Tax Planning and Retirement
Tax Planning and Retirement
When people think about their retirement, the mental picture they summon tends to focus more on beaches and hobbies and less on income tax. However, the tax you'll have to pay on your retirement income will have a large impact on how much you'll really need in retirement. While your tax burden will most likely be lower in your retirement than in your highest-earning years, you'll still have to deal with income taxes. This means that a part of your retirement planning must include planning for taxes in retirement as well. The good news is that being smart about how you invest and making strategic decisions about where you draw your income from in retirement will better prepare you for a secure future.
How Much of Your Benefit Is Yours to Keep?
One of the biggest surprises that retirees encounter is that Social Security, a cornerstone of retirement income for many, is taxable. However, the portion of your Social Security benefit that is subject to tax depends on your total income for the year. If you rely solely on income from Social Security, you will likely not have to pay taxes on those benefits. But many people use Social Security as a supplement to what they withdraw from their retirement accounts. For those people, if their adjusted gross income, nontaxable interest received, and half of their annual Social Security benefit adds up to a number between $32,000 and $44,000 (and they are married), they may have to pay tax on up to half of their benefit. For single people, that amount would have to be between $25,000 and $34,000. If the amount is higher than those figures, up to 85% of the benefit could be taxable.
Downtown Living = Downtown Taxes
Another tax-related aspect of retirement many people don’t realize has a large impact on their finances is where they plan to live. While it’s tempting to move in down the street from the grandkids or downsize to a condo in a walkable city, it’s important to make sure you understand the tax situation of the locale before you pack up and resettle. Some U.S. states, like Nevada and Florida, have no personal income tax. That, combined with the warm weather, makes both states popular landing spots for retirees. If you want to live a bit more adventurously, try Alaska, which has no income or sales tax. States like Georgia offer special perks to draw retirees, by not taxing Social Security income or up to $65,000 of retirement income for people over 65. Other states have higher tax burdens, which can have an outsized effect on your nest egg. You will need to carefully weigh the advantages and disadvantages of any new place to live and budget accordingly.
Mix It Up with Tax-Diversified Investments
It’s common for people saving for retirement to place an emphasis on tax-deferred accounts like 401(k) plans. This way, they save on the tax now in their higher-earning years, and then pay tax when they draw on the funds in retirement and in a most-likely lower tax bracket. While there is nothing wrong with this strategy, it’s also a good idea to have some accounts to draw on that will not incur any tax, like a Roth IRA. This gives retirees more of a choice about what they will draw on and if they will have to pay tax on those funds. You can also keep some of your investments in regular taxable accounts, which provide income that is taxed at a lower capital gains rate. If you are not currently contributing to a Roth IRA, you may want to consider a rollover from a tax-deferred account into a tax-free account. Of course, you will have to pay any taxes owed when the rollover occurs, but you will also have more options for income to draw on in retirement. Because this is not a good choice for everyone, you should speak with a financial advisor to make sure it is appropriate for you.
Don’t Forget about Required Minimum Distributions (RMDs)
Many people are not in the enviable position of being well-off enough to leave funds untouched through their 60s. But for those who are in that situation, they must keep in mind that by the time they turn age 70½, they are required to start making withdrawals from their 401(k), Roth 401(k), IRA, or other similar account. Whether they need the money or not, they have to start taking the RMDs…and that added income could bump them into a higher tax bracket. The best course of action is entirely dependent on your specific situation, but one strategy is to begin making withdrawals before 70½ as long as you remain in a lower tax bracket, and re-investing the unneeded amount elsewhere. There is also the option to rollover the funds into a Roth IRA, which is the only type of retirement account not subject to RMDs. Speaking with a financial advisor can give you a clear picture of what strategies work best for you – the most important step is to have a plan.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.