If You Have a Pension, Smart Tax Planning Should Start Now

Less than 20% of people have a pension nowadays. If you are fortunate enough to have one, there's special planning that you need to consider. The problem is that many financial planners do not talk about planning with pensions because most planners do not specialize in this area. The good news is, through this article, you're going to learn how to maximize your pension and see as much of it in your pockets as possible.

We do this with smart tax planning to help ensure you do not have to pay more taxes than absolutely necessary. Do you ever feel like you are overpaying in taxes each year? Our goal is to change that.

The reason tax planning with pensions can be difficult, and why most people with pensions pay more in taxes than others, is because pensions push your income higher — and that’s without factoring in Social Security income and required minimum distributions (RMDs). RMDs are when you are forced to take out money from your tax-deferred investments at either the age of 73 or 75.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-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.

Sign up

When you combine all these items, you will quickly find yourself in what's called the Social Security tax torpedo, which will decrease the amount you receive from Social Security and force you to pay more in taxes.

What is the Social Security tax torpedo?

The Social Security tax torpedo occurs when your income is high enough that it starts to force your Social Security to be nearly fully taxable. Our goal is to keep our clients out of that torpedo by reducing their RMDs in the future so they can potentially receive more of their Social Security tax-free. Unfortunately, for those who have larger pensions, this may not be possible, and your Social Security may automatically be fully taxable.

Medicare premiums could go up

With a larger pension and RMDs, you also risk forcing yourself into higher Medicare premium tiers, which means you have to pay more for the same Medicare coverage as the person down the street who doesn’t have as much retirement income as you do. It's important to plan so that you pay your fair share of Medicare premiums and nothing more. (Read more about this Medicare surcharge in the article Four Things to Know if Medicare’s IRMAA Kicks In.)

With tax rates expected to increase due to our debt crisis, increased spending, and struggles with Social Security and Medicare funding, this has become a timely and important topic. So if you have a pension, the time to start planning is now to ensure you can pay lower taxes and allow yourself to be in a lower income tax bracket in the future.

Now, I’m not here to tell you to live on a lower income in the future. I'm telling you to be tax-smart and be able to pull from tax-free investments so that you can still live on the amount you want but show a lower income when reporting your income for taxes. I’m suggesting that you implement tax strategies today, to avoid paying more than your share in the future.

How do we fix this?

Fixing this requires tax-smart planning, which involves strategies such as a Roth conversion, where you pay taxes on those tax-deferred investments now and move them to a Roth IRA. This is a very popular strategy right now to take advantage of current low tax rates — especially considering most people will not likely be in a lower tax bracket in the future.

For many people, learning that they may be in a higher or the same tax bracket in the future may be a shock, because all your life you've been told that you'll be in a lower tax bracket in the future. That is true for some people, but when you have a pension and you've been a diligent saver and have the majority of your savings in tax-deferred investments, that's likely to mean that your income is going to be higher in the future than most.

Which, again, is why it's important for you to have tax-smart strategies now. This is also why we recommend you work with financial planners who understand pensions and the ramifications for them down the road. If you work with a planner who does not work with pensions, then your strategy could be lacking.

On the other hand, congrats

To end this article on a positive note, I do want to make it very clear that because you have a pension, you are in a better place than most. In one of the videos on our YouTube channel, I discuss how valuable a $5,000-a-month pension is over time. Under specific calculations, it could mean the same as having nearly $1 million right now if you live for around 20 years or longer.

You can also learn more about tax planning with pensions by reading my book, I Hate Taxes.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Related Content

• What’s the Difference Between a CPA and a Tax Planner?
• Is Your Financial Adviser Doing a Good Job for You?
• Will You Pay Higher Taxes in Retirement?
• Five Estate Planning Things You Need to Do Now
• Do You Have at Least $1 Million in Tax-Deferred Investments?