Retirement Income Blog

Every year, millions of Americans file their 1040s and end up having to pay taxes; even after all possible deductions have been taken. Many are able to itemize, while others are eligible for dependent care credits, or above-the-line deductions for their retirement plan contributions. But those who have enjoyed short-term market gains or other investment income often end up being penalized harshly, especially if they have no losses to offset against them.

But taxpayers that own municipal bonds may be able to use those assets to generate capital losses without altering the overall allocation of their assets. This is a common strategy used by many brokers and investment consultants who have clients that have substantial capital gains, or other reportable investment income to declare on their returns. The swapping process itself is fairly simple. Let’s assume that an investor owns a municipal bond and the market value is less than the purchase price. The investor has a loss on paper.

Let’s assume that the investor is able to sell this bond and buy another bond of the same rating and similar characteristics, such as rate, term, and call features, so exchanging one bond for another will seldom affect the composition of the investor’s portfolio. But this exchange effectively allows the investor to declare the sale of the old bonds at a loss, while maintaining portfolio integrity. For example, assume that a bond investor bought 10 public school bonds at par (which is listed as a price of $100) when the school originally issued them. This means that his original investment amount was $10,000.

Now, a year and a half later, interest rates have risen, and the price of the bonds in the secondary market is now $92 per bond. The broker who sold him the bonds will find 10 other municipal bonds from a similar issuer with similar features and “swap” or exchange them within the portfolio. The replacement bonds may well be trading at a loss as well, but this is largely irrelevant, as the new bonds will vary in price, the same as the old bonds. But the investor will be able to declare a long-term capital loss of $800 on his tax return, as he bought the original bonds for $10,000 and sold them for $9,200.

If you own municipal bonds you may have a possible opportunity each year to cut your senior tax.

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While most tax rules and tax rates apply equally to all taxpayers, there are some tax law provisions that are particularly senior tax issues because seniors are the ones most affected.  Below are a few senior tax issues and an offer to get a more comprehensive booklet if interested.  Some minor tax planning in retirement can result in big saving as you shall see.

Immediate Annuities Help Retirees Reduce Tax
Immediate annuities pay a monthly income and few people below age 60 buy immediate annuities as younger people usually derive their income from working, not from investments.  The senior tax issue here is the exclusion ratio.  For every immediate annuity payment, a significant portion is not subject to tax.  This exclusion ratio means that from each payment, a retiree has more spendable income than from alternate investments.

Immediate or Deferred Annuities can reduce the senior tax on social security income
Since people age 62 and over pay tax on social security income, we can refer to this as a senior tax. The ways to reduce income tax on your social security income is by moving money from items that increase the income tax on your social security income negatively (CDs, bonds, tax free bonds, savings bonds) to deferred annuities or immediate annuities.  Since none of the reinvested interest from a deferred annuity appears on your tax return, the income on your tax return is lower and thus, this will reduce or eliminate tax on your social security income.  This senior tax is also impacted favorably by the ownership of immediate annuities because a large portion of the monthly payments are excluded from reporting on your tax return making immediate annuities a superb source of supplemental retirement income.

Slow down IRA distributions
Since only people that have reached age 70 1/2 must take IRA distributions, the taxation of these withdrawals is certainly a senior tax issue.  Some retirees may be taking more than the IRA required mandatory distribution.  Even if you need the income for living expenses, you will lower your tax by reducing your IRA withdrawals to the IRS required minimum and spending principal from your non-IRA assets to live on.  Although the spending of principal is taboo for many retirees, there is no difference between principal and income. It’s all green money and this recommendation will reduce the senior tax on your IRA.  This dovetails with our next senior tax issue.

Spend your regular money first
The order in which you spend your different pots of money in retirement affects your taxes.  As hinted above, if you take $1 from your IRA, you only have say 70 cents to spend because you must pay income tax on the IRA withdrawals.  However, if you withdraw a dollar form your savings account, whether its interest or principal, this money has already been taxed and you have a full dollar to spend.  So an important general senior tax recommendation is to use up your after-tax dollars before using your pre-tax dollars.

Long Term Care Insurance
Last, consider that the federal government will subsidize your cost for long term care insurance.  Since the average buyer of long term care is age 62 and the government allows a larger deduction based on higher age, this is specifically a senior tax issue.  Although not many people qualify, to the extent your out of pocket medical expenses and health insurance premiums exceed 7.5% of your adjusted gross income, you can deduct that excess as an itemized deduction on your tax return.  If you pay a long term care premium, that can be added to your out of pocket health expenses thereby making it potentially deductible.  You can read more details on utilizing these senior tax benefits in the booklet below.  Click on the booklet and get your free copy.

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