It’s a myth we hear a lot in the retirement planning world: Many people believe that, after years of working and saving for retirement, they will retire and enjoy lower taxes. That could technically be true, if you fall into a lower income bracket in retirement. Or, if you planned for certain types of retirement income, you might not pay taxes on that money at all.
Unfortunately, the idea that taxes will be lower in retirement is not always the case and because some retirees find themselves unpleasantly surprised by their tax liability, we thought it would be a good idea to review this topic.
Social Security. You might be surprised to learn that about one-third of retirees pay taxes on their Social Security benefits, and up to 85 percent of those benefits can be taxed. These taxes only apply to those earning retirement income over certain amounts, but you probably didn’t think the numbers were that high!
Retirement account withdrawals. If you saved for retirement using a traditional IRA or 401k, you enjoyed the ability to save pre-tax dollars all of those years. But when you begin distributions from those accounts, you will pay taxes on the income, according to your overall income bracket.
Required minimum distributions. If you decide to delay your retirement, or otherwise don’t need to access your account, you can allow the money to continue growing for some time. But you will be required to begin distributions by age 70 ½. If you forget, you will be taxed at a rate of 50 percent of the distribution you should have taken. Ouch! Plus, if you wait too long to take your first distribution, you could end up needing to take two during the first year. This situation could also trigger higher income taxes.
There are certainly ways to establish tax-exempt income in retirement. Roth accounts are one popular method, assuming you meet certain qualifications. Certain types of life insurance policies, which build cash value, are another lesser-known strategy. If you’d like to discuss either of these retirement planning options, give us a call. We can discuss different methods of keeping your tax burden manageable.