When it comes to your finances, planning for retirement is one of the most important steps you can take. You need to save as much money as possible, and you also need to think about how taxes will impact your retirement income.
Tax planning in retirement can be tricky, but it’s worth doing. This blog post will explain retirement tax planning, how it works, and why it’s so important. We’ll also give you some tips on how to get started!
What’s Retirement Planning?
Retirement planning involves figuring out how much money you need to save for retirement and how you will generate income during retirement. It includes estimating your future expenses and income and choosing the right retirement account that best suits your needs.
Taxes play a big role in retirement planning because they can significantly impact how much money you have to work with. That’s why it’s important to understand the basics of retirement tax planning before making any decisions about your finances. This is where wealth management services can help you.
How Does Retirement Tax Planning Work?
In general, you need to be aware of two types of taxes when it comes to retirement: income taxes and estate taxes.
Income taxes are levied on all forms of income, including interest, dividends, and capital gains. If you have a traditional IRA or 401(k), your contributions are made with pretax dollars, which means they’re not subject to income taxes until you withdraw them in retirement.
On the other hand, estate taxes are levied on the value of your estate when you die. This includes any property, investments, or money in your name. The good news is that there are ways to minimize or even avoid estate taxes altogether.
Why Is Retirement Tax Planning Important?
Retirement tax planning is important because it can help you keep more of your hard-earned money during retirement. By understanding how taxes work in retirement, you can make smarter decisions about your finances and ensure that you have the best possible chance of a comfortable retirement.
Minimize Taxes In Retirement
There are a few different strategies that you can use to minimize your taxes in retirement. For example, you may want to consider Roth IRA conversions, which allow you to convert your traditional IRA into a Roth IRA. This can be a great way to reduce your tax bill in retirement since withdrawals from a Roth IRA are tax-free.
Another strategy is to manage your taxable income during retirement carefully. This means taking advantage of tax-deferred accounts like traditional IRAs and 401(k)s and only withdrawing as much money as you need each year to avoid bumping into a higher tax bracket.
Common Retirement Planning Concerns
When it comes to retirement planning, a lot of concerns may arise. You may be worried about having enough money to cover your expenses or wondering how you’re going to pay for healthcare. These are all valid concerns, but there are ways to ease your worries.
Some of the best ways to prepare for retirement are starting to save early, investing in a diversified mix of assets, and working with a wealth management team that can help you develop a personalized retirement plan.
Diversification Of Your Taxes
If you’re saving for retirement, it’s also a good idea to diversify how and when your savings will
be taxed. This can help you keep more of your money in retirement.
There Are Three Key Ways To Diversify Your Taxes
Save in a mix of taxable and tax-advantaged accounts: This could include a 401(k), 403(b), 457, Traditional IRA, Roth IRA, and/or health savings account (HSA).
Fund different types of investments within each account: You might hold stocks, bonds, and cash in both your taxable and tax-advantaged accounts.
Take advantage of different tax rates throughout your life: You may be in a lower tax bracket when you’re young and earning a lower salary. You may shift into a higher tax bracket as you earn more and approach retirement. By diversifying how and when you save, you can keep more of your money in retirement.
How Much Of Your Income Will Be Taxable?
The answer to this question depends on several factors, including your income, filing status, and whether you have any tax-exempt income.
- For 2022, the IRS taxes single filers with taxable income over $86,376 at a rate of 24%.
- Married couples filing jointly with taxable income over $172,751 are taxed at a rate of 24%.
- Heads of households with taxable income over $86,351 are taxed at a rate of 24%.
What Will Your Tax Rate Be After You Retire?
This is a difficult question to answer because it depends on many factors, including your income, filing status, and whether you have any tax-exempt income. However, a few general principles can help you estimate your post-retirement tax rate.
- First, remember that your taxable income may be lower in retirement than during your working years. This is because you may no longer be working, and/or you may have less income from investments.
- Second, if you plan to withdraw money from a traditional IRA or 401(k), your taxable income will increase.
- Third, if you’re married and both spouses are retired, you may be able to file taxes as “married filing separately.” This could lower your tax rate.
- Finally, remember that your state and local taxes may also change in retirement.
Strategies For Minimizing Your Retirement Taxes
There are a few key strategies you can use to minimize your taxes in retirement:
Save Money In A Roth IRA: With a Roth IRA, you pay taxes on the money you contribute now, but all withdrawals are tax-free in retirement.
Delay Taking Social Security Benefits: If you wait until after age 70 to take Social Security, your benefits will be larger and taxed at a lower rate.
Consider Relocating To A State With Lower Taxes: This is particularly important if you’re retired and no longer tied to a specific location.
Minimize Your Investment Income: If you choose between taxable and tax-exempt investments, choose the latter.
Make Charitable Donations: Charitable donations are tax-deductible and can help reduce your taxable income.
You can minimize your taxes in retirement and keep more of your hard-earned money by following these strategies.
Common Mistakes In Retirement Tax Planning
One of the most common mistakes people make with retirement tax planning is underestimating their post-retirement tax rate. Remember that your taxable income may be lower in retirement, but this doesn’t mean your overall tax rate will be lower. Be sure to factor in all sources of income, including Social Security and investment income, when estimating your tax rate.
Not Taking Advantage Of Tax Rates
Another mistake people make is failing to take advantage of different tax rates throughout their life. You can keep more of your money in retirement by saving money in both taxable and tax-advantaged accounts.
Not Considering State and Local Taxes
Many people don’t consider how their state and local taxes will change in retirement. This can be a costly mistake if you’re not prepared for it.
Failing To Plan For Required Minimum Distributions
The IRS required minimum distributions (RMDs) starting at age 70 ½. However, many people don’t plan for them and end up with a bigger tax bill than expected.
Not Reviewing Your Withholding
As you get closer to retirement, it’s important to review your withholding to ensure you have the right amount of taxes withheld from your paychecks.
These are just a few of the most common mistakes people make regarding retirement tax planning. Avoiding these mistakes can help ensure a more financially secure retirement.
Develop Your Retirement Tax Plan
There are a few key steps you can take to get started on your retirement tax planning:
- Understand the basics of the tax code and how it applies to retirees.
- Estimate your post-retirement tax rate.
- Save money in both taxable and tax-advantaged accounts.
- Consider how state and local taxes will change in retirement.
- Plan for required minimum distributions.
- Review your withholding as you approach retirement age.
By following these steps, you can develop a retirement tax plan that works for you and helps you avoid common mistakes.
Planning For Widowhood
If you’re married, retirement tax planning becomes even more important. This is because you’ll need to plan for the possibility of widowhood.
Widowhood can have a major impact on your taxes, especially if you’re not prepared for it. That’s why it’s so important to include widowhood in your retirement tax planning.
Key Things To Keep In Mind When Planning For Widowhood
- Your spouse’s Social Security benefits may be reduced or eliminated if they predecease you.
- You may be entitled to a survivor benefit from your spouse’s pension, but this benefit may be less than the pension benefit they received while alive.
- If you’re the owner of a joint tax-deferred account, such as an IRA, the entire account will be subject to taxation when your spouse dies.
- Widowhood can also impact your ability to take advantage of certain tax deductions and credits.
By planning for widowhood, you can help ensure that your taxes don’t increase in the event of your spouse’s death.
A Few Final Thoughts On Retirement Tax Planning
Retirement tax planning is a complex process, but it’s important to understand the basics. Learning about the different aspects of retirement taxes can help ensure a more financially secure retirement.
Get Started On Your Retirement Tax Planning
Getting started will help you be one step closer to financial wealth. At Nesso Wealth, we’ll guide you through your retirement planning by providing you with a step-by-step approach to putting your financial plan into concrete terms.
Unfortunately, people frequently consider retirement in purely theoretical terms: distant and difficult to imagine. Still, at Nesso Wealth, we know this is something you need to start thinking about as soon as possible. Our dedicated team works hard to develop a plan that will suit your needs and help you be closer to your financial goals. Don’t hesitate to reach out now to learn about how we can help you.
Distributions from traditional IRAs and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10% IRS tax penalty. Converting from a traditional retirement account to a Roth retirement account is a taxable event. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.