Retirement income and taxation are concepts that everyone knows are important, but not everyone fully understands how they work together. In a previous article, we discussed how to change the way we view retirement, but there’s a common misconception which can impact your lifestyle adversely. Conventional wisdom suggests that when you reach your retirement years, your income will be lower and therefore you’ll be in a lower tax bracket.
Can that be true? Yes. Is it true for everyone? Absolutely not. In fact, having that mindset may mean you are planning to fail. Planning to be in a lower tax bracket means you’re not properly preparing for a future of financial independence and adequate wealth.
Here is what you should be thinking about regarding taxes during retirement:
Make sure not all of your money is taxable
When you use traditional IRAs, 401(k)s or other retirement plans, you take a tax deduction when you’re contributing to them, but that means you’re paying taxes on every dollar you withdraw in retirement. If your account grows throughout your working years, the balance subject to income taxes could be very large and could actually increase your tax bracket, especially if a future Congress raises income tax rates to pay for our ever-increasing national debt.
You’re also required to start withdrawing a certain amount of money annually once you reach age 70 ½ so that the government can collect the deferred taxes. In fact, if you fail to do so you’ll be charged a penalty of 50% of what you were required to withdrawal. This lack of planning flexibility causes lots of retirees to pay higher income taxes and Medicare premiums than they ever imagined.
Paying taxes on all of your retirement income can significantly lower the amount of money you thought you’d have to spend. Distribute your wealth so that you have tax diversification by utilizing accounts which qualify for favorable capital gains tax treatment or which aren’t taxable at all like Roth IRAs and Health Savings Accounts. For more information about creating non-taxable income in retirement, download a free e-book at www.lowtaxbook.com.
Consider your state of residence.
Not all state income tax codes were created equally. Actually, some weren’t really created at all. There are seven states in the U.S. where you aren’t charged taxes on your income: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.
Our country is seeing a huge migration of retirees to these states specifically for that reason. If you accumulate your wealth throughout your career making tax-deductible contributions in a state that does have income tax and then move to a state that does not when you retire, you will save tremendously when you start making withdrawals from your retirement accounts.
Delay your receipt of Social Security.
If you’re in the financial position to do so, delaying Social Security can have multiple benefits in addition to increasing your lifetime retirement income. Taking Social Security before full retirement age (FRA) can reduce your lifetime payments. Even after reaching FRA, if you are still actively employed and start receiving Social Security benefits, these payments could push you into a higher tax bracket during those years.
There are a lot of big decisions to be made when planning for retirement. When you retire, consider the tax impact on all of those decisions—how you arrange your income, whether or not you’re working, where you’re living and how your assets are positioned.
Article Source: forbes.com