Planning for Taxes in Retirement

Planning for a multi-decade retirement requires planning and tax planning should be one of your major considerations. Wise retirement investors create a plan that will provide adequate income year after year, but if you don’t take taxes into consideration, your income may be significantly reduced over the long run.

Let’s take a look at the kinds of tax considerations that will help you to create a solid comprehensive plan.

Pre-tax Investment Considerations

If your entire nest egg is invested in a traditional, pretax 401(k) plan or if you have a traditional pension plan, you have chosen the least flexible way to manage your post-retirement taxes.¹ When all of your retirement funds are invested in one of these two vehicles, distributions will be taxable at the ordinary income tax rate. This is because you didn’t pay taxes when you invested the money.

Another consideration for people with pension plans is that some pension plans don’t have cost-of-living adjustments. If this is the case with your plan, inflation will eat into your earnings.

How can you structure your retirement planning to keep taxes from sidetracking your retirement plan? Consider a pre-tax and after-tax investment mix.

Pre-tax and After-tax Investment Mix

Instead of putting all your retirement eggs in one basket, so to speak, you may want to consider dividing your assets into pre-tax and after-tax investments.

As we’ve already learned, distributions from pretax 401(k) plans or traditional IRAs will be taxed at ordinary income tax rates when you withdraw them. But if part of your nest egg has been invested in a Roth retirement account, you have more planning options.

The distributions you receive from a Roth IRA or a Roth 401(k) will not be taxable if they meet the following requirements:¹

• You receive the distribution after the five-year period that begins with the first taxable year for which a contribution was made to the Roth retirement account.
• The distribution is made on or after the date when you reach age 59 ½ or when you become disabled; or 
• A beneficiary of your estate receives the distribution after your death.

By dividing your retirement funds between pre-tax and after-tax investments, you may be able to lower your taxes over time and provide yourself with much more flexibility in the future. For example, you could choose to live entirely off your Roth distributions and your Social Security at first so you don’t have to touch your traditional IRA or 401(k) until after age 70 ½. Alternatively, you could reserve your Roth assets as an inheritance since your beneficiaries won’t have to pay taxes on those distributions. It is prudent to consider the available options and choose the best course for your particular situation.

If you’d like to learn more about planning for retirement, our Wealth Managers are here to help. Give us a call today at 1-800-541-7774, send an email or learn more about how we might help you.

 Sources: 

1. Bankrate

The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.