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.]