Retirement planning takes on two phases: accumulation and distribution. The pinnacle is the point in which people retire, and the biggest question they ask is, “Will I have enough to live comfortably in retirement?”. That’s where we help our clients the most.
During the accumulation phase, this is when clients can take advantage of tax-preferred opportunities such as 401(K)s, 403(b)s, IRAs, Roth IRAs, SEP IRAs, pensions, etc. During this phase, it’s important to assess a client’s current and anticipated marginal tax brackets so that they utilize the most appropriate and tax-effective retirement savings vehicle.
During the distributions phase, it takes on an entirely more important concept, which is a science of its own. This is when its important to understand the mathematical phenomenon known as sequencing of returns, as improper planning could have an enormously adverse impact on the success of one’s retirement goals if they experience a downturn in the markets in the early years of retirement.
Also, during the distribution phase, it become imperative to have a firm grasp on the tax effects of taking withdrawals from retirement accounts. Most notably, it is important to understand the impact of those distributions on Social Security. Specifically, the taxation of Social Security income is predicated on other income such as income from pensions, IRAs, and other investment income. Thus, certain amounts of income will effectively cause the Social Security income to be taxed, causing phantom taxation of Social Security, and an abnormally high effective marginal tax bracket. Strangely enough, we have encountered a retired client who has about $40,000 in IRA income, and that placed her into an effective marginal tax bracket over 50% (that means for an extra $1,000 of IRA income, they would pay an extra $500 in Federal tax).