Taxes in Retirement with Pension

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Topic Author
edudad
Posts: 42
Joined: Wed Mar 24, 2021 10:47 am

Taxes in Retirement with Pension

Post by edudad »

H&W in late 30s, both are eligible for state pensions which can be 75% of top pay at full service (25 years), 15 years to go.
we are maxing out all tax advantaged retirement accounts (457, HSA, FSA and Roth) and are also saving on taxable brokerage.
Annual savings are about $98k
Current assets total about $1.3MM

I am just thinking ahead, hypothetically:
At full retirement with 75% of pay (for both H&W) pension earnings, we might make as much money as we do now or maybe even more.
I believe the expenses might be similar or lower in retirement. Healthcare is the biggest expense, I guess.
My estimate is that we might fall under a higher tax bracket as pensioners (compared to now), without 457, HSA, FSA, itemized deductions, dependents, child tax credits etc.

Questions:
What are some ways people save on taxes when receiving pension/s?
Do pensioners get an option to save in a tax advantaged savings plans? (like 457, HSA, FSA etc)
Can pension income be used to fund traditional and Roth IRAs?
What are other strategies to be tax efficient?

Another Question:
With such a pension income, I really don't see a need to dip into our retirement or taxable brokerage saving accounts - is this reasonable to think this way? (assuming we successfully finish our service and retire)

Thank you for your inputs.
Cruise
Posts: 1482
Joined: Mon Nov 21, 2016 7:17 pm

Re: Taxes in Retirement with Pension

Post by Cruise »

Don’t have answers to your questions, but do investigate which states don’t tax government pension income.
calwatch
Posts: 422
Joined: Wed Oct 02, 2013 1:48 am

Re: Taxes in Retirement with Pension

Post by calwatch »

edudad wrote: Fri Jun 18, 2021 1:07 am H&W in late 30s, both are eligible for state pensions which can be 75% of top pay at full service (25 years), 15 years to go.
we are maxing out all tax advantaged retirement accounts (457, HSA, FSA and Roth) and are also saving on taxable brokerage.
Annual savings are about $98k
Current assets total about $1.3MM
Are you sure your pension pays out at 75% at top pay regardless of age? I have not seen a pension top out at under age 55, save for public safety and the infamous 3% at 50's that have come in California.
I am just thinking ahead, hypothetically:
At full retirement with 75% of pay (for both H&W) pension earnings, we might make as much money as we do now or maybe even more.
I believe the expenses might be similar or lower in retirement. Healthcare is the biggest expense, I guess.
My estimate is that we might fall under a higher tax bracket as pensioners (compared to now), without 457, HSA, FSA, itemized deductions, dependents, child tax credits etc.
If you have children now it's very possible that your tax would go up solely based on them no longer being dependents.
Questions:
What are some ways people save on taxes when receiving pension/s?
Do pensioners get an option to save in a tax advantaged savings plans? (like 457, HSA, FSA etc)
Can pension income be used to fund traditional and Roth IRAs?
What are other strategies to be tax efficient?
Pensioners do not get to save their pension in tax advantaged savings plans for retirement, but they do get to participate in a HSA if they have a high deductible health plan. From the sounds of it it looks like you are not getting your retirement health care subsidized by your employer, so an HDHP + HSA may be a cost effective option.

The other way you could continue to fund a Roth is by double dipping a Roth solo 401k contribution and a Roth IRA contribution, which is perfectly legal, with self employment income. Then triple dip it with your health insurance premiums, which would not otherwise be deductible.

So assuming you were both 50 you could with $26,000 in net SE income:
- $26,000 in Roth 401k contribution ($19,500 regular + $6,500 catch up)
- $7,000 in your Roth
- $7,000 in your spouse's Roth
- up to $26,000 in health insurance for you and your family

https://benefitslink.com/boards/index.p ... mitations/

Many people with pensions in my state don't get Social Security so would likely work a bit anyway to unlock otherwise "wasted" benefits. Even with the windfall elimination provision the benefits of working to the first "bend point" (https://thefinancebuff.com/early-retire ... efits.html) will still be meaningful.
Another Question:
With such a pension income, I really don't see a need to dip into our retirement or taxable brokerage saving accounts - is this reasonable to think this way? (assuming we successfully finish our service and retire)

Thank you for your inputs.
You should consider Roth conversions to average out your income over time to avoid a huge jump in tax brackets due to Required Minimum Distributions beginning at age 72. Search "rmd tax bomb" here for discussion on this. Depending in how much your pension is, you may wish to convert more than usual prior to age 63 to avoid being hit with IRMAA (the Medicare income surcharge), based on current law. Once you get closer to retirement, you should consider using a software such as i-ORP to determine how much to convert from traditional accounts to Roth, how much to take from taxable accounts, etc. If your goal is to leave a legacy for your children or charity, spending down the taxable account may not be best. However, when I solve for i-ORP, the Roths are almost always used up last.

viewtopic.php?t=218659
Fishing50
Posts: 523
Joined: Tue Sep 27, 2016 1:18 am

Re: Taxes in Retirement with Pension

Post by Fishing50 »

You are doing extremely well approaching 40 yrs old with current assets about $1.3MM. You're easily on glideslope to retire when you become pension eligible.

You properly identified the tax challenge, sometime called the tax torpedo.
You should map current and future tax brackets to understand the rates you will probably pay in the future.
Determine tax rates for:
Current income
Pension Income
Pension income with Social Security
Pension income with Social Security and RMDs

After that exercise, you could investigate ability to quit working, defer pensions, and do large Roth conversions from tax deferred accounts.
You may also find that your current tax bracket may be your lowest future tax bracket, and choose Roth contributions for current income.

I have no tax advantaged opportunities with our pension income. We've chosen US and Intl equity market index funds in taxable that we can hold forever and are tax efficient. In the 22% tax bracket, we've chosen Roth retirement account contributions during my last year of employment because the money will be invested for a very long time.

This article helped me understand the tax advantage dilemma: https://thefinancebuff.com/most-tsp-par ... h-tsp.html
1yr from military pension. 80 equites / 20 bonds for life, ZERO emergency fund, 100% taxable in equities (dividends in cash), 33% taxable, 30% Roth, 37% tax deferred. | Gone Fishing At 52yrs old!
humblecoder
Posts: 678
Joined: Thu Aug 06, 2020 8:46 am

Re: Taxes in Retirement with Pension

Post by humblecoder »

edudad wrote: Fri Jun 18, 2021 1:07 am Questions:
What are some ways people save on taxes when receiving pension/s?
Do pensioners get an option to save in a tax advantaged savings plans? (like 457, HSA, FSA etc)
Can pension income be used to fund traditional and Roth IRAs?
What are other strategies to be tax efficient?

Another Question:
With such a pension income, I really don't see a need to dip into our retirement or taxable brokerage saving accounts - is this reasonable to think this way? (assuming we successfully finish our service and retire)

Thank you for your inputs.
I am not a tax professional.

I will be receiving a defined benefit pension. However, it is nowhere near as generous as yours. Two ways to save on taxes in your situation that I can think of are
1. Move to a state that has favorable pension income treatment
2. Do Roth contributions/conversions prior to receiving your pension since the pension will probably drive you into a higher tax bracket, especially when RMD's hit

I do also get an option to save in a tax advantaged plan (401k and Roth 401k, HSA)

I don't think you can use pension income to fund an IRA. I believe you must have EARNED income (W2 income or self-employment income).

If you don't need to dip into your retirement savings because your pension covers your expenses, then great. Enjoy the windfall! What is the question or concern?
Topic Author
edudad
Posts: 42
Joined: Wed Mar 24, 2021 10:47 am

Re: Taxes in Retirement with Pension

Post by edudad »

Thanks. Good points to think through.

We will be living in a state with no income taxes in retirement.
We are not eligible for Social Security. We only pay into Medicare which potentially gets us that benefit at 67 I believe.

If all things pan out as planned and we collect the 75% of top pay as pension, we will be in a higher tax rate. (Worst case scenario, if we quit today, we are already eligible for 45% at 60)

Also wondering, if we should scale back a bit on tax advantaged retirement maxout savings and instead, spend/enjoy some portion of the money. Or pay taxes now and get a Roth 457.

Wondering how it would be to never dip into the retirement savings, and thinking what's the purpose of being frugal and saving this much and investing it for never using it.

Off course, we can pass it on to our children or in an unfortunate situation, savings might come in handy?
calwatch
Posts: 422
Joined: Wed Oct 02, 2013 1:48 am

Re: Taxes in Retirement with Pension

Post by calwatch »

If you have access to a Roth 457, you should probably use that in lieu of traditional. Ideally you might target a 50/50 Roth and traditional allocation when you retire, to better hedge against future tax law changes. You didn’t mention what portion of your tax advantaged accounts are which but given Roth 401k/457 are relatively recent probably not much.

Everyone hired after the 80’s, even those who don’t pay into social security, pays into Medicare and you should get it at age 65.
Admiral
Posts: 3575
Joined: Mon Oct 27, 2014 12:35 pm

Re: Taxes in Retirement with Pension

Post by Admiral »

At your age and with those assets and a pension (or pensions), you should no longer be saving in pre-tax. Roth only, preferably 457 because it has higher limits than a Roth IRA and there is no phaseout You will also likely need to do conversions.
nguy44
Posts: 377
Joined: Sun Jul 09, 2017 1:52 pm

Re: Taxes in Retirement with Pension

Post by nguy44 »

edudad wrote: Fri Jun 18, 2021 1:07 am H&W in late 30s, both are eligible for state pensions which can be 75% of top pay at full service (25 years), 15 years to go.
we are maxing out all tax advantaged retirement accounts (457, HSA, FSA and Roth) and are also saving on taxable brokerage.
Annual savings are about $98k
Current assets total about $1.3MM

I am just thinking ahead, hypothetically:
At full retirement with 75% of pay (for both H&W) pension earnings, we might make as much money as we do now or maybe even more.
I believe the expenses might be similar or lower in retirement. Healthcare is the biggest expense, I guess.
My estimate is that we might fall under a higher tax bracket as pensioners (compared to now), without 457, HSA, FSA, itemized deductions, dependents, child tax credits etc.

Questions:
What are some ways people save on taxes when receiving pension/s?
Do pensioners get an option to save in a tax advantaged savings plans? (like 457, HSA, FSA etc)
Can pension income be used to fund traditional and Roth IRAs?
What are other strategies to be tax efficient?

Another Question:
With such a pension income, I really don't see a need to dip into our retirement or taxable brokerage saving accounts - is this reasonable to think this way? (assuming we successfully finish our service and retire)

Thank you for your inputs.
First, you have started off in a great position, congratulations.

My view is that, in your late 30s, it might be too early to be worrying too much about pension and taxes in retirement. A lot can change before then. At 40 I almost lost my corporate pension. I kept it, it was still reduced by about 20-25% had the pension plan not first changed, then frozen. Others 2 years younger than me lost theirs. So... continue to maximize your tax-deferred/taxable contributions/savings, and begin looking at what your expected retirement expenses will be as best as possible (which you have started by considering medical expenses, but even that will likely change in 15 years). If what you have socked away is well more than what you need (including taxes), that makes things a bit easier.

Regarding your questions, from my perspective - retired 3 years with a non-COLA pension of $75K:
- Saving taxes: with no earned income the only current method we reduce taxes is via HSA contributions, but that will no longer be possible once we enroll in Medicare. My wife's earned income for part time work allowed us to contribute to Roth IRA once I retired (before that my income made us ineligible), but with here retiring this year that option will go away. We have been doing converting our traditional IRAs to Roth IRAs, but due to our tax bracket it is more of a "pay known taxes now vs. paying likely higher taxes (and definitely higher after one of us dies) later". Even with the conversions we will have large RMDs in 9 years (when we turn 72).

- Pensioners options for tax advantaged plans: Other than the HSA I am not aware of anything one can use without having earned income. I am far from an expert so would love to find out if I missed something.

- Pension income to fund tIRA/Roth IRA: I cannot use my corporate pension for that.

-Strategies: I only use the HSA, and tax-free muni bond funds, but I am willing to learn from others. The only other thing I am looking at, because we make charitable donations, are Qualified Charitable Donations (QCDs) when I turn 70.5, where I can use QCDs to reduce AGI.

On your last question, regarding not need to dip into retirement/taxable brokerage assets: it is very possible. We may be in that situation. My pension and DW's small SS + interest/dividend payments cover our regular expenses. We planned to have for enough cash for our "extravagant" expenses to not be forced to sell equities, and three years in our cash is down a lot less than we thought. Meanwhile, the growth in our retirement/taxable accounts have far exceeded our cash spending, so 3 years later we have more than when I retired. When I star taking my SS, I will get the maximum payout, so pension+both of our SS+interest/dividends will be very close to my base salary at retirement - and we were hitting 30% savings rate at that level. So it is likely our investments are for our heirs.

In general, while I do look at tax efficiency at this time in our lives, it is not our primary issue or even "problem". We may still pay a relatively "high" amount of taxes, but we will be able to afford to pay them and still have a very comfortable retirement life. Good luck!
Topic Author
edudad
Posts: 42
Joined: Wed Mar 24, 2021 10:47 am

Re: Taxes in Retirement with Pension

Post by edudad »

nguy44 wrote: Fri Jun 18, 2021 7:18 pm
edudad wrote: Fri Jun 18, 2021 1:07 am H&W in late 30s, both are eligible for state pensions which can be 75% of top pay at full service (25 years), 15 years to go.
we are maxing out all tax advantaged retirement accounts (457, HSA, FSA and Roth) and are also saving on taxable brokerage.
Annual savings are about $98k
Current assets total about $1.3MM

I am just thinking ahead, hypothetically:
At full retirement with 75% of pay (for both H&W) pension earnings, we might make as much money as we do now or maybe even more.
I believe the expenses might be similar or lower in retirement. Healthcare is the biggest expense, I guess.
My estimate is that we might fall under a higher tax bracket as pensioners (compared to now), without 457, HSA, FSA, itemized deductions, dependents, child tax credits etc.

Questions:
What are some ways people save on taxes when receiving pension/s?
Do pensioners get an option to save in a tax advantaged savings plans? (like 457, HSA, FSA etc)
Can pension income be used to fund traditional and Roth IRAs?
What are other strategies to be tax efficient?

Another Question:
With such a pension income, I really don't see a need to dip into our retirement or taxable brokerage saving accounts - is this reasonable to think this way? (assuming we successfully finish our service and retire)

Thank you for your inputs.
First, you have started off in a great position, congratulations.

My view is that, in your late 30s, it might be too early to be worrying too much about pension and taxes in retirement. A lot can change before then. At 40 I almost lost my corporate pension. I kept it, it was still reduced by about 20-25% had the pension plan not first changed, then frozen. Others 2 years younger than me lost theirs. So... continue to maximize your tax-deferred/taxable contributions/savings, and begin looking at what your expected retirement expenses will be as best as possible (which you have started by considering medical expenses, but even that will likely change in 15 years). If what you have socked away is well more than what you need (including taxes), that makes things a bit easier.

Regarding your questions, from my perspective - retired 3 years with a non-COLA pension of $75K:
- Saving taxes: with no earned income the only current method we reduce taxes is via HSA contributions, but that will no longer be possible once we enroll in Medicare. My wife's earned income for part time work allowed us to contribute to Roth IRA once I retired (before that my income made us ineligible), but with here retiring this year that option will go away. We have been doing converting our traditional IRAs to Roth IRAs, but due to our tax bracket it is more of a "pay known taxes now vs. paying likely higher taxes (and definitely higher after one of us dies) later". Even with the conversions we will have large RMDs in 9 years (when we turn 72).

- Pensioners options for tax advantaged plans: Other than the HSA I am not aware of anything one can use without having earned income. I am far from an expert so would love to find out if I missed something.

- Pension income to fund tIRA/Roth IRA: I cannot use my corporate pension for that.

-Strategies: I only use the HSA, and tax-free muni bond funds, but I am willing to learn from others. The only other thing I am looking at, because we make charitable donations, are Qualified Charitable Donations (QCDs) when I turn 70.5, where I can use QCDs to reduce AGI.

On your last question, regarding not need to dip into retirement/taxable brokerage assets: it is very possible. We may be in that situation. My pension and DW's small SS + interest/dividend payments cover our regular expenses. We planned to have for enough cash for our "extravagant" expenses to not be forced to sell equities, and three years in our cash is down a lot less than we thought. Meanwhile, the growth in our retirement/taxable accounts have far exceeded our cash spending, so 3 years later we have more than when I retired. When I star taking my SS, I will get the maximum payout, so pension+both of our SS+interest/dividends will be very close to my base salary at retirement - and we were hitting 30% savings rate at that level. So it is likely our investments are for our heirs.

In general, while I do look at tax efficiency at this time in our lives, it is not our primary issue or even "problem". We may still pay a relatively "high" amount of taxes, but we will be able to afford to pay them and still have a very comfortable retirement life. Good luck!
Very thoughtful. Thank you.

Yes, we have 13+ years before we can retire for the 75%. Lots of things could change in that period.

Wanted to ponder the wise minds here to see if there are things that we can plan on, expecting all positive outcomes.

Great suggestions on Roth 457, which I should switch to, paying taxes now.

I am also exploring the possibilities of a reduced pension (50%), but extends after our lifetimes to survivors and beneficiaries.
retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: Taxes in Retirement with Pension

Post by retiredjg »

Consider using some Roth 457 now if your current tax bracket is not too high. Consider retiring earlier.
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Sandi_k
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Re: Taxes in Retirement with Pension

Post by Sandi_k »

You will not be able to avoid withdrawing from your pre-tax accounts forever. The feds want their money! Remember you will have Required Minimum Distributions from your 401(k)/457 at age 72. So the RMDs need to be planned for, in addition to the pension income.

Currently, Medicare starts at age 65.

And yes, you are thinking it through properly. With a pension and grown up kids, and no eligibility to save pre-tax, you may indeed pay more taxes in retirement than you do while working.

Keep in mind that the tax brackets are due to revert to the pre-2017 brackets after 10 years. So I mocked up a "sample" tax return for 2026 tax year in retirement. I was shocked to find that we will be paying at least $20k more per year in federal and state taxes, since our medical premiums costs will not be pre tax; retirement savings and mandatory pension contributions will not reduce our taxable income; and tax brackets will have increased.

Finally, when one of you passes, if you have full survivor benefits on each other's pensions, that means the same income for ONE tax payer. So the survivor's tax bracket will skyrocket.

We are now saving via a Mega Backdoor Roth, with no pre-tax savings, in an attempt to get a better balance of pre-tax and post-tax accounts before retirement.
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LilyFleur
Posts: 1983
Joined: Fri Mar 02, 2018 10:36 pm

Re: Taxes in Retirement with Pension

Post by LilyFleur »

Stay married.

Single tax brackets are very challenging.

The advice to start saving in a Roth is good. Even if one of you dies in their 70s, the RMDs for the survivor in the single tax bracket will be difficult.
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