Being tax efficient in retirement
It’s important to feel financially secure in retirement. Being tax efficient is just one more way to prepare for the future. Taxes are often an intimidating subject, and mixing them with the idea of financial freedom in retirement can seem even more daunting. Because of this, we’ve answered some of the preliminary questions you might have.
Will you pay higher taxes in retirement?
It is possible to pay higher taxes in retirement, though this will depend on how you generate your retirement income. Will it be from investments? Will it be from retirement plans? If it will be from retirement plans, then which plans? How many?
Social Security also plays a heavy hand in retirement and has its own contributing factors like: when do you plan on taking Social Security benefits? Do you have a spouse? If so, when do they plan on taking Social Security benefits?
These are some of the initial factors that contribute to your tax bracket in retirement. Preparing answers to these questions will help give you a much better understanding of how your taxable income will be affected in retirement.
What is a pre-tax investment?
Investments designed to help you save for retirement, like traditional IRAs and 401ks, are pre-tax investments. These investments are also referred to as tax-deferred investments; in other words, the money accumulated in these accounts can benefit from tax-deferred growth.
You will not need to pay taxes on the money in these accounts until you begin taking distributions. While you can begin taking distributions right when you retire, you must begin taking distributions from a traditional IRA, 401k, and other defined contribution plans once you reach the age of 72.
These distributions are taxed as ordinary income. If you choose to begin taking withdrawals before the age of 59½, they will be subject to a 10% federal income tax penalty.
What’s an after-tax investment?
An after tax investment is money paid into a retirement or investment account after income taxes have been deducted from those earnings. The most common after-tax investment account is a Roth IRA.
After-tax investment accounts offer the opportunity for tax-free and penalty-free withdrawals of earnings. For Roth IRA distributions to qualify for tax-free and penalty-free withdrawals, they must occur after the age of 59½ and meet the five-year rule: at least five tax years must pass after the first contribution to any Roth IRA you own.1
In addition to this, tax-free and penalty-free withdrawals can also be taken under certain qualifying circumstances such as purchasing, building, or rebuilding a first home, the event in which the Roth IRA holder becomes disabled, or upon the death of the IRA holder.
Being even more tax efficient.
As stated earlier, understanding the intricacies of taxes is a solid way to prepare for the future. If you’re looking to have more questions answered, or want to look at putting a retirement plan together, reach out to us today!
- https://www.irs.gov/publications/p590b#en_US_2019_publink1000231057