If you are old enough to contemplate retirement, you are old enough to know the lyrics to the song “Taxman” by George Harrison.
“Let me tell you how it will be
There’s one for you, nineteen for me
Cos I’m the taxman…”
There are two ways to look at taxes. If you owe money in taxes, you are earning income and, therefore, paying taxes is good. The other point of view is, who really wants to give their hard earned income to the Federal or State government? Paying taxes is part of living. It never ends, and that includes paying taxes in retirement.
The trick is to set yourself up to pay the majority of your taxes on your earnings while you are working; lessening your tax burden in retirement. This is no easy task, but it is doable. It takes planning and often consulting with a tax professional.
The mathematical equation most retirees need to calculate is:
- Add up all earned income in retirement from all sources / investments. Include earned income from working, retirement instruments like 401K’s, IRA’s, Social Security, rental properties, investments (brokerage accounts, investments and bonds) and pensions.
- Estimate the tax consequences for each of these income sources. Not all income is treated equally. If you are unsure of how your income sources are determined, ask a tax professional to assist you.
- Deduct the estimated taxes you will owe from your projected income total.
- Deduct your current estimated expenses (food/travel/utilities/mortgage/insurances etc.).
- Project your future needs. Plug in an amount which accounts for the rising cost of inflation. Plug in an amount for your health care costs coupled with your anticipated health care needs.
- Lastly, add in a number which reflects the special moments of life. This is the extra money you would like, to support the lifestyle you wish to lead in retirement.
What is the amount you have once you deduct your future estimated expenses against your income? Are you in good financial shape?
You have worked hard and as you approach retirement, you want your golden years to be filled perhaps with traveling to see loved ones, enjoying your hobbies and making memories. Good planning can ensure that you, live your dreams!
Retirement goals should include, protecting your investments, generating future income for your financial security and meeting your long-term care needs / health care needs as you age. Orchestrating your income / finances so you are not exceedingly taxed in your golden years can add usable dollars to every month in retirement.
When is a good time to start planning? Right now! The more you know, the better your financial situation can be. Information is power. The goal is to protect your retirement funds, your retirement income, your Social Security benefits and your pensions from undue tax consequences, “the Taxman”. Providing you, a better life in retirement!
First, keep track of your income from investments and the timing of when you can, or when you must, withdraw from your Retirement Funds. Plug in the numbers from the exercise about to assist you in deciding when the best time will be for you to retire. These factors will assist you in determining when to begin drawing upon your Social Security benefits.
If the majority of your money for retirement is in retirement accounts, there is little to be done to avoid paying taxes. It is recommended that you track your withdrawals from your IRA or 401K’s throughout the year. A colored piece of paper or a chart on your computer allows for easy tracking / organization and quick accessibility. Having all of your information on one chart makes for easy reference. This will be a helpful tool at tax time as well as a great way to track your spending for budgeting purposes throughout the year.
If unexpected expenses have you scrambling for cash, keep in mind that making unplanned withdrawals from a retirement plan may push you into a higher tax bracket (meaning more money paid in taxes). If this occurs toward the end of the year (holiday time), utilizing credit cards for the last month may be a good idea. Remember to pay off your credit card bills in full in January/February to avoid unnecessary interest that may accrue.
Did you know that you may also borrow money from your IRA? You can, but to avoid paying taxes on that borrowed money, remember you must pay it back within 60 days. These two options are meant to be temporary suggestions to get you out of a financial jam or avoid your withdrawing income, placing you in a higher tax bracket.
If you are fortunate to have retirement monies in both retirement plans and nonretirement accounts (brokerage or bank accounts), you will have more options of where to draw upon monies when needed. Investment accounts / brokerage accounts are funded with after tax dollars. Generally speaking, withdrawing money from nonretirement accounts means you will have little tax consequences. For most, it is recommended that withdrawing money from previously taxed dollar funds (non-retirement fund) first, will make the best tax sense. Most retirement accounts will have tax consequences when you withdraw monies.
If you find yourself in the lowest tax bracket at the end of the year, withdraw as much as you can from your retirement account so that money is taxed at the lowest possible rate! Remember, at the age of 70 ½, you may be eligible to make withdrawals from your 401K or other retirement accounts. If possible, start withdrawing only the MRD, (Minimum Required Distribution), the remainder of the funds in your retirement accounts will continue growing as tax deferred income.
Retirement accounts were designed to be used in retirement. You may or may not have benefited from a tax deduction when contributions were made. It depends on your income at the time, whether or not you are married or whether or not you are covered by a retirement plan at work. Both a traditional IRA and a Roth IRA provide tax breaks, but the timing of those tax breaks vary. With a traditional IRA, you see the tax benefits the year you make the contribution. You do not pay taxes on the monies placed in a Roth IRA until those monies are withdrawn. Know that at some point, you will be paying taxes.
POINTS TO REMEMBER
#1. Be mindful of your tax bracket in retirement.
#2. Draw from your investments/assets/retirement funds in a calculated manner.
#3. Lower your monthly expenses. Sometimes this means paying off your existing mortgage to lower your monthly payment.
#4. If you calculate needing more income in retirement, investigate a Reverse Mortgage – converting unusable assets (value in your home) into accessible dollars.
#5. Note the sources of your income in retirement. These incomes are not taxed equally. Below are some potential income sources.
#6. Pay special attention to / and utilize all tax deductions that you may qualify for.
Knowing income diversification and understanding the different tax consequences of your income in retirement can yield tremendous benefits. Clearly the goal is to keep as much of your hard earned money as you can. There are tax credits, tax deductions, continued contributions to a Roth IRA (an excellent way to move wealth to the next generation), timing of your withdrawals from your retirement funds and budgets to consider. All of these factors can aide you in keeping your money in your pocket. Put this money to good use in retirement.
Live your dreams!
Call us today and continue the conversation of planning for retirement.
Senior Security Advisors
3601 Hempstead Turnpike, Suite 300
Levittown, NY 11756
1 (888) 639-4950