It’s not uncommon for people to pay more in taxes than anticipated because our tax system
treats various income types differently and has tax and penalties that are many are unaware.
One way of considering the stages of retirement could be first, your pre-retirement or work and
saving years, usually before age 50 to 60. Next, early retirement, ages 60-70, when many are
going strong. Then middle retirement, ages 70-80 when some slow down. And finally, late
retirement of 80+ years.
Some of the surprises that people run into in retirement include inflation, longevity, expenses
and healthcare. People often view their future costs in today’s dollars and don’t forecast how
those costs will grow with inflation. Many live longer than they expect, which requires more
money. Many also underestimate how much they need to maintain their pre-retirement standard
of living and this includes how much they will likely need to spend on healthcare costs.
Here are some ideas to avoid surprises in your retirement years:
Idea 1: You must know what your after-tax retirement savings picture looks like before retiring.
If you save $1,000,000 in your 401k, it’s not really $1,000,000. Taxes must be paid. If you’re
already retired, you’ll want to start evaluating next year’s potential tax bill before you start
withdrawing your assets in the new year.
Idea 2: Social Security and Medicare have tax traps that you need to plan for.
IRA withdrawals can cause the taxation of your Social Security benefits, and potentially push
you into a higher marginal tax rate. Higher income (for example when you withdraw assets) can
cause potentially hundreds of dollars a month extra in Medicare premiums.
Idea 3: You must plan how and when you will use taxable, tax-deferred, and tax-free assets to
manage your income and tax brackets efficiently.
You may want to consider starting to draw down IRAs early, so that your required minimum
distributions (RMDs) won’t have as large an effect on Social Security taxation and Medicare
premiums. Also consider filling in your tax bracket in lower income years through Roth
conversions or selling appreciated stock, to take advantage of a lower tax rate. You could also
think about donating your RMDs directly to charity to avoid paying income tax on the
distributions, through what is known as a qualified charitable distribution (QCD).
Idea 4: Organize your assets for your family’s benefit with thoughtful estate planning.
If you have a terminal illness, make sure to think about step-up basis strategies. There are
multiple ways to leave IRAs as an inheritance; you need to make sure your heirs get the best
and easiest transfer. Long-term care is a major concern for many people. You need to plan how
you will fund this likely expense, and still leave an inheritance for your heirs.
Because your tax situation can change throughout retirement, you need to anticipate how and
when you tap assets to cover your expenses. By understanding the variety of taxes you will face
at different stages you’ll be able to manage your actions so you can pay as a low a tax rate as
possible.
-Kevin Theissen, HWC Financial, Ludlow.
