#112 Crafting Your 10-Year Tax Plan: How to Reduce Liabilities in Your FERS Retirement

Micah Shilanski  00:03

Welcome to the Plan Your Federal Retirement podcast, I’m your host, Micah Shilanski, and with me is a great financial advisor, Christian Sakamoto. Christian, thanks for joining us, bud. 

Christian Sakamoto  00:12

Hey, what’s going on Micah, excited to be here again, how you doing?

Micah Shilanski  00:15

You know, we get to talk about an amazing topic today, so I’m always doing great talking about this topic, but I’m doing really good, life is doing really well, winter starting to come to Alaska, and it’s a beautiful time. How can I complain? 

Christian Sakamoto  00:28

Good, good, good. Yeah, taxes, right? Taxes, what we’ll be talking about today, and I’m excited too. We get a little bit giddy, do our little tax stance when we talk about there’s a lot of moving pieces with taxes, and I know we talk about them a lot, we thought it would be good to talk about what this 10 year tax plan looks like, and some of the things we’ll be thinking about just in general when we’re planning out the 10 year tax plan, so Micah, where do you think we should start as we’re diving into the taxes a little bit? 

Micah Shilanski  01:00

Boy, and I guess you know Christian why we speak about taxes, and I know our listeners know this so well, I know you know it so well. Taxes is potentially one of the largest expenses you are going to have in retirement. This is why it warrants so much conversation about, how do you lower that future expense, right? It’s not going to be health care, thank you Jesus, right? It’s probably not because you have great health insurance as a retiring federal employee, potentially long term care, that’s a different discussion on how that’s going to be, odds are, for most of us listening, that’s not going to be your largest expense, but taxes is the known, right? Those are the two things certain in life, death and taxes, and so we really got to talk about this bill, and it can be a surprising amount, and especially with this being an election year, depending on what we’re going to see happen or not happen with taxes, so it’s worth having a forward facing look on this, so number one, you’re at least not expected, at the very least, we get done with this conversation, and you’re not having some big shock on what taxes are going to be, and then number two, if I could really set an audacious goal out there, Christian, I know you share this as well, which is great now that you’re not going to be surprised by taxes, how do you lower that overall tax bill so you get to keep more of your hard earned money? 

Christian Sakamoto  02:14

Yeah, how can we be proactive about some of the tax planning, right? Instead of just seeing that in the next few years, taxes are going up, well, taxes are going up nothing we can do now. There’s a lot that we can do and a lot that we can plan for, so that’s a good thing to be talking about today.

Micah Shilanski  02:29

Now as we record this podcast, it is an election year, right? So on an election year, vote, early vote, often on this podcast, so jump in, give us five stars, share this with a friend our goal, as you know, is to help another 1 million federal employees with their retirement, and we can only do that with your help now, in addition to voting for the podcast and giving us some good ratings, this is also an election year, and we have a couple of candidates out there that have a slightly different tax plans. As of this recording, VP Harris has not released her tax plan, so we have little hints at it, we don’t actually know what it is. President Trump has talked about his tax plan and his quasi release, so we have a little bit more information on that side, and so we’re going to give you a couple of different answers, because we got to figure out which way the wind is blowing on this, but Christian more importantly, what we tell clients is, you know, politicians come and go, but we plan for the current law that we have today. Isn’t that right? 

Christian Sakamoto  03:20

Absolutely, and the current law that we have today, we’ve mentioned this quite a bit is the tax cuts and jobs act that as of right now, if no changes are made, sunsets at the end of 2025, so by 2026 this is what we’ve been sharing is that under current tax law, there will be a change, taxes will be higher. Now, as you mentioned, with VP Harris’s tax plan, we don’t know the details of that, just all too yet. on Trump’s side, we know a little bit more, but talk about, I guess, some of those, some of those changes, if, if we know a little bit or what we think there. 

Micah Shilanski  03:54

Well, you know what? Let’s do a little bit of it’s easier. If that’s okay. Let’s talk about changes in a little bit to make sure our listeners pay attention to the end of this, but fair enough, what does it take when we’re looking at tax numbers and projections, right? Like, what are the meat and potatoes that we got to kind of roll our sleeves up and kind of get into to figure out what these numbers are, and so Christian, the way I like to start this, and I think it’s same with you, is it’s all about income. It’s all about how much money you have coming in every single month, right?

Christian Sakamoto  03:55

Right, so whether that’s a W-2 or 1099, what are those sources of income that’s going to affect your tax situation, so I guess most commonly, for the federal employees, that’s going to be the wages that you earn, the W-2 income that you earn for when you’re retired, what else would that be, whether it be your your your pension that’s going to come in any retirement account, distributions that from from a pre tax account, like TSP or 401K or IRA, they can include investment gains, capital gains, interest dividends, right? It’ll include social security that’s taxed up to 85% of Social Security is taxed, not 85% of Social Security, that’s at the rate, but up to 85% is taxed.

Micah Shilanski  05:07

Is included in your income could that be a way to say it, so up to 85% of your Social Security is included in your income, when we go to calculate, when the IRS goes to calculate your taxes. 

Christian Sakamoto  05:16

That’s correct, that’s correct. Rental income is another one, right? If you’re in Alaska, PFD, the Pension Fund Dividend that comes in other sources, right? Other small businesses, or you could be retired and have different wages, so, like, there’s lots of different things that can affect your taxes, and so I know a lot of our listeners are going to fit into one of these categories we got a plan, what’s that actually going to look like, not only today, for 2024 but where will your source of income going to be in the next few years as well?

Micah Shilanski  05:45

Yeah, it’s a good point. Now, Christian, what about Roth accounts? If I have a Roth TSP, a loan IRA and I take money from that, how is that going to affect my my taxable income? 

Christian Sakamoto  05:53

Good news, no taxes on that Roth, you’ve paid them already, so, yeah, it’s a, it’s a can’t say that without a smile, right? Growing tax free, taking it out, tax free, Roth’s great!

Micah Shilanski  06:05

Now keep in mind, with those Roths, the same with the TSP, the same with the IRA, any type of retirement account, there’s always little catches and little rules you need to be aware of, so our Christian and I are going to say, yeah, you can take it out with this and this, we’re assuming you understand some of those rules, so let’s just pick the Roth for fun, you know, there’s a 5 year rule and 59 and a half before you can take money out without a 10% penalty and taxation. So you know, if you start pulling money out early, that could be a problem. Where people get in trouble is that they’re like, hey, the TSP, as soon as I can retire, I can pull money out of there without a penalty, and we assume that is the same rule for all of my retirement accounts, and the answer is no, each retirement account has slightly different rules associated with it, so on the most part, Christian I agree with the 100% Roth should be tax free, but we have to use them correctly in order to make them tax free. Is that a fair statement? 

Christian Sakamoto  06:55

Yeah, absolutely, it’s an important it’s important disclaimer there. Now, when we’re talking specifically on Roth Micah, when it comes to basis, is that also tax, and do we have that 5 year rule with the money that we’ve put in and contributed to the Roth? 

Christian Sakamoto  07:09

Yeah, thanks for clarifying that, it’s helpful to know that that 5 year rule, the 59 and a half is really just on the growth there. Okay, what else when it comes to the taxes? 

Micah Shilanski  07:09

Oh, it’s a great question. All right, so let’s dive in a little bit deep this Roth, we’re gonna geek out for a minute, so bear with us please our listeners. All right, so on a distribution roll in a Roth IRA, the order of operations is, number one whenever you pull money out and this, you don’t get a choice, this is just how it happens, your basis comes out first, right? That’s going to be the first thing that’s going to be pulled out. So what does that mean? Well, if I’m putting in 5 grand a year for 10 years into my Roth IRA, okay, well, that’s, you know, $50,000 that I have as a basis inside of that Roth IRA, at any point in time, at any age, I can reach in and I can pull out my basis with no taxes, no penalties, which is fabulous, I get a lot of flexibility, however, the growth is that’s where these rules come in, so if I put 50 grand in, and, let’s just say, for discussion, my money grew to a total of $75,000 so I have 25,000 of growth in this account, just my hypothetical example, I can pull out that 50 grand without penalties, but the minute I start going into that growth now I have my 5 year rule and 59 and a half that I have to meet before I can access that money without taxes or penalties. 

Micah Shilanski  08:26

Yeah, so Christian, we’re first going to do, right is the income, all of that stuff that you listed, right? We’re going to break that out by year of what we think you’re going to have coming in. Now, we’re going to give you some action items, you know, you don’t got to go out and run a 10 year projection per se, just for yourself right now, but definitely start looking at that income that you have coming in this year, in 2024 and where is it coming, what source is it coming, and then how, what’s that, how is it going to be taxed? And then Christian, after we get the income, we start looking at our deductions, or our adjustments, or potentially credits that you’re available for. So everybody remembers itemized deductions, I say remembers right? Because most people now under the TCJA Tax Cuts and Job Act that went in 2017, most people are no longer filing itemized deductions, most people are doing a standard deduction, which is really good, right? You didn’t lose deductions, you actually got so much more, because what the rule says is that if you have at least X amount or less, you’re going to get the higher of the standard deduction, or you’re itemized. So if you have $35,000 in charitable contributions, taxes paid, real estate property, state income taxes paid, plus mortgage interest, and it’s like 35 grand great news, you’re going to get the higher of that, you’re going to get that as an itemized deduction, but if you have lower than that in Christian I’m blanking right now, what is standard deduction, do you have that by chance? 

Christian Sakamoto  09:43

Yeah, so single in 2024 if you’re under 65 or not blind, would be 14,600 and then 29,200 if you’re married. 

Micah Shilanski  09:55

So 29,000 and change your standard deduction, which is great, and so what we found out is most people were not itemizing are barely qualified to itemize, now they have a much more generous deduction under this tax cut, so that was a really good thing. So most people, Christian that you and I run into, are going to be doing a standard deduction, they’re going to get that 29,000 and change. Sometimes, what we see, though, is clients are a little bit more charitable minded, and that’s where we might exceed that 29,000 is that right? 

Christian Sakamoto  10:24

That’s right, that’s right. So when it’s specific to a few exceptions there, there’s over age 65 and then if you are blind, you can go and have an additional income I’m looking at the practice right now, so 1550 and then 1950 if you’re married filing joint if those additional deductions, if you’re doing the standard, now if you’re itemizing like you had mentioned, and you’re above roughly that 29,000 30,000 then yes, we’re able to take advantage of the itemized deductions, but as you mentioned, statistically, most people are just claiming that standard deduction.

Micah Shilanski  10:59

So where this comes into tax planning is, I have some clients that give a decent amount, but maybe it’s not over 30 grand a year, but maybe their property taxes are 10, because now that’s what it’s limited to, right? 10,000 the most you conduct for property and state income taxes, but maybe they’re given kind of you know that 10,000 15,000 a year in a charitable deduction, well Nelson, that’s 20,25 grand a year, but they’re still taking a standard deduction because it’s higher, so Christian sometimes what we do with clients is we double up on one year they’re charitable contributions, so instead of doing kind of 15,000 a year and one year, we do 30 grand, right? And then when we do 30 grand, we’re able to add, now that 10,000 of potentially real estate taxes that they paid, now that’s a $40,000 deduction. So just by changing the frequency of your charitable contributions, this is a good planning opportunity that we can kind of lower your taxes, and something we might have missed out on if we weren’t being proactive with this. 

Christian Sakamoto  11:53

That’s great, and I know there’s additional planning tools that are available to us, like a qualified charitable distribution that’s available currently if you’re over the age of 70 and a half works in a way where any pre tax money that you have in a in an IRA, if you give that directly to a charity that you wouldn’t be paying taxes on it, so it’s another great benefit, and then donor advised funds could be another good benefit, so maybe we talk a little bit about both of those, DAF and QCDs. 

Micah Shilanski  12:24

Yeah, I love QCDs Christian, I know you do as well, we use them with a lot of our clients, and now get the catch with this one is you got to be 70 and a half years young. Great news. If you’re not there yet, you will be so it’s something to think about, and the way that this works is we can’t do with the TSP unfortunately no, that’s not our rule, that’s the TSPs rule, but it works great with an IRA. So we take a client that is charitable you know, they got enough to take care of them, but they want to make the world a little bit of a better place, which is just a beautiful thing, and so maybe they’re given 5, 10.000, whatever that dollar amount is, to charity, but Christian we just talked about, they get no tax deduction for that, because they’re under the standard deduction. So once they return 70 and a half, wow there’s steps you got to do to make this a success we’re kind of skipping over those tell you what the what the nice part about this is, but what we’ll do is we’ll set up an account, set up for a QCD Qualified Charitable Distribution, and the clients will send money out of their IRA account directly to a charity. Now what happens is they get a huge benefit, the income that gets sent directly to a charity, Christian as you know, does not count as income. So if I’m pulling out money and it goes to Micah’s bank account and then I send it to a charity, I have to pay taxes on that money, however, if I’m over 70 and a half and I send my money from my retirement account directly to a charity, several ways, you got to make sure that gets done, right? But you send it directly to a charity doesn’t go to my bank account, now, all of a sudden, that income does not count. What does that mean? That doesn’t increase it for IRMA, right? Which is that pesky thing that Income Related Medicare Tax which, if your income is above a certain amount, your Medicare premium goes up, it doesn’t increase it that it keeps your tax base a little bit low, it’s a way to get a great standard deduction and exclude some more income from taxation. 

Christian Sakamoto  14:03

Yeah, and we do that quite a bit right now, and one of the things we’ve noticed is that Required Minimum Distribution age has gone up over the years, currently it’s between 73 and 75 they haven’t as of today, they haven’t increased that QCD age, so it’s still that 70 and a half, so it’s a great it’s a great planning tool as we’re looking at deductions for that taxable income, as we’re planning what our tax situation is going to be. So if you’re close to that, and you do, you are planning on giving to charities, one of the things you can do is close to that age, rather, is you could look at it and say, maybe I’ll temporarily reduce some of my gifts and plan when I’m get to that 70 and a half, I kind of make up for some of the gifts that I’ve done or haven’t done over the previous few years we’ve seen that a few times, you can do a few planning tricks with those QCDs. 

Micah Shilanski  14:52

Now, one of the questions Christian we get often and say, hey, my kids’s a charity, so do I write off all the expenses I’m giving to them? The answer is no, right? This is the IRSs definition of a charity, not your definition of a charity, so this does have to be an official charity set up to give money to. One other thing on that charitable fund, and again, we’re big in making this world a better place is those Donor Advised Funds, DAF accounts and Christian we were talking kind of pre gaming about these ones, just a little bit, it’s a really good tool, and basically what it allows if I have an investment account, non retirement account, if I have an investment account, let’s say I bought Apple and Apple’s gone up in value, and no, that’s not a recommendation to go buy Apple, right? But if I bought a stock or whatever, and it’s increased in value, and I sell that stock and give that money to charity, I have to pay taxes on the gains of that stock, but then when I give it to charity, I may or may not get a deduction, depending if I’ve exceeded my standard deduction amount or not, so they created this really cool thing called, years and years ago, a donor advised fund, and basically what I do, and I use Schwab as an example, because that’s where I have my donor advice fund, is I have an appreciation inside of a stock or an investment, which is great, and I want to give money to charity, I will transfer that stock into the donor advised fund, and then I will sell that stock in the donor advised fund, and the donor advised fund then pays the charity. What was the benefit of that little step that I took? Well, I moved it from being taxable to Micah taxable to me, I put it in this donor advised fund where I got a tax deduction for whatever the value was of that, and then when the charity sells it, there’s no, excuse me, the donor advised fund sells it, there’s no capital gains tax on that amount, and then that amount gets to go to charity, so again, it’s knowing how to use these tools properly to make sure we’re beating the IRS out of 10s, if not 1000s, of dollars in taxes. 

Christian Sakamoto  14:54

Agreed, and especially with the donor advice fund, you want to confirm that the charity or the organization you’re giving to is on the list, right, approved charities, or 501, c3, so that’s probably the homework you want to do before you you just willy nilly do that, but I agree that’s a really good option. What about some of these energy credits, like solar credits, what are your thoughts on them?

Micah Shilanski  17:04

So one of the times, whenever we’re going to make an investment, right, I always want to know, why are we doing this investment, right? That’s the big question, what are we trying to solve for right here, and sometimes clients are going to come in Christian say, hey, I want to move to solar because it’s going to save so much money on my energy bill. That may or may or may not be true I’m just gonna speak from the Alaska perspective, because that’s kind of where I’m at. Solar is pretty expensive up here, and believe it or not, it gets dark in Alaska for six months out of the year, so me, it’s exaggeration, it gets pretty dark up here. So sometimes solar, it can be a good way to augment some cost, but not fully replace some cost. So the first thing I want to know is, why are we making this investment? Is it an investment or, hey, do I just want solar and I want to be off the grid? That’s a different discussion than I want to return on my dollars, right? If you want to return on your dollars, we got to run some math and say, are you actually going to get a return, maybe you will, maybe you won’t, let’s look at the numbers, if this is a hey, I want to spend this money as a home improvement, and this is important to me, awesome there’s no problem with that, then we spend the money as a home improvement, and Christian that’s where we have a lot of clients too, but it comes right now with an energy credit of around 30% so if you spend $50,000 in solar, you get 30% which you’re roughly a $15,000 tax credit, which is absolutely amazing, because that credit counts at the tippy, tippy, top of your tax bracket, so it’s worth a lot of money percentage wise. So one of the things Christian whenever we have a client, and you do a great job of this, I know whenever we have a client that does these energy tax credits, we want to say, hey, do I want to trigger more income today and be able to use that credit to offset some of that tax liability, is there some lucrative tax planning available to us, now this doesn’t mean go spend $70,000 in solar, so do a Roth conversion, that’s not what we’re saying, but if you happen to do solar or get an energy tax credit, we should be looking at tax Roth conversions, some type of triggering income today to help offset some of those future taxes.

Christian Sakamoto  19:04

Well, speaking of Roth conversions, we’ve been talking about charitable contributions, donor advised funds and credits that we get. We talk about Roth conversions quite a bit as well, so as we’re looking at our clients tax situation, where the taxes will be for them just this year and the following years, we have to think about where the tax laws might go, and we’ll talk about that here in a second, but Roth conversions play into this, because if we know or confident that our taxes, that we’re in today, that bracket that we’re in today, will be lower than what they will be in the future, then we can do the opposite, where we’re intentionally increasing our tax rate or how much income we’re going to be paying taxes on by doing a Roth conversion, knowing we’re paying the taxes at a lower rate than what they will be when we spend that money in the future. So that’s another point to make, and I know we talk about Roth conversions a lot, but it’s just another, another good tool that we have when it comes to that tax planning that we haveavailable to us. 

Micah Shilanski  20:01

Yeah, 100% so looking at those things would be really important. So Christian, let’s talk about, you know, I know we’re going a little on this podcast, but it’s taxes, how may I go along and chat about it? So how do we start putting that together, what do clients start looking at doing in order to improve their future tax situation?

Christian Sakamoto  20:17

You know, it’s a great question, I think the first place is going to be on cash flow, and not just net expenses and the net spending, but going back to the gross number and saying, what is our income that’s coming in today, between my income, my spouse’s income, potentially any capital gains, dividends, all the things we’ve already talked about, where do we think our income is going to be this year, next year, with any promotions, bonuses, job changes, life event changes, and kind of plan those out, and begin to plan that out, not just this year, but in the future years as well.

Micah Shilanski  20:52

And Christian, I love that, especially for our federal employees that are on salary pretty consistent pay, it becomes an easy thing you could do, you can pull that LES, you can look at it now a lot of them, every agency is a little different, but a lot of them, lot of them, they’re going to tell you your year to date taxable wages, and you can say, great, how many pay periods have been paid, how many pay periods are left, and you can project out your taxable wages, which is so good, now you don’t want to think about your gross, what’s deductible, etc. They put it right on that pay stub for you. If they don’t do that, you should go back to your agency, ask them do that, but then you got to do a little bit more math to figure out what you’re to figure out what your taxable wages are, but Christian I love that. Start with the money you have today, right? Get a good baseline, then we start taking that out into the future and say, how will your income change, whether you turn on Social Security, right? Okay, now that added to your income, what’s your pension going to be, what’s your irate distributions, right? But start with where you’re at today, that’s great advice.

Christian Sakamoto  20:52

And similarly, you know what effect that’s going to have when you turn on that Social Security and when you go to a different tax bracket, and maybe eventually Medicare bracket, like, what are these effects going to be once we turn on these different sources of income that you have available, how that, how that all ties in I think that’s that’s the other thing. But then the last piece really is, how are we going to lower this, or what are things that we can be doing today? Maybe we’re intentionally, like I mentioned, buying the bullet and doing the conversion, knowing we’re paying those taxes, but they’re going to be lower in the future if we, if we did the conversion on these dollars today, and then thinking about some of the other credits and deductions that we’ve already discussed, those are really where we have to head, is not just okay, this is helpful information my taxes are going to be higher in the future, but what can we actually be doing about that today? 

Micah Shilanski  22:33

Now it’s good to look at the stick, right? It’s good to look at the pain if I do nothing, what is the cost? Now, if our current tax laws expire, which that’s currently, the plan is that they’re going to expire in 2026 and normally our clients, which are mainly federal employees, are gonna see a roughly 20% increase in their tax bill. Now, some people are gonna look at the brackets and be like, my it doesn’t go up 20% you must be smoking that crack in Alaska, like, what’s going on, this doesn’t make sense. Well, when you look at it, a couple things are going to happen is, number one, the percentage of taxes goes up and the brackets shrink, we have a progressive tax system, right? So that means the more money you make, you get bumped into the next tax bracket, well, if the tax brackets are wide, that means it takes longer to get bumped into the next one, that means you pay a lower tax before you get to the next one, if the brackets shrink and go on a diet, that means you accelerate through them quicker, and that means you’re going to pay more in taxes. So really start looking at that stick and be like, oh, if I do nothing, what is that cost going to be? For me, Christian, that’s motivation is actually do something now, right? If I look at it and say, hey, if I do nothing, I’m going to pay X amount more taxes, but if I did this today, I’m paying a much lower amount in taxes, okay, that delta is worth the pain today, to make that change.

Christian Sakamoto  23:49

Yeah, absolutely, not only the income brackets are getting squeezed and increasing, but then, as we know, the standard deduction that we’re all familiar with is also supposed to go back to half of what it is adjusted for inflation, so what are those itemized deductions going to be, are those even going to be close to the standard, so, yeah, I can easily see an extra 20% easy for federal employees. 

Micah Shilanski  24:13

So big action items, right is make sure you’re looking at this today. This podcast is all about action and doing things right, and so making sure you’re looking at this now you got a couple months left, make a good plan, we’re being pretty proactive, with a lot of our clients triggering more income today in Roth conversions, paying that taxes. Lot of things to think about in a Roth conversion. I know we do it on another podcast kind of dive into that, so don’t jump into this willy nilly, understand what you’re doing, but really look at that and say, how much of that should you pull the trigger? I know, personally, in the last couple years, I’ve done some very large Roth conversions, I’m going to do it again this year because I want to practice what I breach I breach to clients, hey, pay the tax today let’s get some tax free money. I’m going to put my money in that same category because I have the same concerns my retirees have, which is, when taxes go up, how am I going to pay for that? 

Christian Sakamoto  24:58

Agreed, agreed, and if you’re a younger professional, and you’re getting started in your 401K or your TSP, and you have the choice to do pretext versus Roth, maybe look at it and saying the same thing, maybe instead of having to do those conversions later on, we will contribute to the Roth from the beginning as well, that’s another thing to be considering. 

Micah Shilanski  25:16

All right, Christian, when you said, if you’re a younger professional, you paused, were you about to say like me, implying that I wasn’t the younger professional?

Christian Sakamoto  25:23

No, no, I thought about it for a second, I was like, am I even in a younger professional anymore? I thought I crossed that bridge.

Micah Shilanski  25:34

That’s solid advice, though, right? When are we going to use this money thinking about giving a tax free? I absolutely love it. All right, you guys have our list has a great action items to take away from this week, making sure you’re doing it. Be proactive in your retirement, our goal is to help transform the lives of another 1 million federal employees with great information, so share this, get out there. Our YouTube is blowing up, leave us comments. We now have a great number you can call in and ask questions, it goes right through our voice recording. We listen to those, and now we’re gonna start doing podcast based on those questions, we answer those questions on YouTube, so make sure you’re calling in with your questions so we can get those answered, and if you’re handling this stuff and you’re like, hey, I want an extra set of eyes looking at this, then pick up the phone and give us a call. Sit down with one of us and have us go through this to make sure you have the best information. If it’s not us, find someone else that you trust that’s really good in this, we want to make sure your retirement is in safe hands. Christian, thank you so much for joining us and until next time, Happy Planning!