In your golden years, you don’t want to worry. The goal is to relax and celebrate your retirement. It’s incredibly common to think that retirement means you’re done with the IRS, but how you manage your money after you stop working can have a massive impact on your tax burden.
The good news is that there are a few simple steps you can take to keep more of your money. Here are Neely’s top tips for a tax-smart retirement.
You Still Pay Taxes on Retirement Income
Many retirees are surprised to find that they still owe taxes on their retirement income. Sometimes that amount can be a lot higher than you previously thought. The source of your retirement income largely affects the tax amount.
- Social Security. The federal government can tax up to 85% of your Social Security benefits if your combined income crosses certain thresholds. The IRS taxes lower income brackets at a different rate than higher ones.
- Traditional 401(k) and IRA Withdrawals. The IRS taxes withdrawals from these accounts as ordinary income at your current tax bracket because you funded them with pre-tax dollars. These accounts could be helpful if you expect to be in a lower tax bracket at the time of your retirement.
- Roth IRA Withdrawals. The IRS considers these withdrawals tax-free income during retirement because you fund them with after-tax dollars. These accounts favor younger individuals who have time to let their investment compound and who may think they will be in a higher tax bracket during their retirement.
- Investments. Typically, you pay long-term capital gains tax rather than ordinary income tax. Capital gains tax is tax you pay on profit from selling assets. IRS applies income tax to things like ordinary wages and salaries which is different than capital gains tax. Investments always allow access to your money with close to no consequences. Conversely, if you withdraw money from an IRA early, you could face IRS penalties.
- Pensions. Pensions are almost always taxable at your income’s tax bracket because employers fund them with pre-tax dollars. The IRS treats pension income like ordinary wages.
Don’t Forget About State Taxes
Federal taxes aren’t the only worry when it comes to retirement tax. You also need to consider state tax.
Your state may tax retirement income differently than federal tax law. The key to success in retirement is to stay in the know, so you aren’t blindsided. Think about these state tax tips.
- Watch out for state-specific rules on pensions and Social Security
- Check your estate and inheritance taxes
- States with no income tax may make up for it their sales tax
Smart Ways to Lower Your Tax Bill
There are many ways to lower your tax bill during retirement. The key is to be strategic. Weigh the pros and cons of moving money around to different accounts or completing conversions. A strategic conversion can increase your future tax-free growth, but it could also trigger an immediate tax bill and bump you into a higher tax bracket.
Figure out when pulling income from retirement accounts works best for you. CPAs commonly recommend withdrawing from retirement accounts in this order.
- Brokerage accounts — Pull from these accounts first because you have already paid tax on them. You pay capital gains on the profit which is typically lower than income tax rates.
- Traditional IRAs and 401(k)s — Pull from these accounts second and when you are in a low-income retirement year because the IRS taxes these at ordinary income tax rates.
- Roth IRAs and Roth 401(k)s — You already paid tax on these accounts, so pull income from these last to allow them to grow as long as possible.
Make Tax-Smart Decisions with a Local CPA
Tax planning isn’t just a one-time activity. Interest rates, taxes, and income are constantly shifting and changing. The best way to have a tax-smart retirement is to partner with a CPA who understands tax efficiency. A local Roanoke CPA can help build a personalized plan that adapts to your unique needs and the ever-changing market.
Small decisions help shape your future. Protect your savings by making small, intentional, tax-smart decisions with the guidance of a local, knowledgeable CPA. Ready to make a plan? Call Neely’s today at (540) 366-2767 and we’ll get you prepped for a worry-free retirement.