Uncle Sam will find you, even in retirement

 By DEBRA TARGETT, Financial Consultant, CERTIFIED FINANCIAL PLANNER™ professional, A.G. Edwards & Sons Inc.

With your retirement years right around the corner, it seems that all your hard work is finally going to pay off.  Your nest egg appears to be big enough to support your dreams, from trips overseas to a fabulous vacation home.  But remember, your plans for a dazzling life of leisure may change if you haven’t thought about the impact Uncle Sam may have on your plans.  Fun and freedom may replace work, but unfortunately taxes will continue. 

You may not have thought about it before, but income and capital gains taxes could take 25 percent or more of your retirement income if you’re not careful.  For starters, you will have to pay income taxes on any withdrawals you make from traditional IRAs and 401(k) savings plans, and you will probably have to take out more money to cover state taxes as well as the possible income taxes on the social security payments you receive.  When it comes to capital gains, you’ll owe 15 percent on your long-term gains from a taxable account.

While it is impossible to avoid taxes altogether, there are several things you can do to help reduce the impact they may have on your hard-earned savings.

Maximize contributions to your Roth IRA – Your withdrawals of both your contributions and earnings will be tax-free after age 59 ½, provided you’ve held the Roth for at least five years.  So, be sure to take full advantage of these accounts if you haven’t already.  You can contribute $4,000 a year to a Roth for 2007, or an additional $1,000 “catch-up” contribution if you’re 50 or older.  Because you pay taxes on the contributions to your Roth when you put them into the account, you will avoid paying them upon withdrawal.  Non-qualified distributions may be subject to a 10 percent penalty prior to 59½ and five years as well as ordinary income taxes.

Consider a Traditional IRA – If your modified adjusted gross income (MAGI) is too high for a Roth contribution (exceeding $166,000 for couples filing jointly), you may want to put as much as you can into a traditional IRA.  While this kind of IRA may not be tax-deductible if you are in a high income bracket, it is still an important investment to consider.  This is because starting in 2010, there is a change in the tax law that will let you convert your regular IRA to a Roth without a MAGI restriction.  But, it is important to note that any amount attributable to deductible contributions or growth is going to be taxed as ordinary income upon conversion to a Roth.  This will be an opportunity for investors with a MAGI exceeding $100,000 to convert to a Roth, so it’s important to see if you fall into this category.

Use Taxable Assets First – When you begin to dip into your nest egg, it may be a good idea to use your assets in taxable accounts first.  That way you can allow your tax-deferred assets the opportunity to grow as long as possible and you can avoid an ordinary income tax rate of as much as 35 percent on distributions from these accounts.  By withdrawing your taxable assets you will only be taxed the 15 percent capital gains rate.  But, please note, this maximum 15 percent rate on long-term capital gains and dividends is only temporary.   Starting on January 1, 2011, the capital gains rate will rise to 20 percent.

Gift some of your assets – Hopefully this savings tip will apply to you much further down the road, but it is still something you may want to consider today.  If you already know that you would like to gift some of your assets to family members or other individuals, gifting can result in both income and estate tax savings.  Tax savings can be achieved because as you reduce your assets, you also remove the earnings generated by those assets from your taxable income.  Additionally, with those assets removed from your estate ahead of time, your heirs will receive the benefit of those gifts and possibly avoid costly estate taxes.  Keep in mind, you can gift up to $12,000 in a year to any one of your heirs without incurring any tax penalty.

Unfortunately, taxation is always a sure thing — even in retirement.  But if you keep a few simple tips in mind, you may be able to preserve some of your nest egg from extra helpings by Uncle Sam.

This article provided by Debra Targett who is a financial consultant, CERTIFIED FINANCIAL PLANNER™ professional, with A.G. Edwards & Sons Inc, Member SIPC.  She may be reached at 1101 N. Congress Avenue, Boynton Beach, Fl. (561) 734 - 5054 or (800) 934 - 0543. Her Web site is: www.agedwards.com/fc/debra.targett2.

A.G. Edwards does not render legal, accounting or tax preparation advice. You should consult your tax and legal advisors for questions regarding your specific situation.

A.G. Edwards generally acts as a broker-dealer, but may act as an investment advisor on designated accounts, and the firm's obligations will vary with the role it plays.  When working with clients the firm generally acts as a broker-dealer unless specifically indicated in writing.  To better understand the differences between brokerage and advisory services, please consult “Important Information About Your Relationship With A.G. Edwards” on agedwards.com.