During your working years, everyone told you retirement was the easy life. As you near retirement, however, perhaps it’s seeming like a bit more work than you had imagined. After all, correctly positioning your various retirement accounts, honing in on your risk tolerance, determining your income sources, creating a budget, and deciding the age to start accepting your Social Security benefit are all important issues that should be at the forefront of your retirement planning checklist.
But have you given much thought to the role taxes will play in your retirement lifestyle?
Sadly, most retirees have not, and risk detonating the potential ticking tax time bomb in their portfolio that could have been avoided with a little bit of education and a touch of guidance.
Although taxes are imminent to some extent, once you retire you have the distinct advantage of being able to choose what to pay yourself for income each year by withdrawing from your various accounts or accepting a Social Security benefit. Estimate your taxes for the year and see how much additional room you have in your current tax bracket before you reach the upper threshold. “Maximizing your tax bracket” refers to taking additional withdrawals to “fill up” the entire bracket without going into the next one.
Tax planning for retirement seems simple at first glance, however, retirees face a completely different set of challenges than do younger taxpayers. Oftentimes, clients come to a financial services professional (FSP) with a tax situation they weren’t ever expecting to face, and many of them have forgotten to account for taxes altogether when making important calculations. Each year you should carefully plan out you and your spouse’s income to ensure you know which tax bracket you’re going to land in. By developing and utilizing tax-efficient withdrawal sequences for your income, you can delay having to tap into your tax-deferred accounts until later in life. Many people seem to think that taxable income decreases or goes away in retirement, but that is not the case.
In order to pay Uncle Sam as little as possible over the course of your retirement, you must understand how your different modes of income will be taxed. Planning carefully – on both a long-range and an annual basis – in regards to your tax brackets, will help you increase your post-tax income for retirement. Remember that in retirement, you control (to some degree) how much you pay yourself in income each tax year from actualizing the funds from your retirement accounts.
Long-range tax bracket planning entails putting together a snapshot of the amounts you’ll withdraw from your retirement accounts and other financial vehicles through the years, and carefully coordinating it with when you start accepting your Social Security benefit. In doing so, many retirees are able to rearrange their income sources in such a way that delivers them more after-tax income. While long-range planning assists in designing an overall tax and income strategy over the course of retirement, annual planning, or being able to “control your tax bracket” each year provides an opportunity to revisit ways to reduce tax burden by taking full advantage of standard or itemized deductions and personal exemptions.
As our lives evolve and change, so does our tax situation. Just as it is important to revisit your risk tolerance as your financial landscape continues to undergo major life events and changes, it’s also necessary to do so from a tax perspective. As many retirees leave the working world, they drop into a lower tax bracket initially from the time they retire and stop receiving normal paychecks on through their 60s. At age 70½, however, you’ll be required to take required minimum distributions (RMDs) from your 401(k) or your traditional IRA.
These distributions, along with any other income you’ve still got coming in, has the potential to push you into a higher tax bracket. Some retirees have found success in taking distributions to steadily and carefully draw from their IRA while still in their 60s, and remain in the same tax bracket – many times this helps them avoid getting bumped into a higher bracket.
As most of us know, you’re not able to dismiss taxes altogether. If you are proactively taking measures to be as tax-efficient as possible, however, you will have a leg up on many retirees. It’s always recommended that you work with a tax or financial services professional to help you prepare. With proper tax bracket management, allocation and diversification of your assets, you can be better prepared and help keep as much of your retirement funds as possible.
If you have any questions, please contact Nevada Senior Advisors at 775-674-2223.