Don’t Assume You’ll Pay Less in Taxes in Retirement
Plan now for the taxes of tomorrow. Here are some ways to limit them, stretching your income further throughout your retirement years.
Imagine being a passenger on a 747 jumbo jet, sitting on a runway and preparing for takeoff.
But, there’s one big problem: Your large plane will be trying to get up to speed and into the sky while going down a tiny municipal airport runway.
How unsettling would that feel?
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
This is similar to where we are as a society in terms of how taxes and the tax code will likely change our future financial lives. We have a short runway to do something about it right now, but the end of that runway is quickly approaching.
Today’s retirees have possibly more money than any previous generation – and this could mean they’ll also pay the most in taxes. This generation of retirees has a substantial amount saved in tax-deferred retirement accounts as well as other taxable assets, which means they shouldn’t assume they’ll pay much less in taxes in retirement. There are a few reasons, including changing tax policy and required minimum distributions.
Plan for the taxes of tomorrow
Although no one can predict the future, there’s substantial evidence suggesting that taxes will rise. The Tax Cuts and Jobs Act will expire at the end of 2025, but we could see major changes before then.
Currently, we may be experiencing relatively low tax rates. In 1944, the highest income tax rate was 94%, and in 1978 the maximum capital gains tax rate was almost 40%. Currently, the highest income tax bracket is 37%, and the highest long-term capital gains tax rate is 20%.
The Biden administration’s proposed tax changes include increasing the top marginal income tax rate from 37% to 39.6%. Additionally, the long-term capital gains rate of 20% for those making more than $1 million would disappear. This means that capital gains would instead be taxed at 39.6%, plus the additional 3.8% Net Investment Income Tax.
How much of your retirement income will be taxable?
Once you retire, although you won’t receive a paycheck anymore, many of your retirement income sources will be taxable, possibly including your Social Security benefits, if your income is high enough. In fact, if your combined individual income is between $25,000 and $34,000 or is between $32,000 and $44,000 as a married couple filing jointly, up to 50% of your benefit may be taxable. And, if your combined income as an individual is above $34,000 or above $44,000 as a married couple filing jointly, up to 85% of your benefit may be taxable. Beyond Social Security benefits, capital gains, home sales and inheritance may also be taxable – at unknown future rates.
It's also important to factor in taxes when withdrawing from your tax-deferred 401(k), IRA or other retirement account. While you can decide how much to withdraw at first, starting at age 72 you will have to take out an annual amount specified by the IRS. This means you may have to withdraw more than you normally would, potentially pushing you into a higher tax bracket.
If you’re worried about making your money last for the rest of your life, consider how much of your retirement savings will go toward taxes and whether you could be paying less.
What can you do?
Rather than wait and watch, you can act. Create a long-term tax-minimization strategy and plan for the tax rates of the future, not the rates of today. There are numerous strategies to help minimize taxes on your retirement income, as well as your estate, and a professional can walk you through them. Here are three strategies gaining in popularity:
- A Roth conversion. You pay tax on the amount converted from a traditional 401(k) or IRA to a Roth, and then later withdraw it tax-free. By contrast, with a traditional IRA, you can contribute pre-tax money that reduces your taxable income at the time you contribute, but when you withdraw the money later in retirement, it is taxed as regular income. The maximum annual Roth contribution is 2021 is $6,000, plus $1,000 if you turn 50 by the end of the tax year.
- Health Savings Account. HSAs may be offered by your employer or opened on your own. As with a 401(k), money is contributed to an HSA before taxes. It can be an effective savings vehicle as investments grow tax-free, and you pay no tax on withdrawals for qualified medical expenses. HSAs are also exempt from RMDs. For 2021, the maximum deductible contribution is $3,600 for an individual and $7,200 for a family.
- Municipal bonds. Interest on municipal bonds is exempt from federal taxes. Basically, when you buy a municipal bond, you are lending money to a local or state government entity. Once the bond reaches its maturity date, the full amount of the original investment is repaid to the buyer.
Most agree that taxes will be going up. Now is the time to create a plan to protect against higher taxes that could potentially eat up your retirement savings. Be sure to consult with your tax professional before making any decisions regarding your personal situation.
Dan Dunkin contributed to this article.
Disclaimer
Solutions First Financial Group does not provide tax or legal advice. We are an independent financial services firm that utilizes a variety of investment and insurance products. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Solutions First Financial Group are not affiliated companies. Investing involves risk, including the potential loss of principal. Any references to protection benefits, safety, security, or lifetime income generally refer to fixed insurance products, never securities or investment products. Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. 1063328 – 10/21
Disclaimer
Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Solutions First, Inc. are not affiliated companies. The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Joseph Donti is the founder of Solutions First, Inc. He is a Investment Adviser Representative and specializes in planning and asset preservation. He has passed his Series 65 exam and holds life and health licenses in Arizona. He and his wife, Patty, the company co-founder, have three children and four grandchildren.
-
Strategies to Optimize Your Social Security Benefits
To maximize what you can collect, it’s crucial to know when you can file, how delaying filing affects your checks and the income limit if you’re still working.
By Jason “JB” Beckett Published
-
Don’t Forget to Update Beneficiaries After a Gray Divorce
Some states automatically revoke a former spouse as a beneficiary on some accounts. Waivers can be used, too. Best not to leave it up to your state, though.
By Andrew Hatherley, CDFA®, CRPC® Published
-
Strategies to Optimize Your Social Security Benefits
To maximize what you can collect, it’s crucial to know when you can file, how delaying filing affects your checks and the income limit if you’re still working.
By Jason “JB” Beckett Published
-
Don’t Forget to Update Beneficiaries After a Gray Divorce
Some states automatically revoke a former spouse as a beneficiary on some accounts. Waivers can be used, too. Best not to leave it up to your state, though.
By Andrew Hatherley, CDFA®, CRPC® Published
-
What’s the Difference Between a CPA and a Tax Planner?
CPAs do the important number crunching for tax preparation and filing, but tax planners look at the big picture and come up with tax-saving strategies.
By Joe F. Schmitz Jr., CFP®, ChFC® Published
-
Charitable Remainder Trust: The Stretch IRA Alternative
The SECURE Act killed the stretch IRA, but a properly constructed charitable remainder trust can deliver similar benefits, with some caveats.
By Brandon Mather, CFP®, CEPA, ChFEBC® Published
-
Three Ways to Take Control of Your Money During Financial Literacy Month
Budgeting, building an emergency fund and taking advantage of a multitude of workplace benefits can get you on track and keep you there.
By Craig Rubino Published
-
How Did O.J. Simpson Avoid Paying the Brown and Goldman Families?
And now that he’s died, will the families of Nicole Brown Simpson and Ron Goldman be able to collect on the 1997 civil judgment?
By John M. Goralka Published
-
What Not to Do if an Employee or Loved One Is Kidnapped
Businesses need to have a crisis plan in place so that everyone knows what to do and how to do it. Sometimes, calling the authorities isn’t recommended.
By H. Dennis Beaver, Esq. Published
-
Why You Shouldn’t Let High Interest Rates Seduce You
While increased interest rates are improving the returns on high-yield savings accounts, that may not be an effective place to park your money for the long term.
By Kelly LaVigne, J.D. Published