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Colorado State Tax Exemptions For Retirees

Erik Bowman • Apr 27, 2020

Erik: 00:00

You’re listening to Uncommon Cents, a podcast by Bowman Financial Strategies. I’m your host, Erik Bowman and thank you for joining me today. Hi everyone. This is Erik Bowman, your host for Uncommon Cents and today we’re going to be talking about the Colorado retirement income tax exemptions. Before I get into the details of these specific exemptions that can help lower your Colorado state taxes, it is important to note that before you make any assumptions or attempt to take any of these exemptions, I highly recommend that you get with an accountant to understand how these are going to actually impact your taxes and to ensure that you’re following current state law. The primary topics we’re going to cover today are what is the exemption and what type of income qualifies for the exemption, who does it apply to, and what are some of the planning opportunities that may make sense for you if you’re in retirement and currently taking some type of retirement income?


Erik: 01:07

First, if you meet certain qualifications, you may be able to deduct or subtract some or all of your qualified retirement income on your Colorado individual income tax return. For these purposes, Colorado determines retirement income and defines it as annuity or pension income, IRA distributions, portions of your social security income as well as Roth conversions. All of these potentially apply for this exemption. In addition, if you derive retirement income from the Colorado public employee retirement association, commonly known as Colorado Para, or if you receive a pension from the Denver public school retirement system, you may be able to claim those as well. So first things first, who can actually claim this exemption? Well, you may be able to claim the exemption if you received qualifying retirement income and you meet the following criteria. First, you have to have been at least 55 years old or older at the end of the tax year that you’re wishing to claim the exemption. Erik: 02:17 Or, you should have received the qualifying pension or annuity income as a beneficiary because of the death of a person who earned the pension or annuity. One of those two are the minimum requirements. Let’s talk a little bit more about the type of income that is potentially exempt. As I mentioned, annuity income can be exempt. A Colorado Pera pension may be exempt as well, and so our distributions from your traditional Ira and what we’re talking about here are the taxable distributions from a traditional Ira, not the distributions from a Roth Ira or a non-qualified account. In addition, portions, social security income may be exempt. We do need to remember though that all of your social security income is not necessarily taxable at the federal level, and in order to qualify for the state exemption, the social security income must be taxable at the federal level, so that’s going to require a little bit of accounting help to make sure that you’re accurate in that respect. Roth conversion income is exempt as a part of this rule as well. That’s very important because as a financial strategy, Roth conversions may be a very valuable tool to save income taxes over the life time of retirement.


Erik: 03:41

The second topic I’d like to discuss is how much is potentially exempt? Well, if you’re at least 55 years old but less than 65 years old at the individual level, you may be able to have a maximum allowable subtraction or deduction of $20,000 once you are at least 65 years old, that maximum allowable exemption increases to $24,000. That means that for a married couple filing jointly, you actually have a total potential household state exemption of 24,000 each, which is 48,000 total at the household level. If you’re both over 65 years old, however, you can’t share that exemption, meaning if one person took $48,000 of income from a traditional IRA and the other spouse did not take any retirement income, the spouse that took the $48,000 traditional IRA distribution is capped at the $24,000 maximum allowable subtraction. There are certain exemptions for tax-payers that are under 55 years old where you may have a maximum allowable subtraction of up to $20,000 for example.


Erik: 04:59

You may be able to claim the subtraction for pension or annuity income received due to the death of a person who earned the income even if you’re younger than 55 next, I’d like to touch on some of the planning strategies that you may be able to consider as part of your overall income and tax planning as a retiree. So let’s take an example. This may be the easiest way to explain it. Let’s assume that we have a married couple. Both are age 63, at age 63 if you recall, you have up to a $20,000 exemption because they’re not 65 yet, and let’s assume they both have traditional IRAs of $500,000 each. Just as a reminder, a traditional IRAs is an IRA where you made contributions pretax, you did not pay income tax on the year of contribution. Those dollars grew tax deferred and now upon distribution in the tax year of distribution, you’re going to pay income tax on those distributions.


Erik: 06:03

Well under that scenario, each of the spouses is eligible for a $20,000 state exemption because they are older than 55 but younger than 65 one of the planning strategies would be to consider how much money you’re going to actually take at the household level in distributions to meet your expense needs and then potentially split those distributions between the two traditional IRAs, the husband and wife, so that you can maximize the household deduction. As a more specific example, if they needed to take $48,000 of distributions from traditional IRAs at the household level, you might consider splitting those distributions between the two IRAs so that each person could get a $20,000 exemption. By comparison. If, let’s say we have one of the spouses take all $48,000 from their personal traditional IRA, they are only, you are only going to get a total of a $20,000 exemption in this case as opposed to the household $40,000 exemption.


Erik: 07:06 If they both leverage their $20,000 individual exemption at the state level, that is a potential state tax savings of over $900 and that is because at the individual level, even though they’re married, the maximum allowable potential exemption is $20,000 per person and there is no sharing of that exemption even between a husband and a wife. So once again in review, a potential planning strategy is to maximize the state exemption by looking at the distributions required to meet your income need in retirement and split those distributions between two traditional IRAs, one owned by one spouse and one by another so that each can maximize that state exemption.


Erik: 07:59

Another potential strategy revolves around Roth conversions. Let’s imagine the same couple husband and wife are both age 63 years old, but they don’t need to make any traditional IRA distributions to meet their expense needs. What they can do, if it makes sense for their long term retirement plan, is to perform Roth conversions. This means moving the assets from a traditional IRA to a Roth IRA and pay the taxes on that movement of money or distribution in the year of conversion. The Roth conversions are typically going to be taxable at the federal level as well as at the state level. However, Roth conversions do qualify for the state level exemption, so in any given year, if you actually do Roth conversions and you’re over 55 you can take up to a $20,000 state exemption per person at the state level for that Roth conversion. That type of strategy and managing your marginal tax rates and exemptions can be very beneficial in the long run for your income plan and something that you should be reviewing with your adviser.


Erik: 09:10

One very important consideration when looking at any of these plans is that this exemption does not count at the federal level. Federal exemptions are totally separate and calculated separately. You need to ensure that you’re working with an accountant that has a full understanding of the state tax laws and also understands how specific retirement income exemptions may fit into your tax filing. If you ever have any questions about the financial situations involving Roth conversions, the state exemptions of retirement income, or just want to review your current financial situation, by all means, you can reach out to us at Bowman Financial Strategies at 303-222-8034. You can also feel free to send me an email at erik@bowmanfinancialstrategies.com and that’s Erik, spelled E. R. I. K. We look forward to hearing from you soon and please share this with people that you know, if you think that it would be beneficial to them. If you’re an existing client, you can always call my cell phone or reach out to the office to schedule or call for a face to face meeting. Thanks for joining me today to discuss the Colorado state retirement income tax exemption. Let me know if you have any topics that you would like to see discussed here at uncommon sense. We do want to provide you with information that you find helpful. Thanks again and have a great day.


Erik: 10:29

Thank you for joining me for Uncommon Cents, the Bowman Financial Strategies financial education series. I’d love to hear your feedback on financial topics you would like to learn more about. Just drop me an email at erik@bowmanfinancialstrategies.com or go to the Bowman Financial Strategies website and send me a note on our contact page. In addition, you can always search for topics of interest in my archive on our podcast page at www.bowmanfinancialstrategies.com/podcasts Have a great day. Speaker 3: 11:11

This communication does not constitute federal tax advice and may not be used as such. Please consult a qualified tax professional for tax advice or assistance. In addition, investment advisory services offered by Change Path, LLC, a registered investment adviser. Change Path and Bowman Financial Strategies are unaffiliated entities. [Informational sources from https://www.colorado.gov/pacific/sites/default/files/Income25.pdf. Not affiliated with any government entity. This podcast is for informational purposes only.]

Required Minimum Distribution

By Erik Bowman • 27 Apr, 2020
You’re listening to uncommon sense, a podcast by Bowman Financial Strategies. I’m your host, Erik Bowman, and thank you for joining me today. Hi everyone and thank you for joining me today. This is Erik Bowman, owner of Bowman Financial Strategies. Our topic today is required minimum distributions or more commonly known as RMDs. Erik: (00:32) To some of you, it may come as a shock that you cannot keep your retirement funds in your retirement account indefinitely. Generally speaking, you really must start taking withdrawals from your IRA, your simple IRA or your SEP IRA or even your qualified retirement plans such as a 401k or 403B when you reach 70 and a half. Roth IRAs by contrast do not require withdrawals until after the death of the owner. Your required minimum distribution or RMD is the minimum amount of taxable distribution that you must take out of your retirement account each year. Once you reach 70 and a half. Erik: (01:16) The RMD poses all sorts of conundrums for retirees, like how is it calculated? Who calculates it, when is it due? What happens if I don’t take it and what if I don’t want to take it? And the list goes on. Today I’m going to cover the basics of an RMD. Who does it apply to? Calculations and resources to further educate yourself and of course some potential strategies that may alleviate some of the challenges surrounding RMDs, namely taxes. Erik: (01:52) So let’s start from the beginning. When you turn 70 and a half, you are required to take an RMD from your retirement account, an IRA, for example, by April 1st of the following year. For all subsequent years, you must take the distribution by December 31st of that year. For example, if you turn 70 and a half in August of 2020 you must make your distribution by April 1st of 2021. If you choose to do that, you would also have to calculate your 2021 RMD and also take that in 2021. So in actuality, in the first year that you decided to take that RMD, you would actually have to take two distributions. Now you don’t have to delay until April 1st you can take your RMD in the year that you turn 70 and a half. Erik: (02:49) An exception to this rule applies to 401ks, also known as a qualified retirement plan, which is the terminology that’s used to describe an employer sponsored 401k, 403B, 401A, just to name a few. For these accounts, you must take an RMD by April 1st of the year following the year you turn 70 and a half or upon retirement, whichever is later. If you’re still gainfully employed for example, and you have an act of 401k and you’re 72 years old, you don’t have to take an RMD from that qualified plan that you have at that current employer, even though you’re older than 70 and a half. However, once you retire, those RMDs are due by April 1st following the year that you retire. And one really big caveat and a mistake that you do not want to make that is even if you are working and you’re older than 70 and a half, if you have an IRA in addition to your 401k, you still must take your required minimum distribution from that IRA. Don’t make that mistake and I’m going to be talking about the penalties the IRS can impose if you fail to take your RMDs. Erik: (04:07) here are a few other points that may save you some headaches and money in the future. If you have multiple qualified plans or multiple 401k’s, meaning maybe you’ve worked at previous employers and you have simply left your money behind at those various employers 401ks and you have not moved them into IRAs, you must calculate the RMD for each account individually and then take the distribution from each of those respective 401ks by the deadlines. By contrast though, if you have an IRA or multiple IRAs, you can calculate the required minimum distribution for each IRA individually. Add those together and take the total sum of those as a distribution from one of your IRAs. Now, depending on how you’re investing your assets, this may be a beneficial thing to do. It certainly seems a little bit simpler than making a distribution from multiple IRAs. Since 403B’s are considered qualified plans, you might think that the same rule applies. Erik: (05:09) However, it is a little bit different. If you have more than one 403B tax, sheltered annuity account, also known as a TSA, you can total the RMDs from each of those 403Bs and then take them from any one or more of the tax sheltered annuities. So I mentioned penalties a little bit earlier. So let’s gather round and chat about this one. Most people are aware that if you take money out of an IRA before 59 and a half, that you will pay a 10% penalty on that distribution in addition to the taxes. And that’s not fun and should be avoided in most cases. By comparison, if you fail to take your RMD on time, you will pay a whopping 50% penalty to the IRS. Yes, that’s a 5- 0% penalty. So if you were supposed to take $10,000 out and you failed to do that, by the respect of deadline, you would literally owe a $5,000 penalty to the IRS in addition to income tax on the total amount. The IRS wants their taxes and they will get them one way or another. So don’t let this rule catch you by surprise. Erik: (06:27) So let’s talk a little bit about the actual distributions themselves. You actually do have a couple of options. First, if you’ve calculated your RMD for the current year, you can actually opt to take the full calculated amount in one lump sum anytime up until December 31st of that year. The one exception, of course, is your first year of required minimum distributions. You do have until April 1st of the following year, but that is only for year one. Another option is you may also choose to take periodic distributions over the course of the year to meet your obligation. You also want to take into account income, cash flow and expenses to help guide you here. But there could be strategic and tactical reasons why you might want to spread that out on a monthly or quarterly basis over the course of that year as opposed to making one large lump sum distribution. It’s a little synonymous with the concept of dollar cost averaging when you’re buying into stocks and bonds and other investments that you get a better average share price potentially by buying in over time. Same on the way out when you’re making distributions from your IRA. It could be beneficial to take smaller amounts out over a 12 month period and in that case in, if there was a declining market, you may have actually saved yourself some principle over time. Erik: (07:56) Okay, now onto calculations. How do we determine how much you must withdraw each year? No surprise here. It’s not the same every year. It’s kind of complex and it totally depends on your unique situation. The IRS publishes a table called the uniform lifetime table. It’s table three on the IRA RMD distribution worksheet that’s available on our website on this podcast page. For example, your first IRA distribution for the year you turn 70 and a half, requires you to know your exact balance of your IRA or IRAs on December 31st of the prior year. You then take this balance and divided by 27.4. Seems like an odd number but it’s a joint life expectancy number. So by dividing that balance by 27.4 the answer to that equation is the exact amount you must make as required minimum distribution. You need to do this for every single retirement account you have unless one of the exceptions I mentioned or other exceptions that your financial professional mentions may apply to you. Erik: (09:06) In the next year, when you turn 71, you will take the prior year’s 1231 balance and divided by 26.5 and by the time you reach 114 yes, the table actually goes out to 115 and older, you will divide by 2.1. So 2.1 is the divisor for one 14 it drops down to 1.9 when you reach one 15 and stays there if you happen to live longer than that. But what you’ll notice is that each year that goes by, the lower number in this equation gets smaller and smaller, which means the amount of money you have to distribute from your account becomes a larger portion of that account every single year. Erik: (09:53) another exception that we see periodically, it’s not an everyday occurrence, but it could be your situation. So this is an exception to the rules on that table and that is if your spouse is the sole beneficiary of your IRA and he or she is more than 10 years younger than you in this case, the IRA utilizes another table for you to calculate your distribution. The IRS wants more money from you while you are alive so that when your IRA is left to your younger spouse, who by the way can usually take RMDs based on their age and spread that out over a longer period of time. Well, there’s going to be less money in that account to spread over a supposedly longer lifespan of your younger spouse. It’s just another way of the government saying, we would like to ensure that we get these tax dollars sooner than later, but don’t forget that it is a totally different calculation with a different bottom number on that fraction when you’re calculating your RMDs, if your spouse is more than 10 years younger than you. Now there are many, many other rules regarding RMDs. If you’re a 5% owner of a company for example, and you’re still working in that company and you have a 401k, you’re not allowed to continue to delay RMDs, passed 70 and a half. You actually still have to take them per the original rules, but just know that you really should be talking with your financial professional before you solidify any of your RMD calculations or distribution strategy. Erik: (11:30) So relating to strategies, the name of our company after all is Bowman Financial Strategies and we really try to look for opportunities to save our clients money, save them on taxes and just to be efficient when it comes to the distribution of their assets during the retirement stage of their life. So relating to strategies, one of the challenges to a moderately high net worth individual is that you may have a pretty substantial retirement account. When you turn 70 and a half, you’re going to be forced to take a large taxable distribution if that account has grown and you haven’t made any distributions up until then. So for example, if you have a $3 million IRA under current law, your distribution that’s required the year you turn 70 and a half is roughly $109,000. Imagine you began taking your social security benefits at age 64 because you wanted to get it while the getting was good, you are afraid it was going to run out. Erik: (12:26) And that’s a separate topic. So you don’t take any meaningful distributions from your IRA from age 64 to age 70 and a half. Now you find that not only is your social security payment forever reduced because you filed early, but now you’re forced taxation at 70 and a half, maybe significantly higher than it otherwise would’ve been. All this is to say that your social security filing strategy should include understanding how your retirement accounts will be impacted by RMDs and ultimately how much in taxes you may pay by appropriately timing your social security filing, potential Roth conversions and IRA distributions along with distributions from your non-qualified brokerage accounts and other income streams, you may be able to significantly lower your tax burden over the life of retirement. Erik: (13:20) Well, I’m afraid I only scratched the surface on RMDs and all of the moving parts and potential strategies. Suffice to say it is complex penalties can be onerous and there may be strategies available to you that could lower your taxes significantly under the right circumstances. If any of this information is compelling to you and you want to learn more, I would love to hear from you. You can email me at E R I K @bowmanfinancialstrategies.com. That’s E R I K @bowmanfinancialstrategies.com. You can call our office at (303) 222-8034 and just simply schedule an appointment to come on in, have a cup of coffee and allow us to perform some analysis for you. Thanks so much for your time and I hope you have a great day. Thank you for joining me for Uncommon Cents, the Bowman Financial Strategies financial education series. I’d love to hear your feedback on financial topics you would like to learn more about. Just drop me an email at Erik, that’s E R I K @bowmanfinancialstrategies.com or go to the Bowman Financial Strategies website and send me a note on our contact page. In addition, you can always search for topics of interest in my archive on our podcast page at www.bowmanfinancialstrategies.com/podcasts. Have a great day. Disclosure: (14:52) This communication does not constitute federal tax advice and may not be used as such. Please consult a qualified tax professional for tax advice or assistance. In addition, investment advisory services offered by ChangePath LLC, a registered investment advisor, Change Path and Bowman Financial Strategies are unaffiliated entities.

Three Primary Risks in Retirement

By Erik Bowman • 27 Apr, 2020
You’re listening to uncommon sense, a podcast by Bowman financial strategies. I’m your host, Erik Bowman, and thank you for joining me today. Hi everyone. My name is Erik Bowman and I am the owner and founder of Bowman financial strategies. Thanks for taking the time to listen to this podcast. Today, I’m going to be discussing the three primary risks in retirement. Erik: 00:34 At Bowman Financial Strategies, we work every day helping clients who are transitioning from accumulation to distribution to do so wisely and confidently. I’ve seen the success stories, worked with many challenges facing retirees and helped my clients craft income plans they are confident will meet their needs for the entirety of retirement. Importantly, these plans are built to provide stability and to support your standard of living regardless of market conditions. Getting motivated to take the necessary steps to create an effective retirement plan can be challenging. However, not crafting an effective plan can be catastrophic to your retirement. It’s often been said that your retirement outcome is a result of your retirement income and never truer words have been said. You have worked hard, saved during your careers and budgeted wisely, knowing that the day was going to come when you will need to replace your income without working. Now you have an accumulated bucket of money to retire with and the primary goal many times is to maintain your current standard of living you enjoy now plus add in more travel. 00:34 At Bowman Financial Strategies, we work every day helping clients who are transitioning from accumulation to distribution to do so wisely and confidently. I’ve seen the success stories, worked with many challenges facing retirees and helped my clients craft income plans they are confident will meet their needs for the entirety of retirement. Importantly, these plans are built to provide stability and to support your standard of living regardless of market conditions. Getting motivated to take the necessary steps to create an effective retirement plan can be challenging. However, not crafting an effective plan can be catastrophic to your retirement. It’s often been said that your retirement outcome is a result of your retirement income and never truer words have been said. You have worked hard, saved during your careers and budgeted wisely, knowing that the day was going to come when you will need to replace your income without working. Now you have an accumulated bucket of money to retire with and the primary goal many times is to maintain your current standard of living you enjoy now plus add in more travel. Erik: 01:43 Well one method is to invest in the stock market, hope you’re diversified and allocated correctly, and hope to get enough of a return, and hope that the market doesn’t crash and take your retirement with it. At Bowman Financial Strategies, we don’t ever use the word hope in our retirement plans. Our plans are designed to remove anxiety knowing that all three risks in retirement are addressed appropriately. The Bowman Financial Strategies income planning process known as the LiveWell formula focuses on three primary risks in retirement, and every recommendation in our plans directly addresses these primary risks. The risks in order are sequence of return risk, inflation risk, and longevity risk. To further break these down, let’s look at them one at a time. Erik: 02:37 The first risk: sequence of return risk. I also call this early retirement market timing risk. This risk is represented by the risk of significant negative market returns in the early years of retirement. You only have to go back to 2007 through 2009 to witness over a 50% drop in the U.S. Stock market. It’s been over 10 years since that low and the markets have marched steadily upwards since then with very few exceptions. And with markets routinely setting new highs, some would say that the potential for continued growth for the next 10 years is less likely than a significant drop during that same period. If you are just starting retirement and you’re fully exposed to potential market losses like 2009, and many seniors were and are, your future retirement plans may change dramatically requiring an unpleasant adjustment in your standard of living to make ends meet. We seek ways to limit early retirement market timing risk by using fixed or guaranteed rate of return solutions to reduce the exposure to pure stock market. Erik: 03:50 The second primary risk is: inflation risk. And this is really the opposite of the market timing or sequence of return risk because inflation risk is the risk that your assets and income may not get enough of a return and be able to keep up with the ever rising costs of goods and services. If your income never increases or your assets never increase the rate of return, but the cost of a gallon of milk doubles in 10 years, your effective purchasing power has just dropped significantly. Accounting for inflation is critical to a good income plan. By failing to plan for inflation, you may misjudge the amount of money you can spend each year in retirement, finding yourself running out of money a decade sooner than you planned. This leads once again to a catastrophic change in your standard of living if you run out of supplemental income sources like IRAs, in addition to social security and pensions midway in retirement. We typically address inflation risk by having professionally managed stock and bond portfolios for our clients that are appropriately allocated for their timeline and risk tolerance. Erik: 05:00 The third primary risk is: longevity risk. This risk can be further divided into two types of risk, longevity risk associated with income and longevity risk associated with health care expenses. Income risk is the risk of running out of income sufficient to cover your essential expenses in retirement. Having enough guaranteed income to meet your essential needs or a floor of income provides not only a financial advantage but also a psychological one. Your confidence and baseline income allows you to live anxiety free and stick with the long term plans related to your invest-able assets that may be in the stock market that are dedicated to long term inflation protection. The other longevity risk is healthcare risk, which is the risk that you may experience deteriorating health that require the assistance of qualified professionals to help you with the six basic activities of daily living also known as A.D.L.s. Contrary to what many believe, health insurance and Medicare do not pay for long term care expenses. Erik: 06:05 If you don’t have a strategy in place, you are considered “self-insured”, quote unquote. This means that if you experience a health condition requiring assistance with the six activities of daily living, you will need to spend down your assets until you have $2,000 (at least that’s the requirement in most states to be eligible for Medicaid as well as some income thresholds that if you exceed would make you non eligible). But if you even are eligible for Medicaid at some point, then your state Medicaid program may help. And as former president, Ronald Reagan said, “don’t worry, I’m with the government and I’m here to help.” So most people don’t look at Medicaid as the primary route to take care of their health care expenses later on in life if they have the resources to help plan against that risk. Erik: 06:54 Now that we understand the three basic risks, that being: sequence of return risk, (you don’t want to lose a lot of money early in retirement), inflation risk, (we still need to seek growth with our retirement assets because things will get more expensive and over a long 30 year lifespan in retirement or more, things can get significantly more expensive.) And then finally, longevity risk. And that would be the risk associated with assuming that you can figure out how to have guaranteed income streams that will last as long as you live, no matter how long that is, and then the long-term care expenses that are also commonly associated with longevity. Once we gather all of your required information, we then begin using sophisticated financial software to calculate the maximum annual income using agreed upon assumptions and always addressing those three financial risks in retirement. Thanks a lot for joining me today. I truly appreciate your time. If you ever have any ideas of topics that you would like to have me discuss here, please drop us a line. You can send me an email at erik@bowmanfinancialstrategies.com that’s E R I K @bowmanfinancialstrategies.com or you can simply give us a call at (303) 222-8034. And finally you could go to our Facebook page and you can drop us a note there as well. Thanks again for joining me today. I hope you enjoy the rest of your week. Erik: 08:20 Thank you for joining me for Uncommon Sense. The Bowman Financial Strategies financial education series. I’d love to hear your feedback on financial topics you would like to learn more about. Just drop me an email at Erik, that’s E R I K @bowmanfinancialstrategies.com or go to the Bowman Financial Strategies website and send me a note on our contact page. In addition, you can always search for topics of interest in my archive on our podcast page at www.bowmanfinancialstrategies.com/podcasts. Have a great day. Disclosure: 08:56 This communication does not constitute federal tax advice and may not be used as such. Please consult a qualified tax professional for tax advice or assistance. Any references to protection, guarantees or lifetime income refer to insurance products, never securities products. Insurance and annuity products are backed by the financial strength and claims-paying ability of the issuing insurance company. In addition, investment advisory services offered by Change Path, LLC, a registered investment adviser. Change Path and Bowman financial strategies are unaffiliated entities.
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