Are you planning for Taxes in Retirement?

Will I pay higher taxes after I retire?

Many investors ask this question, and the answer isn't a simple "yes" or "no". It is certainly possible however depending upon your situation.

It depends upon your retirement income. If you have saved and invested much of your life, you may end up retiring at a higher marginal tax rate than your current one. Do you have a 401(k) or a traditional IRA? If so, you will receive income from both after age 72. In fact, the income resulting from a Required Minimum Distribution could push you into a higher tax bracket. Here's a few other  income sources to keep in mind:

• Investment Income 

• Annuity Distributions (depending upon the type of annuity)

• Social Security Income (a portion of this may be taxable)

• Pension Income (taxable in some situations)

Retirees who rely on Social Security as their primary income source may have a lower income and may pay comparatively less income taxes in retirement. Depending upon your state of residence Social Security benefits may not be counted as taxable income.¹

How do I know which of my investments I will pay taxes on?

Traditional IRAs and 401(k)s are examples of pre-tax investments. You can put off paying taxes on the contributions you make to these accounts until you start to take distributions.

When you take distributions from these accounts, in most cases you will owe taxes on the withdrawal. Under the SECURE Act, once you reach age 72, you must begin taking required minimum distributions from a traditional IRA, 401(k), and other defined contribution plans in most circumstances. Withdrawals are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Contributions to a traditional IRA may be fully or partially deductible, depending on your adjusted gross income.

Non-qualified Investment accounts & Roth IRA's are examples of after-tax investments. When you put money into these accounts, the contribution is made with after-tax dollars.

Roth IRA accounts are very attractive from a tax perspective because you may not owe taxes on the withdrawals from that Roth IRA (so long as you have had your Roth IRA at least five years and you are at least 59½ years old). Because distributions from a Roth IRA are not taxable, your total taxable retirement income is not as high as it would be otherwise.²

Smart moves can help you manage your taxable income and taxable estate.

• Make Charitable Gifts wisely  Consider donating appreciated securities that you have held for at least a year. You can also designate all or part of your Required Minimum Distribution as a gift to your church or preferred charity. Contact your financial advisor for more information to be sure that these are handled properly.
  
• Take advantage of the annual gift tax exclusion This gives you a way to remove assets from your taxable estate. You may give up to $15,000 to as many individuals as you wish without paying federal gift tax, so long as your total gifts keep you within the lifetime estate and gift tax exemption of $11.58 million for the year 2020 and $11.7 million for 2021.⁴  We would suggest that you discuss this with your financial advisor and estate planner to be sure this is the best option for your situation.
• Use a Roth Conversion strategy A Roth Conversion strategy allows an investor to move assets from their traditional IRA to Roth IRA. This creates taxable income in the current year when taxes are presumably lower than they will be in the future. Again - this should be discussed with your financial advisor.  You can read more details here.

Are you striving for greater tax efficiency? In retirement, it is especially important – and worth a discussion. A few adjustments  now could pave the way to a more tax-efficient retirement.

To learn more about Tax Strategies for Retirement check out our latest booklet.

Citations.

1. SSA.gov, February 22, 2021
2. IRS.gov, November 16, 2020
3. IRS.gov, March 25, 2020
4. Policygenius.com, December 21, 2020