#113 Retirement Tax Traps: How to Avoid Surprises in Your Federal Retirement Planning

Micah Shilanski  00:03

Welcome back to the Plan Your Federal Retirement podcast. I’m your co host, Micah Shilanski, and with me today, another special guest, Christian Sakamoto. Christian, thanks for joining me bud.

Christian Sakamoto  00:14

Micah, excited to be here as always, how’s it up there in Alaska right now?

Micah Shilanski  00:18

Oh, it’s fantastic, right? Fall is quickly passing by, winter is around the corner, we have a nice, cool air, it was September I was talking to a buddy Christian flying down to teach a class, a tax class in Arizona, and while I was down there they’re Micah what’s the weather like, keep in mind Arizona, it’s like 112 when I’m there, and I’m like, I was 33 degrees when I left my house, right? So a little bit of contrast what about you in Washington? 

Christian Sakamoto  00:44

Oh, all is well over here, we’ve had a very nice fall, we’re still approaching that I’d say maybe half the leaves are still on the trees, and it’s just a very nice time of year. Lot of concerns in the summertime with how dry it actually is in Washington with fires and whatnot, but this time you were starting to see the rain come back and again, it’s just I it is my favorite time of year.

Micah Shilanski  01:10

That’s awesome, that’s pretty fantastic. Well, actually happens to be my favorite time of year as well, but not because of fall, because we got to talk about one of my favorite topics, which is tax planning. I love talking about fall tax planning the but now this is different than spring, because in spring, when we talk about taxes with our clients, we’re looking in the rearview mirror, right? We’re looking at what returns they filed, how things were set up, what went down, and looking for mistakes, but in the fall, we have this amazing opportunity to say what changes do we need to make for this year, and forecasting into future years in order to help reduce our taxes.

Micah Shilanski  01:43

That’s right, at least as of the data recording that IRMAA brackets haven’t been released for this year, right? Which this year it really means two years ago, we’ll talk about IRMAA in just a little bit, that’s a little bit of a beast to be there, but Christian, you’re spot on I love knowing a little bit more knowledge, tax wise, what’s going to happen, and then there’s 10 months under our belt with clients income, so we get a good idea to see what their actual income is going to be, so we can project things in any time throughout the year, but the closer we get to the end of the year, the more accurate those projections really come because we have real data versus hypothetical, right? 

Christian Sakamoto  01:43

That’s exactly right, we get to take action on what some of those things that we were talking about earlier on in the year, and it’s a nice time too, because we have a little bit more that we are solid on with the actual tax laws and what they are, so as some of those thresholds change this time of the year, we can also base our tax planning based on some of those changes, like IRMAA brackets and those kinds of things that those only get posted until later on in the year anyway.

Christian Sakamoto  02:45

Exactly, exactly.

Micah Shilanski  02:47

Perfect. Now, Christian, I want to jump into the top five tax straps that we find federal employees run into, and it’s kind of funny as we’re going through this and kind of talking about these pregame and this, I was thinking about clients that were hitting each one of these and where it happened in their financial plan, so this is something that I see, especially this last one, by the way, this last one, there’s my teaser for you to stay tuned to the end to make sure you’ve given us the five stars, right? This last one catches us by its price, doesn’t apply to everyone, but those that it applies to, it is a big bite, and so we have to talk about that, but Christian, before we jump into this aspect of the top five tax traps we see federal employees make, why do we care like, why do we care about taxes? Why don’t we just file the 1040 when we’re supposed to in March and in April, call it a day and just move on with life, why do we make such a fuss about this?

Christian Sakamoto  03:35

I would say it really is when it comes to taxes, especially in retirement, is probably the largest expense that you’ll have, we’ll all have in retirement will be taxes, and the reason we care so much about it is because we can have some control with our taxes, especially if we are looking at certain things that we’ll talk about a little bit later, you know, Roth Conversions and other different things that we can do today to affect our taxes in the future, so that’s why we spend so much time on it, is because we have a little bit of control with it, and because it’s such a large expense in retirement as well, and you know, if we compare that to cost of health care, living costs, all these other things, taxes, I would say, yeah, that probably going to be one of the larger, if not the largest expense in retirement.

Micah Shilanski  04:22

Boy, Christian, I just want to echo what you said, so listeners, please forgive me for that, but taxes is probably the largest expense you will have in retirement, and on top of that, Christian, it’s not like, oh, crap, taxes are being done to us, okay, part of that’s true, however, there’s a large part of this that we get to control, right? We can look forward a little bit in our planning process and we can move that needle to help reduce our tax bill, is that a fair statement? 

Christian Sakamoto  04:47

Absolutely, absolutely, and that’s why we get so excited, is because if we do nothing, that’s still an option, but when we get to go in and use certain things, we can plan and make some changes, that’s what we have the biggest impact to hopefully reduce the tax burden over the long run.

Micah Shilanski  05:03

I love it, that’s 100% spot on. All right, so let’s get into our tax traps. What are things that we often see that come up that affect clients, and not only let’s talk about them, we’re talking about how it affects, how it surprises, let’s also talk about some action items for us as well, so, Christian, what do you think the top, well you already know you’re cheating, you’re looking at the list, right, I love it, what is that tax top trap we see? 

Christian Sakamoto  05:26

I would say number one would be thinking or not knowing your tax bracket in retirement, thinking that it will be lower, when, in fact, it’s either the same or could even be higher, especially if we throw in some required minimum distributions and a few other things, so having a higher tax bracket in retirement could be a huge trap when we’re used to paying a certain amount based on what we withheld from our taxes while we’re working and thinking that it’s going to be consistent in retirement, it might not be, and so having not planned for that, that could really be a big surprise for people, especially if they’re trying to maintain or have a similar standard of living in retirement, and then not realizing how much taxes will actually have to be withheld in order to achieve that.

Micah Shilanski  06:14

Christian you’re right, right now, the misnomer that I hear so often now we don’t hear from our listeners, our listeners are really educated on top of this, which I love it, right? But from non listeners, one of the things I gotta hear when I talk around that country is, Micah, when I retire, my taxes will be less, and that’s just ingrained in our mentality,we’ve been told that for so long, and it’s like, well, I don’t have a paycheck anymore, if I don’t have that income, then my taxes are going to be low in retirement, but then when we step back and think about it, we get a pension income, we get a Social Security, we get a TSP distribution, an IRA distribution, all of these income sources we have are taxed, and then on top of that, in two years, right? Our current tax laws are going to change, and presently, the way it’s said, Congress can do it in with a stroke of a pen, right? But today, it’s going to change, and almost everyone’s taxes are going to be increased, so if we’re going to retire, and we think our taxes are going to be less, but we have a tax law increase ahead of us, oh, wow, this could be a major shocker, and if we’re borderline on retirement, we got an all preachy Christian forgive me, right, but if we’re borderline on retirement, having an increase in your tax bill, would you take you from a successful retirement to an unsuccessful retirement.

Christian Sakamoto  07:22

Right, right, and I’m glad you mentioned the tax law is changing again, because they can change again and they can change again. What I like to do with my clients when we’re doing cash flow planning retirement planning is I like to air on the side of caution and just estimate a little bit more taxes, just so that we can plan their net income to be a little bit less, so that it just has a little bit more buffer room there, so I agree, and I think that could be a huge trap. Now, what would be the second trap that you would see when it comes to taxes?

Micah Shilanski  07:49

Christian, I’m going to say this dovetails nicely with the first one, right? But we have all taxable income for retirement, and we can talk about RMDs are going to affect this in just a second, but again, going back to what we said before, what we said before you retire, you get your first pension that’s taxable, like 99% of it, right? A little bit tax free, but 99% taxable. Social Security, more than likely up to 85% of your Social Security subject to tax, once your income is above this, 44,000 and change, right, all of a sudden, your income, your income, your Social Security’s virtually all taxable to you, then we’re gonna have IRAs, TSPs, etc. And all of those are taxed when we take money out, realistically, we have very few sets of money which are an after tax account or a tax free account, so a lot of times we’re meeting with retirees, we look at their tax buckets, right? And a lot of its ordinary income tax deferred, that’s kind of the top layer, and our big discussion is, hey, we need tax diversification, we need to move this to these bottom buckets down here, which we have some capital gains and some tax free to give us diversification in our tax planning.

Christian Sakamoto  08:53

Exactly, so the tax trap being, you know, all the income that we have in retirement is going to be at the ordinary income rates, and it’s all taxable, and so some of the things we can be doing and shifting things around with through Roth conversions and or just contributions to the Roth accounts and after tax accounts, I really think that’s a good idea, as well as, and I mentioned this earlier, when it comes to RMDs similarly, if pension income comes in, Social Security income comes in, and life’s good, we’re paying our bills, maybe this required minimum distribution that you have to take out puts you in a higher tax bracket, or just significantly more money that you have to take out, and all of your retirement accounts were pre tax, boy, this could really, really throw a wrench in that plan, because it’s easy to push to the side and think, well, it’s just future self’s worry, but again, we got to be proactive with some of those things, because also have to think about the growth on that account over time. 

Micah Shilanski  09:54

Sure!

Christian Sakamoto  09:54

We’ve got a ton of money in pre tax, and then we’re a decade out from starting required minimum distributions, well, there’s a possibility for invested in the market that that number is going to grow significantly, especially if we’re not drawing down that account, so yeah, those RMDs could really put you in a surprise, and again, just another reason why that tax diversification makes a ton of sense.

Micah Shilanski  10:16

It’s huge, now, what do we think of those RMDs, Christian as well for our listeners, remember, Secure Act 2.0 came into effect, so what does that mean? A couple of things. Number one, RMDs have changed, and our mindset sometimes we’re still in that 70 and a half I got to start taking RMDs now that’s moved to 73 between 73 and 75 depending on the year you were born, so good news is it was kicked down the road a little bit, but it didn’t go away, we still have that that’s out there. Christian, to your point, I can’t tell you how many clients I ran into that they got a lot of after tax savings, and they got their pension coming in, and they’re like, I’m like, I’m not worried about this, you know, my tax bill is really low right now, it’s like 12% I’m not paying anything in taxes because I’m living on my after tax account, which is fantastic, except for they’re delaying their Social Security, so once they’re 70 they have these big Social Security checks that are coming in, which is beautiful, right? Because now I delayed it, I got this great growth rate with it I love it, now I get this big Social Security that’s taxable, and then 73 comes around the corner, and I got to take these distributions that I wasn’t planning on, and you’re starting up 4% then it kind of goes up from there that’s a round number, right? But just a good placeholder, now, listen, you have to take this money out of this IRA, now all of a sudden, we’ve seen multiple times that it bumps people up into higher and higher tax brackets when, if we were looking at it sooner in the planning process, we could have done a whole lot about that to still keep all of their money convert, maybe more to Roth IRAs to make them tax free, but then have that where it’s not subject to the RMDs.

Christian Sakamoto  11:47

Exactly, and that’s the key point right there. Now I’d say the third

Micah Shilanski  11:51

Before that, can I, I’m sorry, I’m on a RMD kick. All right, so the other thing on RMDs that I’d like to mention that catches us by surprise, are inherited IRA accounts, right? 

Christian Sakamoto  12:03

Yeah.

Micah Shilanski  12:04

Because every now and again, someone’s going to pass away, and then they’re going to leave you a parent passes away, they leave you money, we still might be thinking old like pre Secure Act of saying, hey, I can do this stretch IRA, but those stretch IRAs don’t exist anymore. Basically, what happens now, the laws convoluted, by the way, so I’m going to give a quick summary of this, please work with someone that understands inherited IRAs, post Secure Act 2.0 a lot of weird stuff in there, here’s the short answer. Once RMDs start, they can never stop, and you have to empty your account within 10 years, so all of a sudden, mom and dad passes away they leave you 500, 800 thousand in an IRA account, now of a sudden, you’re taking out 50, 80 thousand bucks a year in order to complete that account over 10 years. Well, if you added $80,000 of income to the top line, that quite likely could bump you up into higher tax brackets, right? So maybe you did okay tax planning on your end, then you get this inheritance. And people might say, hh, Micah, oh, the problems to have, but it’s still a problem, you’re still overpaying the IRS, so we need to be thinking about that.

Christian Sakamoto  13:07

Right, right, or if you just took the minimum RMD, for example, and not, let’s say, 10% of the value over 10 years to get it to zero, and you kind of delayed that, that could also be a thing that blows up your taxes as well, because at the end in the 10th year, you might be required to take a very large distribution again, that lump sum could put you in a higher bracket yeah, absolutely, thanks for bringing up the inherited armies as well. 

Micah Shilanski  13:32

Yeah. 

Christian Sakamoto  13:33

Now I’d say the third tax trap that we were going to think about and talk about was IRMAA, the the Medicare premium for Medicare, part B’s premiums.

Micah Shilanski  13:43

That’s that Income Related Monthly Adjustment Amount, right? Comes out, that’s what IRMAA stands for, and that’s what you were saying Christian, when you turn 65 you have to go under Medicare. There’s a few exceptions, right, let’s just go with the generals. You have to go under Medicare Part A as in Alpha, you probably have to go under Part B as in Bravo. Our B’s what we like to call that quasi optional, you don’t have to take it, but you have to take it, and now it’s an extra 175 bucks a month, something of that nature, as long as your income is below a certain threshold, but if your income is above that, what happens, Christian?

Christian Sakamoto  14:15

You pay more, and not only you, but also you and your spouse that they’re on it as well, so that’s just something to be mindful of, and this is especially a sensitive area when we’re thinking about doing those Roth conversions as well is having that discussion that maybe we bite the bullet and do the Roth conversion now temporarily increasing that premium we’re paying for our Medicare, Part B, the IRMAA, because we know that’s going to be just a couple of years, or however many years worth of extra payments for our Medicare, but then in the future, having more money in Roth, that makes a lot of sense, so again, to your point, if our our income in retirement is lower, sure our Medicare is going to be lower, but then again, in the future, if we delayed our Social Security and we turned our Social Security on at 70, and then we’ve waited to take out money from the pre tax retirement accounts, we’re now taking RMDs. Future, you could be in a higher Medicare bracket anyway, because of IRMAA, so it’s one of those things that we have to play with and understand at least how they work, and know about IRMAA, so at least it doesn’t catch you by surprise. 

Micah Shilanski  15:25

And IRMAA is one of those really challenging things that comes up, right? Because it looks at your income as of two years ago, yeah, so you might turn 65 but, like, sweet on underneath the threshold, but they’re actually going back to when you were 63 taking a peek at your income, and it’s super easy to be above that, especially the year of retirement. Now, there’s a few exceptions we can apply and appeal to get it reduced, but you really need to be proactive, clients get get pretty frustrated, understandably, so when all of a sudden their health insurance premium, which that’s Medicare Part B, right, goes up because they made, quote “too much money”. 

Christian Sakamoto  15:58

Agreed, agreed, yeah, we have the next tax trap on here as charitable contributions, so,you know, living, making charitable contributions at living versus at death, so walk us through how that tax trap, what are some concerns to be thinking about there? 

Micah Shilanski  16:15

Yeah, well, charitable contributions, right? I’m a big fan if you have a little extra dollar, let’s make the world a better place, right? So I think it’s really important to give back to it, but how do we do it, we’re reducing our tax bill at the same time. Now, one of the things currently under the TCJA, Tax Cuts And Job Acts, the current tax law we’re under right now, is that we have these high standard deductions. Now, before previous, right? It was like 10 grand. I remember what it was 10, 12 thousand bucks was your standard deduction, it was easy to be above that between your state income tax, your property tax, mortgage interest and charitable contributions, right? So you’re able to write those off, but now the standard deduction is so high, the vast majority of people don’t itemize, they just take a standard deduction so we can give money to charity, which is still a great thing, not getting that immediate tax deduction for it, so there’s a couple things that I like to think about while we’re giving, while we’re living. Number one, if you’re 70 and a half or older, not 73, 70 and a half or older than these cool things called QCDs, Qualified Charitable Distributions, it’s a really cool way to take money from an IRA, send it directly to a charity, and it’s 100% tax. It shows up as a distribution on your tax return, but non taxable, so Christian essentially, it’s just like getting a deduction for that money, because you don’t have to pay taxes on it, right? 

Christian Sakamoto  17:31

Exactly, and that makes it really nice, we just have to understand the nuances to say, okay, it has to go directly from the IRA to the charity the 501 c3, it can’t go to your pocket first, then to the charity, so understanding the rules, understanding it starts at 70 and a half, but it could be a really, really good tool for giving money away and getting a tax benefit for it.

Micah Shilanski  17:55

You know, Christian this is a good time to throw a disclosure in here, again I was at that tax conference last week I was speaking at and somebody came up, and they’re like, hey, Micah, I saw this on A, B and C, I saw this idea, and I’m going to go ahead and I’m executing, and I said, well, hold on hit a pause button real quick, where did you see that idea, and it was kind of stummering and stammering and whatnot in the stores, it came out of Tiktok, they saw a Tiktok tax idea, and they executed on it. Now the problem is, the concept of the idea might be better, but in that 32nd video, they failed to explain all of the rules associated with it, and this person did not qualify for that great deduction that they were trying to do. Now, good news is we saw this in the same tax year, we’re able to work with the advisor, he’s fixing it kind of going forward, which is really good, but a really challenging thing is you can listen to this podcast and say, hey, I want to do this, you know, Qualified Charitable Donation this QCD, right? Okay, Christian and Micah said, just go ahead and do it, and you execute it with the wrong details and it doesn’t count, so these are great, I think they’re great ideas we’re talking about, but before you pull the trigger on any of them, make sure you really know how it works, or at least work with somebody who knows the details of these so you get the full benefit of it, Christian, is that fair?

Christian Sakamoto  19:04

Oh, 100%, yeah good disclaimer there. Similarly, with QCDa, I would say would be the donor advised funds, right? Very, very nuanced details, but why don’t you explain how the donor advised fund works as far as giving for charitable contributions? 

Micah Shilanski  19:20

Boy I love, the donor advised fund, I am too young for the QCDs right? So I’m not eligible in order to do those, so I can talk in theory about those, I can talk how I use it with my clients, but I have first hand I’m not doing them. The donor advised fund doesn’t have any age restrictions, this is something that I use, and so what this is Christian is I can take some of my after tax investments, right? Let’s say I’ve been I’ve been lucky. I’ve been good, the market has appreciated, boy since the last 14 years, the market’s gone up, right? We haven’t seen a bear market since, you know, 2012 really, so we’ve seen a huge increase in the stock market in this time, and let’s say I was going to do a charitable donation, I will have a choice, I have this appreciated stock, I have this appreciated account, you know, or part of an account, and instead of me giving cash to a charity, which I get a tax deduction for, that’s one option, instead of doing that, I’m going to take some of my appreciated stock and I’m going to put it in this donor advised fund. Now you Schwab, there’s a bunch of different ones out there, I’m going to put it in the Schwab donor advised fund so it comes out of my account, let’s say I’m going to make a $20,000 contribution, I’m going to take this 20 grand, I’m going to move that $20,000 stock into this donor advised fund, then I’m going to tell the donor advised fund send it to this charity, then the donor advised fund sells that stock, I pay no capital gains tax because it wasn’t mine, right when I put it in, then the 20 grand goes to the charity, I get the $20,000 tax deduction. I did zero in capital gains right on that because the donor advised fund sold it and I didn’t, and let’s just say I had the $20,000 in cash I was going to give, I’m going to put that back into my investment portfolio and rebuy the stock today. What did I just do? I just increased my basis in the stock and got that $20,000 tax deduction that I wanted to, so if we’re charitable minded, of slightly larger dollars, these donor advice funds are a really cool way to help slowly increase our basis while giving to charity.

Christian Sakamoto  21:08

Oh yeah, absolutely, and again, we get excited about talking about the tax planning, but this is great, and it’s not right for everybody, because this isn’t something we can do in the TSP, right? We’d have to have it outside of a retirement account. It’s got to be in a, you know, just normal brokerage type account, that’s non retirement account, but to be able to do what you just said, to have this stock, let’s say you bought Apple, Microsoft, whatever the stock was been years ago, it’s grown in value, to be able to gift that to charity, not pay the taxes, get the deduction for it, and, you know, have to make the world a better place, at the same time, it’s a pretty good, pretty good win there, I would say, so what about death for charitable contributions?

Micah Shilanski  21:52

Yes, again, this is my conversation, Christian, you and I do a lot of in depth estate planning, working with clients, the attorneys, etc, setting up, and one of the questions I like to ask is, you know, Mr. And Mrs. Client, if you were to pass away and every penny went to who you wanted it to go to your kids, whomever, but there was $1 left over, would you like to use that to make the world a better place, it is essentially, what I’m asking is, do you want to give to charity when we pass away? Sometimes the answer is yes, sometimes the answer is no, guess what, it’s your money, it’s your call, but when that answer is yes, they now need to have a conversation about what’s the best way to give it to charity, and this is going to seem like a minor detail, but it’s pretty important. Let’s say we had either a life insurance policy or we had a bank account or an investment account, and let’s just say for discussion was $500,000 of value, and we had an IRA that was also $500,000 of value, right? So you have a million dollars between both of these accounts, and now we look at it and say, oh, well, you know, I’m gonna give Johnny my IRA account, you know, my son, for that 500,000 bucks, and I’m gonna give, you know, this life insurance or this investment account, this brokerage account, whatever it is, I’m gonna give that $500,000 to charity when I passed away, and what I did, bada boom, bada bing, both get $500,000 everything is fine. Well, that’s one idea, but just Johnny really get $500,000? No, because Johnny has got to pay taxes on that 500 grand, right? It’s now an inherited IRA, gotta take the money out over 10 years, once our RMD start, they can never stop all over again, right? All this is taxable income, up to 40% may go to an IRS, maybe that’s not what we want, so Christian, a lot of times, is knowing how to put the correct beneficiary, so the same example, I would just swap them, I’d have that $500,000 IRA go to a charity, why? Because when a charity gets money, it’s 100% tax free, we can sell from the IRA, we can send them a check, zero tax dollars are paid, then I take the 500,000 Life Insurance bank account, whatever it is, and I would name Johnny as the beneficiary of that. Now, when Johnny gets that money, there’s 100% adjustment basis upon death, now Johnny gets that $500,000 tax free. Now you really gave a million dollars away, tax free between kids and charity. This is by good tax planning, it’s not 50-50 amounts are too big, right? That to suit you, that’s not what I’m solving for here. It’s about being intentional with your money, making sure it goes where you want it to go.

Christian Sakamoto  24:15

I think that’s excellent, and I love that example, because we’re talking about taxes, but it’s interwoven in your legacy planning, in your estate planning, and how so many of these areas in financial planning all are interconnected, it’s really good that we’re again talking about taxes and then at the same time talking about beneficiary designations for estate planning, it’s, it’s a they’re all connected.

Micah Shilanski  24:39

Well Christian and you know this, that’s why, when we work with clients, right? We say we work with everything, or we work with nothing, for that exact reason, everything’s intertwined, everything’s connected, when I pull on one thread, all these other threads start to move, you got to make sure it’s set up correctly. Well, Christian, I think the last thing right, that really catches a lot of clients by surprise, our last tax track, again, this isn’t gonna apply to everyone, but who it applies to, it makes a massive difference, and this comes in when people have rental properties, or any type of real estate besides their primary residence, and they go to sell it, and a dirty little thing happens when you go to sell it is you talk to a real estate agent, they’re like, oh, this is great, you talk to idle, they’re like, hey, they’re gonna give you a cash to close document, and they’re gonna say how much your net proceeds are gonna be. You bought this property for 500 grand years and years, 10 years ago, and now it’s worth 800,000 bucks, and you’re like, sweet, I’m getting 800 grand, but you’re like, oh, I gotta pay the real estate agent, I gotta pay off my mortgage, which is now 300,000, all right, well, great I’m gonna get 450 grand at the end of the day, and you start spending, mentally this $450,000 of money that you’re going to get, but Christian, I forgot about an important relative, that’s part of this transaction that we have to bring up, didn’t I?

Christian Sakamoto  25:50

Yeah, the T word, our favorite tax word there.

Micah Shilanski  25:54

That’s right, an IRS, right? The IRS is going to be part of this, yes, so we got to pay taxes on this transaction, and sometimes Christian what happens is, clients are like, oh, well, I bought it for 500 grand. It’s now worth 800 grand, that’s 300,000 I gained, I just have to pay taxes on this 300,000 but as you know, that’s not the case with rental property. We get this nasty little thing called depreciation, which you have to take and it’s basically a loan from the IRS, and the loan is due when you sell your property, and so what happens is we start depreciating this rental property over years, we sell it with this nasty thing called recapture, we gotta recapture all of that depreciation the IRS gave us and pay taxes on it on one year, and it’s taxed at up to 20 your rate, or up to 25% whichever is going to be less, so this is a big dollar amount, which happens when we sell our rental property, and what I find with clients is, instead of paying $30,000 in taxes, when they did their own math, they’re paying closer to $100,000 of taxes, right? And they don’t have this 450,000 anymore, they have 350,000 and that’s quite a sticker shock.

Christian Sakamoto  27:04

Absolutely, the depreciation recapture is huge, and something that you really just have to be mindful of, as if that applies to you if you’re planning to sell rental property. Now, Micah, I’ll ask you this question maybe a curveball, but if you have rental property, and let’s say you were making some improvements to it, some capital improvements, how does that fit into the mix and you did you did good accounting over the years, and you know you you weren’t just paying the house, but you’re actually putting on a new deck, or you were doing those things to the house, remodeling it, how does capital improvements affect taxes on a rental property?

Micah Shilanski  27:41

I’m going to completely oversimplify this, right for the sake of time, but there’s two types of expenses with rental properties. There’s maintenance and improvements, right? Maintenance, or, hey, I got to fix things that are happening right now, and we get a full deduction on those maintenance, the water pipe broke, the toilet broke, right? Something of that nature, and I have to fix it, that’s a maintenance thing, and you generally are able to write all of that off in one year. An improvement has a life expectancy with it, so let’s take a deck, forgive me, I don’t know what a decks life is, I’m just going to say it’s seven years, that’s a good average, right? So the IRS is going to say the deck is, it has to be amortized over seven years, that means depreciated over seven years, so I spent 20 grand on this deck, I got to write it off over the next seven years, and when you do that, there’s still a recapture element that comes to play. It’s slightly different with other assets versus with the real property of real estate, but the concepts the same Christian, there’s still this recapture tax that has to get paid.

Micah Shilanski  27:42

Even on those improvements, right?

Micah Shilanski  27:44

Got to be careful on those right? Now, there’s some fun tax schemes we can play in order to reduce that, and how we structure and how we do it, you know, one of the things that sometimes happen in other clients, replace the deck I’m like, that’s a deck replacement, was that maintenance or an improvement? I expanded the deck, awesome, then replacing the existing deck was maintenance, anything beyond that is that an improvement, right? Can we play this little tax game a little bit you got to get your CPA involved, but there’s things to think about when we’re going down that path.

Christian Sakamoto  29:07

Yeah, yeah, all good stuff there.

Micah Shilanski  29:09

All right, well, I know we talked about a lot of things, again, real high level, these top five tax traps, are you probably in a higher bracket retirement if you don’t do something about it. Now, how much income do you have is taxable, especially those RMBs, watch out for IRMAA, she’s out there to get a little extra money, right? That’s that Medicare premium age 65 you have charitable contributions while you’re living and when you passed, and then number five is selling rental property, what is your net proceeds at the end of the day. Guys, I know we talked a lot about this in concept, be really careful, there’s a lot of laws in here, you’re savvy listeners, you can figure it out, but this is where second opinion is always great. If it’s not Christian, I go hire somebody else, have someone else review what you’re doing to make sure you’re making the best decisions. Now, Christian, this podcast is all about action items, right? So number one, like share, our goal is to help another million federal employees with their retirement, we can always do that with your help, so please send this information out. Christian what else, what’s another action item our listeners this week?

Christian Sakamoto  30:06

I would say run a tax projection, it sounds harder than it might be. This could be simple, this could be, what is my salary, what is my wages this year going to be, what do we think it’s going to be next year? And it could just be as simple as that. If it’s more complex, maybe we want to involve an advisor or some tax professional there, but you, if you don’t have a tax projection, then all of this is just fun to talk about. It doesn’t actually get us to make actionable changes with our tax point, we got to start there, we got to have a tax projection put in place.

Micah Shilanski  30:40

Great point. Number two, what’s your plan to reduce your taxes over time, so this is going to piggyback. Step one is the tax projection, but step two, we got to take action on that information. So what if you did other things? You gave more charitable you did Roth conversions, you delayed Social Security, you accelerated Social Security, right? How do all those things affect your taxes over the next 10 years, and how do you lower your 10 year tax bill? Where CPAs and they can get mad at me all they like when I make this comment where CPAs do a little bit of a bad job or room for improvement, in my opinion, is they’re so focused on reducing your tax bill today, we missed the tax bill for the next 10 years. You got to do both, we got to look at reducing tax bill today, but more importantly, reducing it over the next 10 years. 

Christian Sakamoto  31:21

Great! Last one. Think about Gross versus Net, really, we want to be thinking about Net, especially with that rental property example, how you talked about depreciationrecapture versus just the capital gains there on the sale, but this could be true just with your first pension, right? It’s fun to talk about what’s that gross number, but we have to think about all the other deductions, especially taxes, and not to mention if you live in a state that has state taxes as well, we gotta be thinking about that, and especially when you go into retirement, OPM is not gonna withhold for state taxe, you’re gonna have to elect for that as well, so just know that we’ll throw that in there. So always think about the Net after taxes, with all of the income sources that you’ll have.

Micah Shilanski  32:03

I love it Christian thank you so much for joining us on this podcast. Our goal is to make a difference in the lives of federal employees, and I appreciate your help doing that, and until next time, Happy Planning!

Christian Sakamoto  32:12

Happy Planning!