Many Americans work all their lives to make enough money so that they can retire without fear. Yet, many don’t realize the obstacles they need to overcome to make that dream a reality.
Taxation, inflation, market fluctuations, and health care expenses are a few of those obstacles. In this article, I’d like to address taxation.
Taxes are something we all face every year. Without preparation and planning, they will impact your future.
Retirement account taxes
In 1978, the government invented 401(k)s, 403(b)s, SEPs, and other pre-tax vehicles.1 They wanted to convince American workers to invest through pre-tax accounts. The benefit was tax deference until the retiree withdrew the money.
In theory, this is great for Americans. They can accumulate wealth without paying taxes. But, in reality, the payday to the government looms. If a person doesn’t develop a plan, that payday can be devastating later in life.
Whether needed or not, the IRA requires yearly withdrawals once you turn age 70 ½.2 The IRS sets withdrawal percentages each year, called required minimum distributions (RMDs).
As an example, if your previous year-end balance were $1,000,000, the RMD for the next year would be about $37,000. That money would be taxable income. Adding this amount to other income, a family could impact the taxes owed in a year.
I’ve seen many instances where a family has to pay more taxes in retirement than they paid while they were working. That’s because they didn’t plan well for retirement.
Social Security income tax
The key to retirement taxes is remembering sources of income. Those sources include Social Security, pensions, wages, and any earned interest, dividends, or IRA withdrawals.
To determine how much tax you’ll pay on Social Security income, the IRS has a calculation called provisional income. Provisional income equals ½ Social Security income plus ordinary earnings, interest, dividends, and non-taxable interest earnings (such as muni bonds).3
If this amount totals more than $32,000 for married joint filers or $25,000 for single filers, 15% of Social Security will be taxed. At $44,600 for married joint filers, or $32,000 for single filers, up to 85% of Social Security could be taxed.
Tax planning and preparation are necessary for retirement. A qualified advisor who concentrates in these areas can help in this planning process.
The advantage of Roth IRAs
It may be worth converting some of your retirement accounts from taxable to non-taxable. By the time you reach age 70 ½, your RMDs could be significantly less, bringing your tax liability down.
You’ll still pay on the annual conversion transfers at the current rates for that year. However, with the new 2018 tax laws, brackets may not increase — a good argument for converting. In later years, this would move money into tax-advantaged accounts. Roth IRAs and many insurance company products could accomplish this goal.
You should seek a qualified advisor who can answer questions before beginning conversions. One question I often hear: “If I do conversions between ages 60 and 70, how do I pay the taxes on the money I convert?”
The taxes will be taken out of the conversion money before they’re reinvested into a tax-advantaged account. The remaining funds would go in a tax-advantaged account that could earn interest while not losing value due to a market downturn.
If you choose Roth IRAs, the post-tax funds will go in a bank product like a certificate of deposit, savings account, or money market. If a bank is not the vehicle of choice, the only other option for a Roth could be the stock market. It’s worth asking yourself if you want to take on that market risk or want something more stable.
Don’t allow the “tax monster” to control you. Take time to research and plan for your retirement years. Find a qualified planner today so that you can take advantage of tax breaks in retirement.
This content was brought to you by Impact PartnersVoice. Investment advisory services are offered through Foundations Investment Advisors, LLC, an SEC-Registered Investment Advisor, South Carolina Insurance License #6415305. DT006651-0220