Q: We haven’t seen much information on folks in our position. Here is our situation: My wife is 65, I am 67. We have been retired for five years. Our yearly income is around $120,000. Together, we have close to $1 million in two 457 accounts [government version of 401(k)], one IRA and my self-directed portion of a state pension. Currently we are not taking any money out of those accounts. I know that at age 70 1/2 we will be required to start taking distributions from the accounts.
Will it be better to wait until we have to start distributions, or start now? Is there a magic income number that we should avoid due to income tax, or are the taxes just a gradual progression?
A: You’ll need to visit with your tax accountant to get a fix on this because it should be tailored to your situation. But let me point out the major milestones in your tax future. First, the 15 percent tax bracket now ends at $72,500 for those filing a joint return. Every dollar of taxable income over $72,500 is taxed at 25 percent until you reach $146,400. That’s when the marginal tax rate rises to 28 percent. Make allowance for your deductions and exemptions, and you’ve got some run room before hitting the 28 percent racket.
Meanwhile, you are solidly in the 25 percent tax bracket today. Required minimum distributions in the future will move you toward the 28 percent tax bracket. You can create some future financial flexibility by making withdrawals from your qualified accounts up to the edge of the 28 percent tax bracket. You can do a Roth conversion with the withdrawals until you reach the age for required minimum distributions. This will help you create a pool of money that will grow tax-deferred. Later, making a withdrawal won’t cause a “taxable event” because withdrawals from Roth IRAs are tax-free.
The other milestone you want to watch for is the threshold rate for having to pay a surcharge on your Medicare insurance. This year the basic monthly premium for Medicare Part B for most people is $104.90. The Part B premium will rise to $146.90 for joint filers with taxable incomes of $170,000 ($85,000 for single taxpayers), and there will be a Medicare Part D surcharge of an additional $11.60 a month. Required minimum distributions may drive your taxable income into this range, so some amount of Roth conversion will serve to reduce the odds that this will happen.
This is what some would call a “Cadillac problem,” a dilemma few people will get to experience. It is, however, further evidence of the rising de facto means-testing of Social Security and Medicare that I discussed in a recent column.
Q: I am 66 years old and retired. I have owned one rental property for the past 25 years. I am earning about 5 percent on this property (after taxes, insurance, upkeep, etc.). Because I don’t really want to own any more rentals, can you tell me what options I have to capture a 5 percent yield? Are there any REITs or ETFs that can give me anything close to this kind of return?
D.G., San Antonio
A: There are REITs that can provide a yield of 5 percent or more, but you will find that most are doing this by paying out more than they are generating from FFO (funds from operations). So their 5 percent yield may not be the same (or as secure) as your 5 percent yield. More important, it may not be as sustainable.
Most yields are lower. The yield on the iShares FTSE NAREIT Residential Index REIT (ticker: REZ), for instance, is just more than 3 percent. The yield on the Vanguard REIT Index Fund (ticker: VNQ), is about 3.4 percent. So looking for 5 percent is reaching and may be quite risky.
My suggestion: Either lower your yield requirement or consider another high-yield venue such as a pipeline master limited partnership, known as an MLP. Kinder Morgan Energy Partners (ticker: KMP), a leader in the field, currently yields a bit under 6 percent. There are many others as well. (Caveat: These are complicated investments and will deliver tax benefits at the expense of making your tax return much longer.)
SCOTT BURNS is a principal of the Plano-based investment firm AssetBuilder Inc.
— Universal Press Syndicate
ON THE WEB
Scott Burns, “Means-Testing Social Security”: http://assetbuilder.com/scott_burns/means_testing_social_security