Getting Around 'Double Taxation

Arden Dale for the Wall St. Journal writes: It isn't really "double taxation," but it can feel like it.  Retirees pay taxes on dividends, interest and retirement-account distributions. If they plow the money back into the market, they then will owe taxes on any future dividends and capital gains.

To be sure, the sense of being taxed twice is more psychological than financial. But many retirees, loath to pay the tax man twice on what feels like the same money, might want to find ways to manage their cash flow so that they can use the capital for living expenses or for gifts to family or charity instead, financial advisers say.
The place to start is with a master plan that encompasses cash flow, living expenses and any giving goals.
As people age, their sources of income change, which makes it important to adjust lest they end up with too much or too little cash.

For example, when individual retirement account holders reach age 70½, they must begin taking annual required minimum distributions, which can amount to a lot of money if the account is large.
"Clients that are already paying taxes on such amounts should consider using it as part of their cash flow," says Laura Sundquist, a financial planner and accountant at Sage Financial Design in Simsbury, Conn.
Ms. Sundquist says retirees should figure out how much they need to live on a monthly basis. With that figured, the investor, or his financial planner, can calculate how much to draw from various sources, such as dividends, interest and retirement accounts, while keeping taxes in mind.

They will be glad they did. Changes in federal tax rates this year raised the top rate on qualified dividends to 20% from 15%. Interest and retirement account income is taxed as ordinary income, with a new top rate of 39.6%.

Beginning this year, investment income will be taxed an additional 3.8% for singles whose adjusted gross income exceeds $200,000, or $250,000 for couples, to help fund the health-care overhaul.
Retirees should update the plan annually, mapping out cash flow for the next year, says Thomas Zimmerman, a financial planner in Evanston, Ill., who manages about $190 million.
Though most of Mr. Zimmerman's clients have a net worth of between $3 million and $5 million, many of them still rely on required minimum distributions to help cover living expenses, he says. Whatever is left, they could reinvest.

Retirees who want to give to charity may find it tax-efficient to roll part or all of a required minimum distribution to a favorite cause, advisers say. For taxpayers 70½ and older, the law allows a direct rollover of up to $100,000. 

The strategy works especially well when a charitable contribution brings a taxpayer's adjusted gross income below the thresholds for the new 3.8% investment-income surtax, says Larry Maddox, president of Horizon Advisors, a Houston firm with $205 million under management.
When giving goals are centered around family, gifts to family can be a good way to avoid being taxed twice, advisers say. A person this year can give unlimited tax-free gifts of up to $14,000 per recipient.