and when you're single, you have the same tax rates, so the same 10%, 12%, 22%, 24, so on and so forth but you have a lower threshold until you hit those rates. So, all else being equal, all income and expenses being equal, you would be in a higher tax bracket single than you would married, filing jointly. However, there are certainly some other things that we want to consider that may not make the picture as challenging or as grim as it might appear to be at the beginning. So let me just quickly summarize, if we don't have it already, jennifer's situation financially as it stands today.
Speaker 1:She has $2 million in a traditional 403b. This is her 403b at work and one of her challenges is she cannot do any conversions within the 403b. So she's saying should I get ahead of this whole Roth conversion thing to get money out of pre-tax accounts now when we have the joint tax bracket of married filing jointly. But her plan doesn't allow for that, she cannot do an in-plan conversion of her 403B. In addition to the 403B, she has $200,000 in a traditional IRA already and, as with anyone's traditional IRA, she could do conversions on that anytime she wanted to. So that's outside of her workplace retirement plan. And then, in addition to that, she does already have $50,000 in a Roth IRA and she has $50,000 in a 457B, which for all intents and purposes, in most cases, is going to be just like that 403B or just like a 401k, with a few nuances or a few differences.
Speaker 1:Now, in addition to these financial assets, which are combined about $2.3 million by the way, jennifer, I don't know if your husband has assets above and beyond that. I just know that these are what Jennifer listed as her assets. In addition to that, they're spending about $13,000 per month and that's a combination of her husband's social security benefit. I don't know exactly how much that is, but part of that is her husband's social security benefit and the rest is Jennifer's take-home pay. And she's concerned because she's feeling like, oh my gosh, in the future I'm going to be totally in a difficult spot because my tax bracket is going to go up pretty significantly once my husband passes before I do Now.
Speaker 1:Of course, we're going to jump into this today and start to help Jennifer understand what are some things you should be thinking through and maybe start to shift the perspective just a little bit. This is always much better if you can do it with a CPA, with a financial advisor, to actually understand Jennifer's specific tax situation today, to project out her probable specific tax situation in the future, to do some more specific planning. But what we can do today is offer some high level looks at this. I want to start with this. One of the things Jennifer said directly in her question is quote should I retire sooner, roll the 403B into my IRA and start aggressive Roth conversions? End quote.
Speaker 1:Rarely, rarely, rarely, rarely does it ever make sense to retire early just for tax reasons. In other words, the benefit that you're going to get by retiring earlier and having another year to do Roth conversions is almost always going to be offset to a pretty significant degree by the loss of income that would no longer be coming in. There would now be one fewer year or two fewer years or three fewer years, depending on how early Jennifer ends up retiring of that income coming in, which is lost income. It now means she needs to start drawing down her retirement assets sooner, which means there's now lost compounding interest or compounding growth on that going forward. That is going to pretty significantly in most cases offset any potential tax benefit that Jennifer would now have to say okay, now I have a longer time to convert some of my pre-tax accounts from their pre-tax accounts into the Roth while we have married filing jointly tax status. So while I don't know Jennifer's specific situation, I can say pretty clearly in most cases very rarely does it make sense to retire early just for the tax benefits.
Speaker 1:The next thing I want to go to from Jennifer's question is she says should I change my future contributions to the Roth 403b, even if that means paying more taxes now at the height of my career? So this is the crux of Jennifer's issue. She's saying look, I'm in my peak earning years and typically those are years that we want to contribute to maybe traditional retirement accounts, because once we retire we go into a lower tax bracket and then we can implement a Roth conversion strategy. Well, that is true in most cases. But the challenge that Jennifer has is what if her husband passes away when she retires, or even before she retires? Well now, all of a sudden, her overall income might go down, but so too do her tax thresholds. So she now doesn't have as high of tax brackets to work with, or as high of tax thresholds, I should say, before she jumps into a higher tax bracket.
Speaker 1:Here's the thing, though when you're looking at this, you should be comparing today's tax bracket to your future tax bracket, and that sounds pretty simple, but what Jennifer is doing is looking at only one aspect of that, and what most people are doing, at least in this question, the way it's presented, is only looking at one aspect of that, and the aspect they're looking at is married, filing jointly tax rates versus single tax rates, and again, the dollar amounts, or the percentages, are the same for the actual tax rates themselves, but there's lower dollar amounts that you have to cross over before jumping into the higher tax brackets. But that's only one part of it. What we really need to know is what will the actual income look like at that time? Because, as we mentioned, currently Jennifer is spending $13,000 per month.
Speaker 1:Let's walk through a quick exercise using some numbers I'm going to somewhat take some liberties with here. But she says she's spending $13,000 per month, which is a combination of her take-home income plus her husband's social security benefit. Let's assume that $13,000 per month is $20,000 per month before taxes. I'm just making this number up to illustrate this here real quick. $20,000 per month pre-tax is $240,000 per year. That would put them, jennifer and her husband, at the high end of the 22% bracket, to maybe the low end of the 24% federal tax bracket. 22% bracket to maybe the low end of the 24% federal tax bracket. So somewhere in that range, high 22s or low 24s. Now this is going to depend upon how much of that income comes from social security versus how much of it comes from Jennifer's income and a number of other factors. But let's just say that's the approximate place that they're going to land high 22 or low 24% tax bracket. Now what we need to compare that to is what will Jennifer's future tax bracket be? Because what Jennifer is concerned about and rightfully so is those tax brackets are going to be compressed. But that's not the whole story.
Speaker 1:My first question would be Jennifer, are your expenses still going to be $13,000 per month when you're retired? They might be, but some expenses are probably going to go away. Don't want to boil human life down just to an expense, but if we talk about the fact that maybe Jennifer's husband does pass away, it's not as if all $13,000 that they're currently spending is going to be maintained going forward. Some of those expenses are likely things that are going to go away, whether that's basic things like, okay, some of the food budget or entertainment budget or travel budget that's no longer going to carry on. Maybe a lot of the expenses today are health expenses. I have no idea what the $13,000 per month is comprised of, but I do know that Jennifer's husband has some pretty serious health issues. Are those a big chunk of the budget?
Speaker 1:Let's just assume and I'm making up a number here a big number. What if it's $3,000 a month that are just healthcare expenses? Well, right off the bat, $13,000 shrinks down to $10,000. Well, what if after that, there's less food expenses? Maybe they drop down to one vehicle, maybe some insurance expenses go away?
Speaker 1:What if, after Jennifer's husband passed, she's only spending, say, $8,000 per month? I'm not saying this is Jennifer's actual situation, but let's just go through this exercise of what if she's actually spending $8,000 per month after her husband passes. Well, to simplify, I'm going to assume that that's $10,000 per month pre-tax and that's a bit of circular reasoning. I'm trying to determine her tax rate by assuming the pre-tax amount that she needs to live on. But if she's spending $10,000 per month pre-tax, that's $120,000 per year of adjusted gross income.
Speaker 1:If Jennifer were then to apply her standard deduction and I'm using standard deductions for 2024, obviously after 2025 tax law will change, but just assuming this year's numbers she would have a standard deduction of $14,600. So $120,000 of adjusted gross income minus Jennifer's standard deduction assuming she's single, that leads to $105,400 of taxable income. That puts her at the very bottom of the 24% federal tax bracket. Well, what else was at the very bottom of the 24% federal tax bracket? Their current income, at least based upon some assumptions and some liberties I'm taking with the income that they have today. So at first blush and again I'm taking some pretty serious liberties here with some assumed expenses and tax rates I don't see any major changes happening to Jennifer's tax rate today versus where it might be if she were single.
Speaker 1:So that's where I would start is yes, jennifer, your tax brackets are coming down. You'd have lower amounts of income if you were single. That would push you into higher tax brackets. But don't start there. Start with the fact that we have to now understand what will your expenses be. The exercise I would go through if I was Jennifer or if you're someone listening in a similar situation is don't look at tax brackets as a starting point.
Speaker 1:That's the final step. The first step is understanding what will your retirement budget look like. What will your income needs be? Then, with that, you can start to understand what will that look like for your taxable income. Meaning, based upon what's coming from social security or what's coming from an IRA or what's coming from a Roth IRA, what will your taxable income look like. Then you can finally look at tax brackets, so saying, based upon this level of taxable income, even if it's just an estimate, let's apply that to the tax brackets for single filers and see where I might end up there. Once you have that in place, then you can make the determination of okay, does it make sense to convert some of my IRA If I'm Jennifer speaking now? Does it make sense to convert some of my IRA If I'm Jennifer speaking now? Does it make sense to convert some of my IRA to my Roth IRA today, because I know that I'm in a lower tax bracket today, even though I made my peak earning years, then I will be in the future at single tax rates, or at a minimum. Does it make sense to prioritize Roth 403b contributions going forward as opposed to traditional 403b contributions going forward, to at least start building up my Roth balance? Now, in addition to this and this wasn't really part of Jennifer's question, but I think it's really pertinent to our situation also start to assess what are the potential social security strategies in front of you.
Speaker 1:Assuming Jennifer's husband does pass away before her, there's going to be a social security claiming strategy that Jennifer should implement. Should she collect a survivor benefit early? You know you can do that as soon as age 60. So if 62 is the earliest, you can collect your own benefit. If you're a widow or a widower, you can collect a survivor benefit as soon as age 60. Now, in addition to that, there's some strategies of when do you collect your own benefit versus when do you collect that survivor benefit. You can collect one early, allowing time for the other to continue growing, and then switch over to that at a later day. Now this doesn't seem like it's part of the tax strategy, but it really is, because social security is taxed more favorably. Many states don't tax social security at all, whereas they will tax income from, say, an IRA or other types of income, depending on the state. Some states don't, and federally, never more than 85% of your social security benefit is going to be included in the income that you pay taxes on. So even getting the right social security strategy is going to help to understand what Jennifer's tax picture might look like, because it's going to be taxed differently than what distributions from her 403b or her traditional IRA.
Speaker 1:Another thing to take into account for someone like Jennifer is just living situation. I have no idea the living situation for Jennifer and her husband, but what I do know is not uncommon, especially for people who have lived in their homes for a long period of time and those homes are in high cost of living areas, as it's not uncommon to say maybe Jennifer and husband purchased a home for $300,000 years and years and years ago. Now that home is worth 1.5 million, so a lot of appreciation. And maybe Jennifer and her husband again I'm totally making this up. This may not apply to them, but my guess is it certainly applies to a lot of you listening they're kind of cautious to sell it, because if they sell it today, well, there's going to be a six-figure tax bill. They would pay because of all those capital gains, even after the capital gain exclusions.
Speaker 1:Well, if Jennifer's husband passes away and if they're in a community property state, there's a full step up in basis. So that home that they bought for $300,000, and if they sold today it would sell for $1.5 million. That's $1.2 million of capital gains. Some are excluded if they've lived there for two out of the previous five years, but there's still a big tax bill. Well, after Jennifer's husband passes away, that home is Assuming these numbers that I'm making up here the cost basis would become $1.5 million.
Speaker 1:So now that's something that Jennifer could use in her plan and say, okay, maybe now it could be something that I sell. I'm not paying a six figure tax bill to the IRS and my state treasury, depending on what state she lives in, and that's something that could be incorporated into her plan as well. What if at that point she said I don't need this big home? What if I sell the $1.5 million home, buy something for $800,000 or $900,000, and then she has $600,000, $700,000 to live on? That that would really help out with any potential Roth conversions she might do so. Again, these aren't things that were directly part of Jennifer's question. They're absolutely nuances I would want to explore because they could absolutely fit into some of these tax questions that Jennifer has around her 403b IRA, roth IRA, et cetera.
Speaker 1:Now I want to quickly circle back to one of Jennifer's concerns, where there's the limitation with her 403b, and that limitation is no in-service plan conversions To me. I don't see this as a huge issue, and the reason I don't see it as a huge issue isn't because I'm saying she shouldn't do any Roth conversions. It's more so because she has $200,000 in a traditional IRA and if you're going to convert anything, it doesn't really matter so much if she's converting her 403B or her IRA. The tax implications are going to be the same and, assuming the investments are somewhat the same, then the long-term growth potential from either is going to be the same as well. So I'm not too bothered, jennifer, that you can't do in-service conversions.
Speaker 1:And again, I'm not even saying whether you should do a conversion or not. I'm just saying that if you determine after looking through this or after working with your financial planner or tax planner, you can always start with that $200,000 in your IRA and fully convert that first, before turning your focus to the 403b. So work with a financial advisor, work with a tax professional to determine that. But I certainly wouldn't retire early just to get access to that 403b so you could roll it over to an IRA and then convert. I would absolutely assuming you were going to do conversions, I would absolutely start with that traditional IRA and not until you had fully converted that would I even think about.
Speaker 1:Do you need to do anything differently with your 403b in terms of some type of in-service rollover or take steps to allow that 403b to become available? And then, in addition to that, one of the good things, jennifer, about your 403b is there is a Roth option. So with that Roth option, you're not necessarily doing a conversion, but you're now starting to build more of a Roth balance because now future contributions are going to the Roth 403b as well as to the traditional 403b. The downside, of course, is no tax deduction today, as I think you know. But the upside is if in the future you're in a lower tax bracket because you're single as opposed to married, filing jointly for your tax status, those are distributions, when you take them, that you will not pay taxes on, assuming you meet the required holding periods for Roth IRAs.
Speaker 1:So the main takeaways for me is Jennifer, I don't think you are in as dire of a situation as maybe your concern was at the beginning. At the end of the day and I'll say this quite a bit taxes are absolutely something we want to plan around. We want to make sure we have a good tax plan but, at the same time, taxes are very rarely going to be the thing that causes your retirement to be totally disrupted. It's almost like someone saying, hey, I just got a raise, but I don't really want it because I'm going to be paying more in taxes. Well, if you're paying a lot of taxes from your IRA distributions, it means it's a pretty significant distribution. Yes, there is the caveat that you're paying more in taxes as a single filer than you would be as a married filing jointly filer, all else being equal, but paying more in taxes is a sign that you're probably going to be okay because you probably have a good, significant retirement balance that's going to allow you to live out the rest of your life and do what you want to do. That being said, you still absolutely want to have a tax strategy.
Speaker 1:But I wouldn't just look at tax rates today and in the future. I would look at your specific expense needs in the future, your income needs in the future. I would do an estimate of what would that put you at in terms of a taxable income and then I would do an analysis of what total tax bracket are you in today versus what tax bracket might you be in the future. That should then help to dictate what conversions, if any, you do and what types of contributions you do to your Roth 403b or to your traditional 403b. And then, above and beyond just that, other things we talked about Social security strategy One you want to maximize this for maximum income potential. But number two social security has more tax advantages than do than does the equivalent amount of income from other sources. So get that right. And then even things like your primary residence. Is there something that you could do after a husband passes away to sell it and pay less in taxes than you would today? Does husband have other assets that weren't included in this projection at all? Are there various things like total expenses today that are going to change in the future if your husband is no longer with us? So there's all kinds of other things that are going to play into this decision, but I hope this sheds some light on some of those things that you should be considering as you work through an analysis for yourself.
Speaker 1:So, jennifer, thank you very much for that question. I appreciate you submitting that, really. I appreciate all of you submitting questions. I can't get to all of them, of course, but I do read every single one that comes in just to try to determine what's the best question that will impact the most amount of people if we can address it here on a podcast. So, if you're enjoying these podcasts, we'd really appreciate it if you took a moment and left a five-star review to let us know that you're enjoying it. Also, if you are watching on YouTube, make sure that you like, make sure that you subscribe and make sure you share this with a friend. If you know someone that you think would get value from some of these episodes would really appreciate you sharing this episode with them. The more the show grows, the more people can be impacted and everyone wins. But at the end of the day, just want to say thank you for tuning in, thank you for watching, really appreciate it, and I'll see you all next time.
Speaker 1:Hey everyone, it's me again for the disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed in this podcast, then go to rootfinancialpartnerscom and click start here, where you can schedule a call with one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.
