How To Factor Taxes Into Your Retirement Planning
Retirement planning is not just about saving money — it’s about surviving on the money you saved and may receive in retirement, such as Social Security benefits. Tax considerations are easy to overlook when establishing a retirement plan, and various forms of retirement income are taxed differently. Knowing these details might help you save more money without being surprised by taxes. Here are things to consider about taxes in retirement.
Why Taxes Matter in Retirement
You may think of having lower tax rates when you retire, but you may not. The tax bills you pay could be quite substantial, depending on your retirement income, where you live, and your general financial situation. Tax planning before retirement may help you save more for retirement by paying fewer taxes now.
Don’t let surprise tax bills diminish your nest egg. Choose investments based on your risk tolerance and attractive after-tax return.
If you must pay taxes on withdrawals from your tax-deferred retirement accounts, plan how to manage your tax burden during retirement.
Retirement Account Types and How They’re Taxed
Knowing the tax rates for each retirement account is essential to plan appropriately. Here are some details about popular account types:
Traditional 401(k) and Individual Retirement Account (IRA)
- Contributions are deductible before your current taxes, meaning they lower your taxes now before retirement.
- Pension distributions in retirement are taxed as ordinary income.
- Required minimum distributions (RMDs) start at age 73, and you must begin withdrawing money annually even if you don’t use it, potentially putting you in a higher tax bracket.
Tip: Consider how much you currently pay in taxes and how much you plan to earn when you retire. Contribute to a traditional IRA or 401(k) if you predict being in a lower tax bracket in the future.
Roth 401(k) and Roth IRA
- Contributions are made with money after you pay taxes, so these accounts don’t impact your regular taxable income before retirement.
- Withdrawals in retirement are not taxed, provided you have had the account for at least five years and are over 59 and a half.
- Roth IRAs don’t have RMDs, so you have more flexibility about taking withdrawals when it comes to retirement.
Tip: Roth accounts are helpful if you anticipate being at the higher end of the tax spectrum when you retire or if you worry about future tax hikes.
Taxable Investment Accounts
Investments in taxable accounts don’t receive tax-free advantages but are more versatile. Dividends and capital gains are taxed when received. Long-term capital gains on investments held for at least one year are subject to lower tax rates than short-term gains and ordinary income.
Tip: Open taxable accounts to get qualified dividends or long-term capital gains and take advantage of the tax advantages.
Ways To Pay Lower Taxes in Retirement
Here are some tips to make retirement taxes less challenging to manage.
Roth Conversions
It may be an appropriate strategy to convert some of your traditional IRA or 401(k) money into a Roth account if you expect to be in a higher tax bracket in the future. The conversion is taxable on its own, but after the money is in a Roth IRA, any gains are potentially tax-free, and you may also take withdrawals at any time.
Tip: To avoid a significant tax bill in one year, spread any Roth conversions over several years.
Take Advantage of Tax Brackets
Plan your withdrawals well to stay within a lower tax bracket. By taking calculated steps to withdraw from different accounts, you may cut down on your higher tax rate-exempt income.
Tip: Consider a mix of taxable, tax-sheltered, and tax-free accounts for more options. Track income and taxes each year.
Delay Social Security Benefits
Taking Social Security after age 70 raises your monthly benefits payment and lowers your taxable income. You may choose to use the rest of your income first, so Social Security benefits may be used later to help manage your tax bill during retirement.
Tip: Consider your retirement cash flow needs and hold off on taking Social Security to increase benefits. However, economists predict that the Social Security Trust Fund may run out of money around 2036.
You must include tax considerations in your retirement strategy if you want to manage your financial future. You may guard your nest egg to hopefully have adequate funds available during your retirement by knowing how income from different sources is taxed and by doing your homework so that you’re less exposed to taxes.
It is a wise strategy to work with a financial professional before retirement to get the benefits from your hard-earned savings and keep tax season in your golden years less stressful.
Transform Your Money-Fears into Money-Loves!
Unlock your patterns, gain clarity and focus, and become supremely confident with money using my simple 8-step approach to changing your financial future.
Transform Your Money-Fears into Money-Loves!
Unlock your patterns, gain clarity and focus, and become supremely confident with money using my simple 8-step approach to changing your financial future.
