Worries about Life after Work are real
Let's face it: Taxes are a drag at any time in life. But in retirement, they can constitute a major strain on your limited financial resources. As such, it pays to find ways to lower your tax burden as a senior, and here are three ways to do it.
1. Save in a Roth IRA or Roth 401(k)
IRAs and 401(k)s come in two main varieties: traditional and Roth. With the former, contributions go in tax-free, and workers get an immediate tax break for funding their accounts. Withdrawals in retirement, however, are taxable.
Roth accounts work the opposite way: Contributions are made with after-tax dollars, so there's no immediate benefit to funding an account. Withdrawals, on the other hand, are taken tax-free in retirement, thereby lowering your taxes at a time in life when you could really use that flexibility.
Older man with gray hair leaning against a tree
Image source: Getty Images.
If your company offers a 401(k) plan with a Roth savings feature, you can sign up regardless of how much you earn. Roth IRAs, by contrast, prohibit higher earners from making direct contributions, but if your income is too high to fund a Roth IRA directly, you can instead put money into a traditional IRA and then convert it to a Roth after the fact.
2. Invest in municipal bonds
Seniors are generally advised to shift toward more conservative investments as they age, which generally means choosing bonds over stocks (though it's still a good idea to hang on to some stocks during retirement). If you're going to load up on bonds, then choosing municipal bonds over corporate bonds is a good way to keep your taxes to a minimum. That's because the interest you collect from municipal bonds is always exempt from federal taxes, and if you buy municipal bonds issued by your home state, you'll avoid state and local taxes as well. Corporate bond interest, on the other hand, is always taxable.
3. Hold investments for at least a year and a day
Whenever you sell an investment at a price that's higher than what you paid for it, you're liable for capital gains taxes. But the amount of time you hold that investment before unloading it could dictate how much tax you pay for selling it at a profit.
Investments held for a year or less fall into the short-term capital gains category, and the taxes you'll pay on short-term gains mimic those you'll pay on your ordinary income. On the other hand, if you hold your investments for at least a year and a day, you'll be propelled into the long-term capital gains category, and you'll benefit from the lower tax rates associated with it.
Though long-term capital gains tax rates can change from year to year, in 2019, you'll pay nothing if you earn less than $39,375 as a single tax filer. And if your income is above $39,375 but less than $434,550, you'll pay just 15% on long-term capital gains, which is far less than what you'd pay in income taxes for earnings at the high end of that range.
The less tax you're liable for in retirement, the more money you'll have to pay your bills and enjoy your life. Therefore, think about the ways you might reduce your tax burden as a senior well before that milestone arrives, so that once it does, you're well positioned to keep more of your income away from the IRS.
Are you trying to make the most of your social security benefits? Learn more here:
Determining how much protection you will need from a life insurance policy can be tricky. There are a number of different factors that go into deciding how much you should be saving. Here is a quick little calculation device that you can use to get a general idea of your current standings.
When it comes to life insurance, there are many choices. Whole life. Variable universal life. Term. What do these descriptions really mean?
All life insurance policies have two things in common. They guarantee to pay a death benefit to a designated beneficiary after a policyholder dies (although, the guarantee may be waived if the death is a suicide occurring within two years of the policy purchase). All require recurring payments (premiums) to keep the policy in force. Beyond those basics, the differences begin.1
Some life insurance coverage is permanent, some not. Permanent life insurance is designed to cover you for your entire life (not just a portion or “term” of it), and it can become an important element in your retirement planning. Whole life insurance is its most common form.2
Whole life policies accumulate cash value. How does that happen? An insurer directs some of your premium payments into a reserve account and puts those dollars into investments (typically conservative ones). The return on the investments influences the growth of the cash value, which builds up according to a formula the insurer sets.3
A whole life policy’s cash value grows with taxes deferred. After a while, you gain the ability to borrow against that cash value. You can even cancel the policy and receive a surrender value. Premiums on whole life policies, though, are usually higher than premiums on term life policies, and they may rise with time. Also, beneficiaries only receive a death benefit (not the policy’s cash value) when a whole life policyholder dies.2,4
Universal life insurance is whole life insurance with a key difference. Universal life policies also build cash value with taxes deferred, but there is the chance to eventually pay the monthly premiums out of the policy’s investment portion.5
Month by month, some of your premium on a universal life policy gets credited to the cash reserve of the policy. Sooner or later, you may elect to pay premiums out of the cash reserve – so, the policy essentially begins to “pay for itself.” If all goes well, a universal life policy may have a lower net cost than a whole life policy. If the investments chosen by the insurer severely underperform, that can mean a dilemma: the cash reserve of your policy may dwindle and be insufficient to keep paying the premiums. That could mean the cancellation of the policy.5
What about variable life (and variable universal life) policies? Variable life policies are basically whole life or universal life policies with a riskier investment component. In VL and VUL policies, you may direct percentages of the cash reserve into investment sub-accounts managed by the insurer. Assets allocated to the sub-accounts may be put into equity investments of your choice as well as fixed-income investments. If you choose equity investments, you (and the insurer) assume greater risk in exchange for the possibility of greater reward. The performance of the subaccounts cannot be guaranteed. As an effect of this risk exposure, a VUL policy usually has a higher annual cost than a comparable UL policy.6
The performance of the stock market may heavily affect the performance of the subaccounts and the policy premiums. A bull market may mean better growth for the policy’s cash value and lower premiums. A bear market may mean reduced cash value and higher monthly payments to keep the policy going. In the worst-case scenario, the cash value plummets, the insurer hikes the premiums in order to provide the guaranteed death benefit, the premiums become too expensive to pay, and the policy lapses.6
Term life insurance is life insurance that you “rent” rather than own. It provides coverage for a set period (usually 10-30 years). Should you die within that period, your beneficiary will get a death benefit. Typically, the premium payments and death benefit on a term policy are fixed from the start, and the premiums are much lower than those of permanent life policies. When the term of coverage ends, you may be offered the option to renew the coverage for another term or to convert the policy to a form of permanent life insurance.2,7
Term life is cheap, but the tradeoff comes when the term is up. Just as you cannot build up home equity by renting, you cannot build up cash value by “renting” life insurance. When the term of coverage is over, you usually walk away with nothing for the premiums you have paid.7
Which coverage is right for you? Many factors may come into play when deciding which type of life insurance will suit your needs. The best thing to do is to speak with a qualified insurance professional who can help you examine these factors, so you can determine which type of coverage may be appropriate.
Charles West may be reached at 1-919-650-3928 or Charles@EnduranceFinancialOnline.com.
1 - thebalance.com/does-a-life-insurance-policy-cover-suicide-2645609 [6/5/18]
2 - fool.com/retirement/2017/07/20/term-vs-whole-life-insurance-which-is-best-for-y-2.aspx [7/20/17]
3 - investopedia.com/articles/personal-finance/082114/how-cash-value-builds-life-insurance-policy.asp [4/30/18]
4 - insure.com/life-insurance/cash-value.html [12/12/17]
5 - thebalance.com/what-you-need-to-know-about-universal-life-insurance-2645831 [5/8/18]
6 - insuranceandestates.com/top-10-pros-cons-variable-universal-life-insurance/ [9/1/17]
7 - consumerreports.org/life-insurance/how-to-choose-the-right-amount-of-life-insurance/ [3/30/18]
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