Income taxes can be the biggest bite out of your retirement dollar…but you can take control back. By following a few basic principles of smart asset location (not allocation) and proactive income tax planning, you can optimize your income taxes and and help keep more money in your pocket.

Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.

For more information, visit Medina Law Group or Private Client Capital Group.

Click below to read the full transcript…

Announcer:  Welcome to “Make it Last,” helping you keep your legal docs in a row and your NASDAQ secure, with your host, Victor Medina, an estate planning and elder law attorney and certified financial planner.

Victor Medina:  Everybody, welcome back to Make it Last. I’m your host, Victor Medina. I am an estate planning and elder law attorney as well as a certified financial planner.

If you’re listening to this live, it’s Saturday morning at 7:30 AM. If you’re listening to this on the podcast replay, it’s whatever time it is when you’re listening to it.

I’m going to tell you something. Today, we’re going to talk about proactive income taxes, which sounds like it’s delightful enough to get your eyes to roll in the back of your head, but I promise I’m going to make it as fun as I can. [laughs] Before I do that, because we are on an early morning breakfast kick, I want to talk to you about yogurt.

[laughs] I know, right? You didn’t come in to this to listen about yogurt. This is a retirement podcast. What am I talking about?

I’ll tie it in this way. If you’re not healthy, [laughs] then you won’t grow old enough to go to retirement. Here’s the thing, I had the absolute best yogurt I have ever tasted. I had it this morning.

I am a huge fan of “America’s Test Kitchen.” If you don’t know, this is a television show on PBS. What they basically do is they’re like little scientists around cooking. You watch some cooking shows and you’re watching the artists. They’re flinging ingredients around, chopping stuff, and you’re like, “How did you get to that recipe?”

The thing about America’s Test Kitchen is if they tell you that they want you to stir it 42 times, it’s because they tested 41 and 43 and it turns out that 42 is better. They test everything and one of the segments that they have are taste tests.

I was watching an episode. I got like six of these on the DVR. This is the worst thing to do, when I’m hungry, I’ll watch this. The reason why it’s the worst thing to do is because it just makes me hungrier and it looks delightful what they’re cooking.

Anyway, they had a segment on taste test for whole milk Greek yogurt. Greek yogurt is the biggest thing. Every time I go to the grocery store, my wife asks me to bring back a four pack of Chobani, the coconut flavor, and so I bring that back.

Now, that’s not my favorite. I’ve tasted it and I don’t tend to like yogurt generally. Sometimes I eat yogurt but I don’t like that yogurt.

They did a taste test. They did a taste test of whole milk Greek yogurt and here’s the thing, it grew, Greek yogurt, from 1 percent of the yogurt market in 2007 to 50 percent of the market today. In 10 years, it took 50 percent market share. Everyone is buying Greek yogurt.

One of the reasons for that is that it’s high in protein and it is something that is creamy, and people like it. They like it a lot.

Most of the yogurts that are available are like the non‑fat variety. I’ve been working with the dietician who basically says, “Stay away from the non‑fat stuff, get the whole fat, just eat the right amount of it and we can go from there.” Here’s the thing, I really want to like yogurt. I want to eat good yogurt.

They’re doing this segment, and they are talking about the difference between these different yogurts that they tested. To start the segment out, they put a spoon inside of the yogurt and left it there. You would see the good stuff, the spoon doesn’t fall over. In a stuff that is mass produced, the spoon falls right over.

I took to it. I went in and I bought the one that they recommended. I’m going to share it with you because I think that you should go and try it. I told you, this is the best yogurt [laughs] I’ve ever had.

To understand what the difference is between the different options down there, you’re going to understand how yogurt is made. Yogurt is made essentially by adding live bacterial cultures to warm milk and as the bacteria digest the lactose in the milk ‑‑ because milk has got this natural producing sugar, this lactose, they produce lactic acid which lowers the pH.

It coagulates the protein into a gel and that both gives the tang as well as some of thickness.

To make Greek yogurt, the fermented milk is often strained for several hours to cheese cloth to drain off the clear liquid, which is called whey.

Because so much of the liquid is strained out, the traditional Greek yogurt starts with three or four more times the amount of milk that is necessary to make regular yogurt. It’s the straining that makes the Greek yogurt tend to cost more and it’s higher in protein.

That’s the basic traditional process but to keep up with mass production, manufacturers have a number of tricks that they can use to allow that to happen faster and cheaper. They could change the bacteria cultures. They could change the type of milk, from grain or grass‑fed cows, the fat level, the fermenting time.

They can also add a thickening agent called pectin, which is essentially a milk protein concentrate or a whey protein concentrate which avoids the need for investing in costly separators and waste‑producing systems for the strained waste.

By adding the pectin, it allows them to avoid losing all of that volume that they pour down the drain. The problem is that pectin also traps the liquid, which helps prevent the separation.

The idea is that the tasting is pretty much the same, but it changes how thick the yogurt becomes. By using pectin, you don’t get that super thickness that’s in there, and there’s a mouth taste to it. There’s a mouth feel to what you’re eating.

To make a long story short, when you look at one of the ones that is strained as opposed to adding in pectin, really the one that came out on top was this thing called FAGE. FAGE is spelled F‑A‑G‑E. It has a texture that is unlike anything I have tried before. It was phenomenal. Phenomenal! It was the best yogurt I’ve ever tasted.

It’s not much more than a regular Greek yogurt packet. A regular Greek yogurt is $1.20 or something like that. For an individual one, this is like a $1.30 or $1.40, but it’s so worth it. It was the most phenomenal yogurt, I totally recommend it, and I think you should go and try it. [laughs]

We spent the first segment talking about yogurt. The other thing that I did before we break is I went to go visit my dad over the weekend. He turned 70 years old. What do I give a 70‑year‑old? I’ll give him a watch? He didn’t need a watch.

What we did was we went ahead and booked a photographer to come out and to take a group family photo of us. This poor photographer, she was the best, just a delightful person, really got us working well together.

She had to deal with my three kids, one of which is a four‑year‑old, so good luck with that, and a dog. We gave her the worst of the circumstances to deal with for [laughs] how to take a photograph. Anyway, she did great. My dad had a good time.

Victor:  We took pictures out on the beach where he lives in Connecticut. We’ve got them up posted on my Facebook page and just some of the proofs. We’re really looking forward to the rest of them. We’ll print it out and give it to him.

We’re going to come back, and I’m going to talk about income taxes. I’m going to try to make it as interesting as I can, as interesting as I’ve made the yogurt discussion anyway.

When we come back from the break, I’m going to help you save money on income taxes, so stick with us. When we come back, we’ll talk about income taxes. This is Make it Last.

 

Victor:  Welcome back to Make It Last. We’re talking today about income taxes. Many people just wait till April to figure out what their income tax is. Usually, they wait until April, they’re looking at in January, but the point is that the tax year has passed them already.

I remember that when I got started in my practice, I had a client, the proverbial little old lady, who came in and taught me something. I had a client come in, and she said, “My accountant told me that I could take out $10,000 more and not pay any taxes on it.”

I said, “Well, what did you do?” She said, “I took $10,000 out.” I said, “But he said $10,000 more.” She says, “That’s funny, because he told me again the next year that I could take $10,000 out.”

This opened my eyes to this idea of proactive income tax planning, rather than reactive income tax planning. Reactive income tax planning is usually done on the income tax form as we try to line up what the deductions are and figure out what we can do to reduce the tax bill.

I realized that there’s more work that can be done if we’re willing to think about income taxes before the end of the year.

We are dropping this show in the middle of July and you have the opportunity to proactively manage your income taxes in the upcoming year. This is timely stuff. I first want to take the time in the first segment to explain why you might want to do proactive income tax planning.

It’s not just or necessarily about reducing your current income tax bill, but also thinking about future income tax bills. That’s the first segment. The second segment is I’m going to give you essentially three things that you can do now in this year that dovetail in with this concept.

Again, too many times at the end of the year our tax bill is just what it is when we prepare it. We don’t take the time to think proactively about income taxes. Proactive income tax planning which is a concept that I use in my practice with my clients, in most of the time with my financial planning clients.

It’s not cost effective to do it on the legal side because for somebody to pay my hourly rate to manage their income taxes, that’s not as effective as if we’re managing your money and helping them through retirement.

If you fast‑forward to retirement, one of the biggest things that determines how much money you have are your income taxes. Your social security, that’s fixed. Your pension income if you have some, that’s fixed. What you have saved is largely fixed. You might invest in a micro over time but that’s what you’re starting with. You’re not going to add to it by future contributions.

The last battle is going to be fought in the area of income taxes. Managing income taxes proactively in retirement is one of the best things that you can do. We worry about this for a couple of different reasons. One of the primary reasons has to do with my favorite married‑couple families.

My married‑couple families have one big thing that’s going to happen which is that one of them is going to die and they’re going to filing status. They’re going to go from filling married to filling single. The reason why that’s a problem is that the single income tax rate are less generous than the married ones.

Said in other way, you’re going to end up paying more taxes sooner on income if you file single than if you file married. To give you some numbers around this. You know that there’s different brackets. There’s different tax and buckets and depending on how much income you make, it tells you how much taxes that you owe.

For a married couple for the first $18,000 your tax rate is about 10 percent. Then between $18,000 and $75,000 of adjusted gross income after deductions and exemptions, the next layer is tax at 15 percent. If you go past $75,000, the next tax brackets is 25 percent.

The difference between those two tax brackets is 10 percent. The difference between 25 and 15 that’s 10 percent. That means if you have to go into the 25 percent bracket, you’re going to pay 10 cents on the dollar more than you did on the previous money.

That’s for married couple. You get to the top of the15 percent bracket at $75,000. When you file single, the top of that tax bracket is $37,000. It half of the exemption for the first one or for married people.

What it means is, I’m going to keep talking in numbers and I know that’s complicated and I apologize ahead of time there’re really no way around way it. If you have somebody who’s making $50,000 a year as a married couple, that’s what they need to live on. Its 50,000. The other spouse doesn’t need that much more.

When you are filing married that is below the $75,000 threshold. You’re paying 15 percent maximum on that money. When you change to a single‑filing status, because the limit is $37,000 that means that the amount over that or another $13,000 is taxed at 25 percent.

The difference between the two rates is 10 percent. We walked about that. What it means is that on that 13, 000 you’re paying $1,300 more of federal income tax than you did before just because of your filing status. That’s a big difference. When you lose $1,300 a year to income taxes that is huge.

You might think you say, “What can I do about that?” Most of my clients under utilize their tax brackets in any given year. What I mean by that is that couple that’s making $50,000 a year of taxable income, they have $25,000 of space in that 15 percent bracket.

I told you the top of that was $75,000. If they’re only making 50, the difference between that is 25,000. That goes unused every year because we reset the taxes on every year. We can’t ever get that back. When I’m meeting with the couple and helping them manage their income taxes, what I’m thinking about is making sure that we reduce the impact of losing one spouse which is obviously a huge impact.

I want to make sure that the filing status on the income taxes doesn’t negatively affect how much they have to take out. If everyone is relying just on taking money out of their IRA to live, then when one spouse dies you got to continue to take that money out.

If you proactively moved money out of the IRA and paid the income taxes on it and you locked in the income taxes at 15 percent, you would be able to get together a little war chest of money that you could use to supplement your income. After the first spouse dies, you don’t have to continue to move that money out of the IRA.

The next reason why that’s helpful is because you’re able to reduce the impact of required minimum distributions. Remember required minimum distributions is the amount that the federal government makes you take out of your account every year based on your age. They multiply a percentage against the account value.

If you leave that account value really, really high and you going to take four percent out of that, that is going to fix how much money you have to take out and it’s a bigger number. If you are proactively moving money out and you reduce the size of that, then the percentage goes against the smaller number and the amount that you have to take out is lower.

I know this one can get confusing, stick with me on here. The idea is that you can proactively manage your income taxes today and in the future. Doing that will allow you to save more money overall. That’s the goal. Do I expect that everyone’s going to be able to do this on their own all the time? The truth of the matter is no.

I believe that this is most effectively done with an advisor. The advisor then is responsible for managing that process and making sure that you’re doing them. Making all the calculations, staying ahead of the curve.

It’s probably best if you work with an advisor through it, but you have to be with an advisor who even knows that this is an option for you to be able to take advantage of it. That’s really where I’m pushing the issues today.

Victor:  To be working with somebody that knows how to do this and for you to be aware that it’s something that can be done.

When we come back from the break, I’m going to give you three concepts, three implementable things that you can do this year to help you proactively manage your income taxes.

Stick with us on the break. When we come back, we’re going to talk about three things that you can do to proactively manage your income taxes. We’ll be right back.

 

Victor:  Welcome back from the break. This is Make It Last. You’re listening to us, and we’re talking about proactively manage your income taxes. If you stuck with us this long, that means we have managed not to bore you to death, talking about income taxes.

We’re going to spend this last segment talking about specific things that you can do to help you manage your income taxes. As a reminder, you’re going to want to do this, because it will allow you to lower the impact of required minimum distributions.

It may allow you to make conversions to Roths, which are tax‑free accounts. One of the other reasons is that it will allow you to reduce the income taxes on the inheritance that you leave behind.

Many people are pretty clear that they’re not going to spend through their retirement before they die, and they’re going to leave it behind. If you leave an IRA behind, you’re essentially making sure that your kids pay taxes at their rates when they receive that money.

If your kids are working, they’re probably in a higher tax bracket than you. If you convert money out at a lower tax bracket and lock in the tax rate 15 percent, then when they receive that money, they don’t have to pay it at the higher rate. They could be at 33 percent.

Lots of good reasons for doing that. Let’s talk about three things that you can do that will help you proactively manage your income taxes. Two of them are pretty straight forward.

I don’t want to go through the calculations on them, because we’ll eat up too much time in the show. It’s a little too much complicated to do the math on the air. I will spend a lot of time on the third one.

The first two is to move money out of your IRA up to your next tax bracket. Remember before on the prior segment, I talked about a fictional family making $50,000 of taxable income.

In current tax brackets, that’s $25,000 that they can move out of their IRA and lock that in at 15 percent. That’s not tax free. You’re going to pay taxes but you’re going to lock in the tax rate at 15 percent and make sure that you don’t have to pay that in the future at a higher rate.

That calculation is not a straight line calculation, because the amount of taxes that you pay on your social security income is driven by the amount of income that you’re getting from other sources.

As you increase the distributions out of the IRA, more of your social security may be taxable. It’s a three‑part test that’s done on schedule [inaudible 22:12] . You can get software, buy TurboTax, and play with moving more money out.

You see how much money is taxable, but the idea here is I don’t want you to think that it’s a straight line calculation. If you move more money out of your IRA, you might in fact owe more taxes on the social security. You just watch that.

A second recommendation is thinking about harvesting your capital gains at zero percent. This is one great way to pay zero percent in taxes. Most people know that long‑term capital gains is taxed at 15 percent. That’s a pretty common concept that people know ‑‑ capital gains 15 percent.

There’s actually another tax rate for capital gains, and that’s zero percent. You pay zero percent in capital gains on the amount of money that you convert at long‑term capital gains, which is below your 15 percent threshold. Let’s work that out.

My family making $50,000 can convert capital gains of $25,000 and pay zero percent on. This is essentially one way to pay zero percent in taxes. They can’t have you taking either two.

You can’t do twice. You can’t have $25,000 and then $25,000 of income. That doesn’t quite work from the IRA, but you can do $25,000 of capital gains and pay zero percent.

Again, calculation best done with your advisor. However, here is one that you should know about and your advisor if they’re worth anything should be doing for you. This has to do with investment location or asset location.

It’s not asset allocation. That’s diversification across a broad set of asset classes. However, this is asset location, and it works like this. People understand that their stocks essentially can grow and pay long‑term capital gains rates.

People understand that bonds pay interest. It’s one of the reasons they hold them in their portfolio because it’s throwing off interests pretty regularly. The amount of interest that is thrown off is tax that ordinary income tax rates.

If you’re the 15 percent, 25 percent bracket, whatever it is, you’re going to pay it at that rate. That’s the rate you’re going to pay that income. If we think about where assets should be, here is a real quick litmus test to whether or not your financial advisor knows what they’re doing.

If you look at your statement and you own exactly the same investments in every kind of account that you have, that your brokerage account has the same mutual funds as your either IRA as your Roth IRA, if they all have the same investments, then your broker doesn’t know what they’re doing.

Your advisor has no clue how to maximize this stuff for you. What you should have is 100 percent of your bonds or as much as will fit of your bond portfolio in your IRA so that when the interest is being thrown off of that, you don’t pay the taxes on that money until you move it out of the IRA.

That’s a tax‑deferred account on growth, so we won’t be paying that until we move it moved out. Whereas if we held those bonds inside of your brokerage account, the after‑tax account, you’d be paying that at your marginal income taxes.

There are certain sized slots for certain investments based on pretty clear understanding about how taxes go. We want as much bonds as can fit in your IRA.

We also want as much of your equity or stock funds in your after‑tax account, because those grow and are paid at long‑term capital gains rates, which we talked about as being either 0 or 15 percent.

If we put the stock and equity funds into the IRA, then even though we’ve held them for long‑term capital gains, when they come out, you’re going to pay ordinary income taxes on them as every distribution out of your IRA is that ordinary income tax rates.

It’s going to be way deep to talk about what should be on your raw, because that has to do with past your taxation on real state. The idea is that there are certain funds that should be held in certain accounts, certain kinds of assets, and certain kinds of accounts.

If you review your statement and you’re seeing that you want the same investments in every account, big no no. That’s no good. We know in fact that that’s not right. It doesn’t work. It’s not the right strategy, so go visit somebody different. [laughs]

Go visit somebody that knows what they’re doing, because this person that’s working with you clearly doesn’t. That’s a strategy that you can use now.

If you reallocate your investments so that they’re optimized on income taxes, it will give you so much leverage on how your money is used because you have your way. Your ability to proactively manage your income taxes. That’s huge in any events.

We’re going to wrap up for today. I want to thank you for joining us, listening to my rant about yogurt. Go try FAGE yogurt. Go proactively manage your income taxes and if you can’t get capable of doing it, work with an advisor that can do it.

We want to make sure that you’re working with the best people. If you’ve got any questions about this and you like to learn more about our services, go and contact us. You know that we are at Medina Law Group or Private Client Capital Group.

Do a Web search for that stuff. Send an email to the show, and we will forward it off to the law firm or to the financial services firm and be able to help that with you. We’re talking about total wealth planning when you’re working with us. If that’s something that you are interested in, we’d love to hear more from you.

This has been Make It Last. We want to thank everybody for joining us. If you like this episode, please go ahead and go to iTunes and give it a great review. It will help people find the show.

If you like this show and you are good friends with somebody that you think could benefit, do me a favor. Send them a link to it. Tell them to go in iTunes and download this and all the prior episodes, so they can listen and be as up to speed as you are on all these topics.

Thanks so much for joining us today. We’re going to catch you next Saturday. When we do that, we’re going to have another great topic for you. That’s it. We’re going to catch you next Saturday.

This has been Make It Last, helping you keep your legal ducks in a row and your financial nest eggs secure. See you next time.

Announcer:  The foregoing content reflects the opinions of Medina Law Group, LLC and Private Client Capital Group, LLC and is subject to change at any time without notice.

Content provided herein is for informational purposes only and should not be used or construed as investment or legal advice or a recommendation regarding the purchase or sale of any security or to follow any legal strategy.

There is no guarantee that the strategies, statements, opinions, or forecast provided herein will prove to be correct.

Announcer:  Past performance is not a guarantee of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns.

All investing involves risk, including the potential for loss of principal. There’s no guarantee that any investment plan or strategy will be successful. We recommend that you consult with a professional dedicated to your needs.

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