This morning I was reviewing my year-to-date expenses. Yup, you’re jealous right – we retirees have all the fun. Don’t feel bad. I have a big BBQ lunch coming up later.
Anyway, once again, I was surprised at our expenses. Everyone said they’d go down once we retired, but they’re up. What gives??
Taxes
I did some digging and the big unexpected (at least different from pre-retirement) item is taxes. Before we dig in, let’s take a brief detour.
Account Aggregators
I have 3 credit cards that I use regularly. I pay bills from my brokerage cash account and I transfer money in (since I’m not working) from my brokerage investment account.
So that’s 5 accounts that make up my day to day spending.
If I want to look at my spending in total, I need to log in to the site for each account, download transactions to a spreadsheet, get all of the sheets in a standard format, and then combine them.
Not a huge task, but a bit of a pain. Plus it could be error prone with all the manual work.
Instead, I use my brokerage firm’s account aggregator. I go to a page where it asks me what credit card or bank accounts I have, It brings me to a page where I log in to the other financial institution, and Bob’s your uncle. From there on out, I can see all my transactions together. I can create a budget with notifications, I can see all my transactions in one place or I can download to a spreadsheet for analysis.
My aggregator is pretty good at guessing that the transaction from National Grid is categorized as Utilities, but sometimes it makes a mistake and I need to adjust. I go in every couple of weeks to review transactions to make sure they are all legit and to adjust any mis-categorized.
As an added bonus, this makes monitoring so much easier. I go to one site to see all transactions. I don’t need to log in to all 3 credit card sites on a regular basis to monitor.
My brokerage offers this (and when I was working, I helped build the site so I am pretty comfortable with the security) but there is some risk to using an aggregator. Let’s say you decide to use Credit Karma or another site. Once you link your accounts, they have access to all of your transactions.
Security has improved. In the old days, the aggregator stored your external site user ids and passwords. Now, they typically present you with a page to log in to your financial institution and they don’t save the id and password. But it’s a good idea to check how the aggregator handles this.
Back to Taxes
When my wife and I were working, we got bi-weekly paychecks. Our employers were nice enough to withhold Federal, State, Social Security taxes, as well as our 401k contributions. The rest was direct deposited into our account for easy spending.
I only thought about taxes once a year, when I usually discovered that I hadn’t withheld enough and I wrote a huge check. I then wiped this from my memory until next April.
No More Withholding
I am in that grey area – I’m no longer getting a paycheck but social security hasn’t started yet (but it will next month!!!)
While looking into a Roth conversion a while back, I was surprised to find out that the US has a pay-as-you-go tax system. We are required to pay (roughly 90% of our tax due) throughout the year as we earn income.
Not a problem if our employer withholds, big problem if not.
Income
While I don’t get a paycheck, I have interest and capital gains, and I have distributions from tax deferred retirement accounts.
I’ve moved into bond funds and dividend-paying stocks to fund my retirement. That’s awesome, but I owe tax on any of these interest or dividend payments that are outside of my retirement accounts.
I also take retirement account distributions from my 401k and traditional IRA. These are both tax-deferred accounts. That means I paid no tax on the earnings while the accounts grew and Uncle Sam patiently waited.
Now that I’m taking the money out, Uncle Sam is finally getting his due. I must pay ordinary income taxes on every penny I withdraw. That’s what tax deferred means.
Roth & HSA
As a side note, I have loaded up my Roth and HSA accounts because these are largely tax-free growth accounts.
On a Roth IRA or Roth 401k contributions, there is no tax benefit when the money goes in, but all distributions – both principal and income, are tax-free.
On an HSA, it’s an even better deal. The money gets a tax benefit going in, and as long as we use it for qualified medical expenses, it is not taxed going out. I made the huge mistake of paying current medical expenses with my HSA. I figured out at some point that it was much more beneficial to invest my HSA funds in a nice low-cost S&P 500 fund and let it grow tax-free.
I’ll have lots of medical expenses in retirement so I’m sure I’ll be able to use this. And if I don’t use it for qualified medical expenses, I just pay the taxes on the withdrawals, I never lose the money like I would in a Flexible Spending Account (FSA).
Estimated Taxes
I never really understood estimated taxes and I paid some penalties because of this.
I now calculate my full year tax burden in January and make quarterly estimated tax payments to both the federal government and the State of Massachusetts.
I’m also doing some Roth conversions, so my estimated tax payments are my largest spending category so far this year.
Wrap-Up
This continues to be a big shocker for me. After 35 years of never having to worry about estimated payments because my employer kindly handled this for me, I now need to do this myself.
I need to figure out the amount, and I need to make the payments quarterly.
So in my retirement spending plan, I need to account for cell phone, electric, heat, travel, golf, dining, and all my other normal expenses, but I also need to budget for quarterly tax payments.
And because I’m doing Roth conversions (I am taking traditional IRA money out, paying taxes today, and moving it to a Roth, where it will grow tax free) my tax burden is heavier than normal.
This is a big expense that I totally missed in my planning.
And while this improves once Social Security payments begin, and I can withhold, I will always need to calculate and pay estimated tax for any traditional IRA or 401k distributions.
Many record-keepers/brokerages will allow us the ability to withhold once we begin Minimum Required Distributions (MRDs) but we need to be sure we plan.