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Retirement Answers is a podcast built to help you succeed in retirement. The thought of retirement can be overwhelming and downright scary for many... but it doesn't have to be!
The goal of this podcast is to provide thoughtful insights and strategies to give you the confidence you need to retire successfully. At the end of the day, my ultimate goal for my clients and podcast listeners is to live a fulfilling retirement.
Follow along as I publish a new episode each week covering everything from retirement income planning, tax planning, Social Security, insurance planning, investing, and much more.
Here's to learning everything you need to know to live out your dream retirement!
You have to have a Roth IRA or do Roth conversions if you want to succeed in retirement, or at least that's what you've been told. And here's the thing. Having a Roth IRA in retirement can be absolutely awesome because it allows you to have tax free income. But today, I want to tell you why a Roth IRA is not needed in retirement to create that tax free income. So we're gonna learn about that here in just a moment.
Jacob:Hey, friends, welcome back to another episode of Retirement Answers. My name is Jacob Duke. I'm your host here. As always, I'm a certified financial planner and the owner of River Tree Wealth, a full service wealth management firm where we help people just like you plan smarter and retire better. And I'll warn you on the front end of this episode because it might get a little bit technical.
Jacob:So if you have to stop and pause along the way to make notes, feel free to do so, because this will be a combination of a few different concepts like Social Security taxation, tax gain harvesting, taking money out of your IRA without paying any taxes, and how all these different planning opportunities actually fit together. And the reason I wanna talk about this is because the general consensus is that you have to have a Roth IRA throughout your career, and you have to be saving to one if you want tax free income and retirement, or if you don't have money saved into a Roth IRA, you're gonna be needing to do Roth conversions in retirement. But I'm here to explain why Roth money isn't required to create tax free income, but please don't mishear me and assume that you shouldn't be doing any Roth conversions either because conversions are very much needed for the right type of person in the right situation. So I guess the idea of this is to show you that there are many different ways to get you where you're trying to go, which is creating tax free income or creating income with as little tax as possible, and there just isn't any one size fits all.
Jacob:So first, let's quickly review a few different concepts and then we're gonna tie it all together and look at the case study to show you how these different things will work together. So first, let's talk about Social Security taxation quickly. I'm not going to explain the whole calculation because I've done whole episodes and videos on that. They'll be linked down below in the description, but in short, not all of your benefits are ever going to be taxable. So at most 85% of your Social Security benefits would ever be taxable, but here's the cool part, up to none or 0% of your benefits could be taxable if a few things are true.
Jacob:One of those scenarios where you wouldn't pay any taxes on your social security benefits is if your social security benefits are your only source of income. Now, we can add a little bit more income to this. I'm gonna show you this here in just a moment that we can add just a little bit more and still pay no taxes on the social security benefits, but also pay no taxes on that extra income. So we'll go through that here in just a moment. But social security taxation in general is in my opinion, one of the most beneficial things that a retiree has available to them because of how it's calculated and how it works.
Jacob:Next, let's talk about tax gain harvesting. So maybe you've heard me talk about this before, but most of you have heard of tax loss harvesting, which is kind of the opposite of tax gain harvesting, but very few really know about how this gain harvesting opportunity works or that is even available to them. And I'm not gonna explain it completely here because again, I've done episodes on this, I'll try to have those linked down below. But in short, it's whenever you intentionally sell something within your brokerage account that has long term capital gains, and you're trying to actually realize those gains at a 0% long term capital gain rate. And here's why this is something most people just don't know about.
Jacob:It's because there are long term capital gain rates and there's three of them. There's the 0%, the 15 and the 20% brackets. In 2025, you can have upwards of almost $97,000 of taxable income, that's all long term capital gains and pay no taxes on that. And when you add in your standard deduction on top of that, it's upwards of a 135,000 plus dollars that you could have capital gains at completely tax free. Now, obviously, if you have other income stacked on top of this, it reduces how much of your gains would be at the 0% bracket.
Jacob:But the key is most people don't even know this opportunity exists, and they think they're gonna pay long term capital gains on all of their gains they realize, whether it be from a house sale or real estate or rental properties they're selling or their gains within their brokerage account. All those things can qualify for long term capital gains rate or treatments if they're held for at least one year. So I've done a video on this on YouTube. Again, I'll have that linked in the description. Once you see that on paper, of me walking through that with a whiteboard, it might make a lot more sense to you.
Jacob:Again, not gonna cover it completely here today. And the next, we kind of have to remember that our standard deduction is something that's a huge benefit for us as retirees, and your standard deduction actually allows you to take money from your IRAs completely tax free, right? So in 2025, the standard deductions are as follows for married filing jointly, it is $31,500 and this is after the updates from the one big beautiful bill. And for single filers, is 15,750, which is exactly half of the married filing jointly deduction. Now, if you're 65 or older, you actually get some bonus deductions.
Jacob:The first one being the $1,600 per person deduction for those of you who are 65 plus or blind. And so if one spouse is 65 or older and the other is not, you get an extra $1,600 on your normal married filing jointly deduction. If you are both above 65 and you're married, then guess what? Get $3,200 total. Now, that's the one that's been there for the last few years, and so that's the extra deduction for the seniors there that are 65 or older.
Jacob:But now, under the one big beautiful bill, there is an additional deduction for seniors who are 65 plus, and it is $6,000 per person. So $12,000 total. And so for those of you who are 65 or older and married filing jointly, your standard deduction in 2025 is gonna be $46,700 That is a lot of money. Obviously, if you're single, it could be half of that, but still that is a lot of money. So that means again, if you're 65 or older and married filing jointly, you can take upwards of $46,000 out of your tax deferred accounts, assuming you have no other income and pay no tax on that $46,000 So this is a huge benefit for all retirees, no matter how you look at it, more deductions is obviously more tax free money.
Jacob:So when we understand how these three primary concepts actually work, we can begin to actually use them to our advantage and piece them together. So let's walk through an example really quickly to show you how I would think about piecing this whole thing together if someone were a client with these different assumptions. So here's the situation. Let's just assume that you are married filing jointly, you and your spouse are both 60, and you need $6,000 a month of retirement income needs for your expenses. And let's say you're retired or just retired.
Jacob:And right now you've got $700,000 in your IRA, you've got $500,000 in a brokerage account, and this actually all came from a house that was inherited from a parent, which you then sold, paid no taxes on that because of that step up in basis, but has since been reinvested and the gains on that 500,000, 100,000 of that 500 is actually going to be growth. So $400,000 is what you invested in that brokerage account, the $100,000 is the gains, those have been held for longer than a year, so they qualify for that long term capital gain treatment. Now, whenever you think about this, whenever I say $6,000 a month is the income need and then you have about 1,200,000 of actual liquid savings, You you know, you're thinking, oh no, 72,000 out of 1.2, that's way too high of a distribution rate. That's 6% Jacob, how is that even going to be sustainable? Right?
Jacob:Well, whenever we go through this, we have to evaluate what our distribution rate is going to be yes, immediately at the beginning of retirement, we have to look at it from the whole picture. So all of retirement, the next twenty, thirty, forty years, whatever ends up being in terms of your timeframe, is 6% going to be the distribution rate for that entire thirty or forty years? It's likely not because here's the thing, typically what I see is whenever someone is early in retirement, normally they don't have social security turned on yet, maybe they don't have a pension at all, or they don't qualify for it yet. And so their only source of income is their portfolio, which means on paper, the math is gonna show that your distribution rate is gonna be the highest it will likely ever be. So a 6% distribution rate until social security begins is high, yes, but it's not outrageous.
Jacob:Now you do have to pay attention to sequence of return risks here and kind of manage that if you lose 30% of your portfolio to stock market decline, well, your distribution rate is gonna be closer to seven, eight, 10%, depending on how that affects your overall portfolio's balance. So you have to pay attention to it, but don't be afraid of a distribution rate above 4%. I know everyone's heard of the 4% rule, just know it's not so much a rule, it is simply a mathematical equation that says, if you invest your money a certain way and take a certain amount of money out, you'll never run out over a thirty year period regardless of the return cycles you get. So it's not so much really helpful for real life retirement if that makes sense. Now, we'll continue here with the assumptions and we're gonna say that at 67, both of you would have a combined social security of about $4,000 per month.
Jacob:And remember, we have no Roth money at all. So we have a tax deferred IRAs, and we have some brokerage account money that has a little bit of gains in there, but it came from inheritance from a house sale and real estate property that was given to them. So anyway, that's the situation. Now, the way I want to think about this is I want to kind of piece together their income plan to see what we can do in terms of getting tax free income or close to tax free income kind of down into three different timeframes. So the first time frame I want to focus on is from 60 until 67.
Jacob:So that's going be the range whenever we don't have a social security, we're just going to assume that they would start getting their 4,000 a month at 67. So they're not going to take it early. And the second time frame is going to be from 67 until 75, that's whenever they would have Social Security, but they would not yet be having RMDs. And then let's say 75 plus is that final time frame. So this is whenever you would have social security, but also required minimum distributions as well.
Jacob:So three different timeframes, three different sources of income, different maybe forced income on the back end because of RMD. So let's kind of look at this in three different timeframes. Let's focus right now at least on the sixty to sixty seven timeframe when we don't have social security. How do we create income? Well, here's how I would think about it.
Jacob:Number one, we have IRA distribution opportunities, right? So we are above 59 and a half, we can take money out of our IRAs without penalty, although that money would always be subject to taxation. So the first thing I would do is no matter what, I would definitely take the standard deduction or whatever that equals out of your IRA. So again, here in 2025, they're under age 65, so their standard deduction married filing jointly would be $31,500. So no matter what, I would take $31,500 out of their accounts.
Jacob:Remember, need about 72,000 ish dollars per year to meet all their expense needs. So in this situation, that $31,000 that would come from the IRA right now anyway, that would be completely tax free assuming no other income, right? So they would have no other income on top of that. So 31,500 from the IRA, that's not quite half or 50% of their income needs. Now, what we would do here is we take the other amount about 40,500 is what's left over in terms of what they need to meet their $72,000 of expenses, we take all of that from their brokerage.
Jacob:Now, of that $40,000 we're gonna assume that one fifth of that amount is actually going to be long term capital gains. So, not quite 10,000, but let's just say that $10,000 is gonna be how much they would have as gains there out of the brokerage account. Now, here's the key, if you take $10,000 and then you add the 31,500 to it, that equals 41,500. Well, in 2025, the 0% long term capital gain bracket goes up to $96,700 of taxable income, not even including the 31.5. So here's how you can think about this.
Jacob:If they've got about, let's call it $10,000 to keep it round numbers, but $10,000 of capital gains, okay, out of their brokerage account that's being realized, that's all gonna be at 0% because they're taking 31,000 out of their IRA, okay, 31,500, that's gonna eat up all of their married filing jointly standard deduction, which means they have $96,000 of room, of capital gain room at the long term rate at 0%, and they're only going to be using 10,000 of it, which means, again, they have $86,000 more of long term capital gain room here, which does maybe present an opportunity. So the first thing is, they can get $72,000 of income from their portfolios completely tax free. Now, I'll get to the opportunity around, you know, what they could do there with the leftover $86,000 of room at the long term capital gain rate of 0%, what they maybe can think about doing there. But first, some of you might be thinking, Jacob, what if they only take the standard deduction out of their IRA for however many years? Does that mean that their IRA is gonna grow a bunch because they're not taking as much out?
Jacob:What if they need to be doing Roth conversions as well? They're not spending enough money, they're not doing conversions. Well, maybe we'd have to run some projections on it to see, but $700,000 of a balance in a tax deferred account, whether it be split evenly between them or all in one person's, it doesn't really concern me a ton. Really, whenever I start to think about Roth conversions in terms of the need for them is whenever someone has a million dollars or more in tax deferred accounts. If you've got less than a million, your first year RMD is not gonna be outrageous, it's not gonna be burdensome for you to take money out.
Jacob:So for example, you know, on $700,000 if we could find a way to, number one, take money out of the account like we would be doing here in the first seven years, at least up to that standard deduction, so 30 plus thousand, you know, a year will be coming out for seven years. If we could find a way to take that money out, but also grow the account, but maybe not try to grow it to the extent that, you know, it'd be the highest growing account we have, we'd almost rather the brokerage account grow more. So asset location is kind of what we're looking at there and talking about. But what if we can, you know, maintain good growth, but maybe a little bit lower growth rate intentionally, but also too, we are taking money from the account. So let's assume that we have, you know, $700,000 as our first year RMD balance, you know, when we get to 75, the RMD on that's gonna be about $28,000 which is about what they need, if not less than what they need from the account in terms of what their income will be at that point with social security, and then obviously an RMD on top of that.
Jacob:So I'm not super worried about them not taking enough money out of the account, at least just yet. Now there could be an opportunity for them to convert dollars at the 10 or the 12% brackets that might be efficient, we have to look at it and evaluate it, but again, right now we're not focusing on that so much, we're focusing on trying to create income in a completely tax free way. So that's how from 60 to 67, they could think about creating tax free income, take up to the standard deduction out of their IRA, everything else comes from the brokerage account at which any of those capital gains that are long term would be at 0%. Now, again, there is an opportunity here in this window of time, wherever they could actually realize more gains than what they need in this particular year, they could realize all of the gains and basically reset their basis. So they could sell all of their positions almost and rebuy back the same positions the next day and reset their basis upwards and pay no taxes on those gains by doing so.
Jacob:So maybe this is actually a good thing because now you are maybe setting aside more cash for the following years to then pay taxes on the Roth conversions that you would be doing at that 1012% bracket, right? Because you'd have less gains harvesting to do or need to do. Just need to have more cash in general for the next year for a big purchase that's upcoming, you wanna realize that and take your wins, take your gains off the table now, pay no tax on it, set that aside. So you have more options than just taking out what you need from the brokerage account in this situation I've outlined, they could actually sell the majority of their brokerage account and pay no taxes on all those gains, reset the basis, hold more cash, set aside more cash for paying taxes next year on that Roth conversion if they decide that's something they want to do. So that's 60 to 67.
Jacob:Now let's look forward to 67 to 75. At this point, Social Security is that's whenever we've got that set to begin be about $4,000 a month for about 48,000 a year. So the first thing to remember here is that, you know, again, social security taxation is a huge benefit to you. If you only have social security as your income, you're not gonna pay any taxes on those benefits. But here's the cool part, you can actually have some other income and still pay no taxes on that social security or that other income.
Jacob:So let's look at how this might would work out for them. So assuming no inflation, no cost living adjustments, just in today's dollars at today's standard deductions, you know, let's keep all the numbers the same. They would get $48,000 of social security income at 67, okay? And that's obviously not enough, they need 72,000 total. But let's assume that they're going to impose $20,000 out of their IRA as well, gives them a total of $68,000 of income for them to use and spend that year.
Jacob:Yes, they're a couple thousand bucks short, maybe they can have some cash set aside to meet the other amount, which would be completely tax free. Now, how is it possible that they can get that $68,000 of income and IRA distribution plus Social Security completely tax free? Well, again, it's because of how Social Security is taxed. So I'm not gonna run through the math completely here, but in this example where we get 48,000 of social security plus $20,000 of IRA distributions, only $6,000 of the social security would actually be subject to taxation. And since you have $20,000 of an IRA distribution, you would add that 6,000 to that, your total AGI in this scenario would only be $26,000 which means that your standard deduction is gonna be well more than that 26,000.
Jacob:So your AGI is $26, your standard deduction is more than that, okay? So there's actually a little bit more room perhaps, I'm not gonna do the math exactly, I'll talk about this here in just a moment, but there may be a little bit more room than 20,000, so 21, dollars 22,000 maybe they could pull out of the IRA if they had to and still pay no taxes. So again, this is pointing out the fact that social security taxation and how that works is actually beneficial to you. Yes, it's not completely tax free, just, you know, blanketly, it's actually subject to taxation, but the key is this, you could still have the benefits in this scenario and still take money out of an IRA based on the numbers I'm providing you, then pay no taxes on the benefits or the IRA distribution, which is huge. So again, no Roth in this scenario, no need to have it because you have other forms of tax free income because of how the tax code works.
Jacob:Now, let's move on to 75 in this age range. How's it possible to have tax free income at 75 whenever RMDs are in play, Jacob? I thought RMDs were the worst thing in the world. They're gonna be evil and they're maybe pay a ton in tax as well. They might, if you have a lot of money in tax deferred accounts, which some people do and that's totally justifiable.
Jacob:We've got to do something about that. But for others, I don't want you to think that you have to do Roth conversions just because I or anyone else is talking about them. So let's look at this. The same concept is gonna apply as before from '67 to '75, where we're going to have social security benefits and then some amount of IRA distribution will be on top of that. Now, this scenario, let's just say that your RMD, required minimum distribution 75 plus is going to be $30,000 instead of the $20,000 distribution that we took from '67 to '75.
Jacob:So in this scenario, again, we're gonna try to keep all numbers the same and not, you know, do cost saving adjustments or inflation adjustments, but we're just assuming that you're still getting $48,000 per year in social security, and you're also getting $30,000 per year in RMDs now. So in this scenario, 14,500 of your social security benefits are actually gonna be subject to taxation. So a $10,000 increase in IRA distribution means that $14,500 of benefits are taxable compared to only $6,000 of your benefits that were subject to taxation at only a $20,000 IRA distribution. So since you have that RMD of 30,000, you add that to this 14,500 gives your total AGI, it comes out to be 44,500. Now, this is a lot higher than before, and what's interesting here is if you're paying attention, is that we only added $10,000 of income by increasing the IRA distribution, which is the RMD from $20,000 to $30,000 But the AGI jumped by 18,000 from 26 to 44.5.
Jacob:So this is showing you the relationship between social security, taxability and your income, and that it's not a one for one trade off. Meaning if you add another dollar of income, you're actually adding nearly $2 to your AGI. So if you think back to our income ideas for '67 to '75, when we had 48,000 of social security and $20,000 of IRA distribution, which resulted in $26,000 of adjusted gross income, which is about 5,000 less than the standard deduction. When you see that, might think, oh, well, why don't I just take $5,000 more out of my IRA since I have that much room left for my standard deduction? And I love the idea, right?
Jacob:Because you're trying to maximize this, but if you did that, your AGI would likely go closer to $36,000 because the extra 5,000 of IRA distribution you thought was going to fill up the standard deduction actually has to be counted when determining how much of your social security is taxable, which would then have a higher number added into your total AGI. So again, the goal in talking through all this is not to tell you what to do or not to do, but really to show you how you should be thinking about things and really what to look for. Now, to our income whenever we're 75 plus and we're getting those RMDs, our AGI in this scenario is 44,500 in the example that I gave, and if we assume the bonus deductions for 65 plus are still in place in the future, who knows, we'll see if they are, but right now we'll assume they'll move that forward and continue doing that, then you would still be completely tax free because anyone who's married filing jointly and 65 plus at least in 2025, you have up to $46,700 this year of a standard deduction, which is again, more than 44,500, which is what our AGI was here.
Jacob:Now, if we don't have that extra deduction at that time, and the AGI of 44,500 is above the standard deduction amount, then guess what? You have some income that would fall into that 10% federal tax bracket, which is again, not the worst thing in the world. That's a really low tax rate. But if you are charitable, you could utilize a qualified charitable distribution, a QCD for short, to give a portion of your RMD to a church or charity, and that would actually reduce your income and maybe keep you below that standard deduction and match that up perfectly. So this is like an outline of how I would think about piecing together an income plan and try to do so in a tax free way for someone with $1,200,000.
Jacob:So as I've gone through this, I hope it's maybe opened your eyes to the fact that this couple in this scenario with $1,200,000, they can not only just retire but do so and pay basically no taxes throughout retirement. Now, I know this example is somewhat basic and doesn't consider things like ACA subsidy opportunities or decisions on how much the IRAs would grow leading to maybe higher RMDs in the future. But again, the goal is to look ahead and think about how to use this tax code and all the opportunities available to you to your advantage. So just remember, you don't need to have an Roth IRA or do Roth conversions to create tax free income. You just need a better plan and a system to follow.
Jacob:And these are the types of ideas and things that I talk about with my client and think about with them as we build their plan that's unique to their situation. I think it's really fun to put all the pieces of the puzzle together. Hope this has been helpful and if it has, please share it with a friend who could benefit from learning about these same ideas and concepts. Thanks so much for tuning in. I'll talk to you again next week.
Jacob:Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning in to this week's episode. I look forward to talking with you again next week.