Retirees face plenty of financial challenges these days, from volatile markets that can upend their security to low interest yields that in some cases don’t even allow them to keep up with inflation.
But with all the issues that confront them, perhaps the most significant financial burden is this one: taxes. After all, many retirees — and people approaching retirement — have stashed much of their savings in traditional IRAs or 401(k)s, which are tax-deferred methods for accumulating wealth. Also, taxpayers may elect to use other tax-deferred accounts in order to avoid interest, dividends and capital gains from spilling onto their tax returns. These methods can allow taxpayers to potentially lower their income and taxes.
However, once we “turn on the faucet” and withdraw money from these tax-deferred accounts, additional income will need to be claimed on our tax returns.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
That is, unless the retirees take steps that will help them reduce how much they owe the government. After all, designing a strategic income plan to help mitigate the tax burden of income in retirement is an essential, but often neglected, part of financial planning.
I refer to such a plan as “TAP,” or tax-advantaged payout. One lesser-known tool to consider tapping into for tax-free income is a home equity line of credit, or HELOC, on your home.
Here are two scenarios in which a HELOC may make sense in your retirement:
IRA drawdown.
Consider the example of an average married retired couple wanting to stay in the 12% tax bracket as joint filers. They can take up to $78,950 of taxable income from their IRAs to stay under this threshold in 2019, and that amount increases to $103,350 after adding the standard deduction of $24,400. Then, for any additional funds they may need during the year, they can tap into the HELOC. For example, if they take $15,000 out, they will actually receive $15,000 tax-free.
By comparison, taking the same amount from their IRA would push them into the 22% tax bracket, resulting in $3,300 in federal taxes being due in addition to any state or local income taxes. Thus, they may only receive roughly $10,000 after taxes from their IRA withdrawal. Not only is the HELOC tax-free, the interest rate charged on a HELOC is generally low at this point in time. In addition, depending on what you use the money for, that interest may be tax deductible, and repayments can be planned over a multiyear term to be covered by future IRA distributions or other investment income. This strategic “TAP” approach spreads out the tax impact to continuously stay under tax bracket thresholds, keeping as much of your money in your hands as possible.
Emergency money.
Unexpected expenses can crop up throughout a lifetime, whether for significant home repairs, health care needs or other costly surprises. If you do not have the funds available in a checking or savings account, don’t let the emotion of a stressful emergency drive you to make impulsive (and costly) financial decisions. Rather than turning to a high-interest credit card or cashing out investments at an inopportune time in the market, a HELOC can be a smart place to turn. This can give your financial adviser time to plan an exit strategy rather than rushing to liquidate securities. This also allows time to design a repayment plan that maximizes both tax and investment advantages to your favor.
As a bonus potential savings opportunity, if you are considering purchasing a new home or refinancing an existing home, you may consider setting up a HELOC at the same time. Many banks will offer a discounted or “free” HELOC closing, making it an even more cost-effective tool to consider.
Of course, like most things in life a HELOC does have disadvantages. For example, the interest rate is variable, which means the monthly payment can be unpredictable, especially during times of rising interest rates.
While there are other ways to leverage the equity of your home to create cash flow in retirement, a HELOC may be most desirable for some retirees, based on its flexibility for scenarios such as future downsizing or the potential need for assisted living facilities down the road.
In short, a HELOC can be a powerful tool as part of a proactive and comprehensive cash-flow plan in retirement.
Ronnie Blair contributed to this article.
Investment advisory services are offered through Calibre Investment Management, LLC, a Registered Investment Adviser. For a list of full disclosures, please click here and scroll to the bottom of the page.
-
Where There's a Will, There's a Way Your Assets Will Be Distributed as You WishYour will is the backbone of a strong, adaptable estate plan that ensures what you leave behind goes to your selected beneficiaries. Without a will, state laws determine who gets your assets.
-
I'm a Financial Adviser: This Is What You're Really Losing if You Cut Back on Your 401(k) ContributionsMissing out on the benefits of the employer match and compounding growth could force you to work longer and lower your standard of living in retirement. Here are some alternative options.
-
Preferred Bank Stocks: The Investment Retirees (and Others) May Be Missing Out OnMost large banks issue preferred stocks that pay out fixed dividends, often with higher yields than bonds. Should you make room for them in your portfolio?
-
Don't Let Your Equity Compensation Trip You Up: A Financial Expert's GuideStock options, RSUs and other executive perks can come with some serious strings attached. To avoid a nasty tax surprise, you need a plan.
-
The Spendthrift Trap: Here's One Way to Protect Your Legacy From an Irresponsible HeirA spendthrift clause in an estate plan can protect an inheritance from a financially irresponsible child's debts and poor decisions.
-
Adapting to AI's Evolving Landscape: A Survival Guide for BusinessesLike it or not, AI is here to stay, and opting out could be disastrous for your organization. Instead, focus on what you can control and be flexible, as AI is still evolving.
-
Striking Gold (or Gas): A Financial Pro Unpacks the Nuances of Energy InvestingInvesting in the energy industry, particularly oil and gas, involves understanding the facts about how projects generate returns through cash flow and long-term asset building, while also being aware of the risks.
-
Escaping the New Golden Handcuffs: A Financial Expert Has a Plan for Today's ExecutivesFeeling stuck in your job? It could be your complicated compensation package, but it also could be where you live, your family or even how you view yourself.
