When most people think of retirement, financial problems often appear. With so many people having no savings for retirement, benefits such as social security often make up most, if not all, retirement income.
Yet even those who to have managed to set aside a reasonable nest egg often find that the money they saved did not go as far as they had hoped. Although many expenses may be more expensive than expected, the most surprising thing for many retirees is the amount of their taxes to pay. Much of this is due to a single factor – and thankfully you have at least some control.
How retirement account distributions affect your taxes
Throughout your career, the most important thing for you in terms of retirement savings was to find a way to set aside all the money you could afford. By combining different types of accounts, such as 401 (k) s and IRA, you can take advantage of various tax advantages while preparing you to invest in your future.
Yet when it comes time to retire, the focus is on making the best use of the money you have accumulated in your retirement accounts. Most of the most popular savings options that give you an initial tax deduction when you make contributions over the course of your career may become more fiscally problematic in retirement. In fact, you usually have to pay taxes on the money you withdraw from these traditional 401 (k) and IRA accounts, that this money represents your initial contributions or the income and gains that your investments have generated in your accounts. retirement. .
Even worse, withdrawals from these types of retirement accounts can have an impact on how other types of income are taxed. The most common situation is social security, because if your total income exceeds certain thresholds, including those you withdraw from traditional retirement accounts, then part of what you receive from social security benefits can be taxed. With the potential of having to process up to 85% of what you receive from social security as taxable income, every dollar you withdraw from a 401 (k) traditional or an IRA can have a domino effect on the rest of your taxes.
In contrast, a few people successfully use other types of retirement accounts that have different tax consequences. In particular, the Roth IRAs allow you to make tax free withdrawals in retirement. By using them as a source of retirement money, you avoid worrying about the tax consequences, but the total amount in Roth IRA is only a small fraction of what you will find in classic retirement accounts.
Get the right mix
The best approach to tax planning in retirement involves prior preparation. In particular, taking the following steps in advance can help you tremendously once you retire:
- Have a mix of traditional retirement accounts and Roth. If you have always used traditional retirement accounts to get initial deductions, consider taking the single tax impact of a Roth conversion in order to avail the flexibility of tax free resources available. The sooner you do this, the more your account will generate income and earnings, increasing the amount you can withdraw without paying taxes.
- Consider having savings outside retirement accounts entirely. Many people think that you should use tax-favored retirement accounts to save, but if you invest in long-term shares, you can get an equally important tax benefit by keeping your shares rather than selling them. and generating taxable capital. gains. When you sell retirement investments, you should only include gains in your taxable income rather than the full proceeds of the sale.
- Be smart about tax brackets. Sometimes it may be wise to pay the tax as soon as possible if you can do it at a lower rate than you would pay in the future. This can guide investment movement decisions, retirement account withdrawals and a host of other tax considerations.
IRAs and 401 (k) s can have a huge difference in your success in saving for retirement. If you know their tax consequences, you will be better able to take steps to control the adverse tax consequences and put yourself in the best position to keep as much as possible your hard-earned savings during your dream years.