Retirement planning requires a lot of different elements. Investments, tax planning, income planning, and more. Many people dedicate their focus towards managing their investment returns, and while that’s important other factors that can have an even bigger impact on their nest egg get overlooked. One huge factor is taxes.
Taxes could be your largest expense in retirement. Developing strategies around them is key to best positioning your retirement future. To mitigate the negative impact that taxes might have on your retirement savings, be aware of these common tax traps before you start planning that retirement party.
Retirement Tax Trap #1: Claiming Social Security Could Increase Your Tax Bill
Claiming your Social Security benefits could be one of the most important financial decisions of your life. How and when you claim Social Security could impact far more than just the amount of your benefits check. It could also trigger paying taxes on as much as 85% of your benefits.
Don’t make your decision solely based on maximizing your benefits. Instead, consider how it could impact your taxes, Medicare premiums and spousal benefits.
Retirement Tax Trap #2: Withdrawals from Your IRA and 401(k) Are Taxable
Contributing money to your IRA and 401K is easy. But withdrawing this money in retirement is complicated and confusing.
Remember, you must pay taxes when you withdraw this money in retirement. And Required Minimum Distributions will further complicate matters. When you turn 73, “RMD’s” force you to start withdrawing money from these accounts, whether you want to or not. And this could result in paying more and more taxes every year.
The solution? Start planning for RMDs in your 60s to minimize their impact on your tax bill.
Retirement Tax Trap #3: Failing to Diversify for Taxes
Most people understand investment diversification, but few think about diversifying their tax exposure. Many individuals have too much of their retirement savings in tax-deferred accounts, which can lead to big tax headaches down the road.
To minimize your tax burden, aim to have a balance of accounts in three categories: taxed always, taxed later and taxed rarely. If you have too many eggs in one basket, it could spell serious financial trouble in retirement.
Retirement Tax Trap #4: Missing the ROTH IRA or 401(k) Conversion Window
A Traditional IRA or 401K allow tax-free contributions. But you must pay taxes when you withdraw this money in retirement unless you convert some, or all your traditional IRA or 401K to a ROTH.
A ROTH IRA or 401K doesn’t allow tax-free contributions (that’s the catch), but you pay zero taxes when you withdraw money in retirement. ROTH accounts are not subject to RMDs either. That means you get tax-free growth, which could add up to tens of thousands of dollars in retirement (possibly more).
A financial advisor can help you determine whether a ROTH conversion is right for you.
Take Control of Your Retirement Taxes
The good news? You have more control over how much you pay in taxes during retirement than at any other point in your life. But lowering your tax bill doesn’t happen automatically—it requires proactive planning. By addressing these tax traps early, you can set yourself up for a more tax-efficient, stress-free retirement. To set yourself up, give us a call: 952-460-3290.
