By Tami Noll Russo, CPA, CFP, CLU | Noll Financial Services

Is income-tax-free retirement possible for you? It very well may be, and you should closely review your finances to find out!

First of all, calculating income that is taxable during retirement is different than calculating income tax on wages and salary. The percentage of Social Security benefits that are subject to federal income tax ranges from 0 percent to 85 percent. The mind-set for achieving a 0 percent rate is not the typical income bracket framework most of us have grown accustomed to during our working lives.

There are many variables that go into the taxability calculation, and I’d like to share some real-world situations to demonstrate that how you are taxed is less dependent on your total retirement income than on the makeup of your retirement income. The goal is to figure out a way to get as close to the 0 percent rate for Social Security, and that’s not an easy task.

While meeting with a couple who had been long-time clients to calculate their retirement cash flow needs, I couldn’t help myself but play with their numbers. It was just a sense I had. The wife had just retired from a long career at age 69 to discover she had breast cancer. Her health and life expectancy would play a role in their retirement plan, but many hard-working people – even those with advanced degrees – don’t know to ask about how much “other income” they can take before too much of their Social Security becomes taxable. It is the CPA’s job, as trusted professionals, to point out to them the planning opportunities.

In this instance, as a married couple both over age 65, they could have $23,300 of tax-free taxable income before going into the 10 percent bracket because of the following factors:

This is where it gets complicated. It’s not important to know the actual calculations because online calculators are helpful in telling us the expected outcome of our “what if” scenarios. We know that $23,300 is tax free, and of that they used up $17,650 with IRA withdrawals. This leaves a $5,650 cushion in what I call the 0 percent taxable income bracket. So, we can push up to $5,650, or 11 percent, of Social Security into the taxable income column at the 0 percent tax rate. Once we ran the numbers through the Social Security calculation with this adjustment, the results came in: my client will pay $0 in federal income tax!

The clients were presented with the following question: Can you comfortably live on $5,725 per month ($68,698 /12 months)? If not, how much would they need? As a CPA reviewing the numbers and knowledgeable of their assets, I could work out an option to do this on an every-other-year basis. Or they could liquidate more assets this year to set up a greater tax reduction next year.

You have to be careful when making these decisions. Keep in mind that if their IRA withdrawals increase by $12,000 to $29,650, the effective tax rate on that $12,000 additional IRA withdrawal is 19.6 percent ($2,360 tax due / $12,000). The reason the tax effect was so high is that the additional $12,000 of “other income” pushed more Social Security into the taxable column.

To further illustrate the complexity of retirement tax planning, let’s change the type of income received. If one has a civil service pension of $60,000 and only gets $8,698 of Social Security benefits, the total income is the same, but in this situation 85 percent of the Social Security is taxable. Taxable income would then equal $67,393, with $23,300 taxed at 0 percent, $18,650 taxed at 10 percent, and $25,443 taxed at 15 percent. The total tax bill would be $5,681, bringing monthly income down to $5,251/month.

As another example, consider a high-wage-earning couple who waited to collect Social Security until age 70 and collected the maximum monthly benefit for 2017 of $3,538 each. Total income in this case would be $84,912. The Social Security taxable calculation results in only $784 of taxable income, a zero tax bracket. If we added $10,000 of other income, that would push 16 percent, or $13,188 of Social Security, into the taxable column, and they would be closing in on the $23,300 income-tax-free amount, but our couple is still achieving the income-tax-free retirement goal.

Everybody’s financial history may be different. It’s pointless to do any retirement planning without a detailed discussion of expected longevity along with your financial health. For some, however, spending down other assets and letting their Social Security grow may help reduce taxes in the future and provide the possibility of a tax-free retirement.

Tami Noll Russo, CPA, CFP, CLU is a consultant at Noll Financial Services in Middletown, Pa. A PICPA member, she serves on its CPA Image Enhancement Committee, is co-chair of the South Central Chapter’s Personal Financial Planning Committee, and is a Trustee of the Scholarship Fund. She is a past president of PICPA’s South Central Chapter.