Tax Planning Should Be a Part of Your Retirement Plan

Retirement planning is on every worker’s mind, but there’s one area that people often overlook: tax planning for retirement. You work hard for your money, and if you take the time to plan out your taxes before retirement, it can keep more money in your pocket.

Why Should Tax Planning Be a Part of Your Retirement Planning?

Tax planning in retirement has become such a major importance that it’s something we’ve incorporated into our service. We bundle a lot of things into the cost, such as:

  • Estate planning
  • Tax planning
  • Retirement planning

We believe taxes are so important that we’ve partnered with CPAs to better help our clients. However, if you’re not a client of ours and are wondering why taxes are something to consider when you’re trying to secure your retirement, we’re going to clear that up for you.

Note: This is a high-level aspect of tax planning and is not exhaustive.

Linking Taxes and Retirement

When you enter retirement, you may have an IRA, Social Security and other income sources, all of which have their own tax requirements attached to them. Reviewing these income sources allows us to find ways to minimize your tax burdens.

Understanding the accounts that you have is the first step in the process.

Many of us have saved into pre-tax accounts, such as:

  • 401(k)
  • Traditional IRA

However, Roth accounts are handled differently, too. 

If you receive Social Security, it can also be taxed in many cases. So, there’s a lot to consider when entering retirement with all of these income sources. Let’s start with the one that most people don’t know about.

Social Security and Taxes

We’re concerned about Social Security because there’s been a lot of talk about changing it. Many of these changes may also lead to higher taxes on this income, but in the current space, you can still have benefits taxed.

Based on income, 85% of your Social Security can be taxed.

  • Individuals with an income of $25,000+ will have up to 85% of Social Security converted into taxable income.
  • Joint taxes filed with income of $32,000+ will have up to 85% of Social Security converted into taxable income.

Through tax planning and retirement planning, we may make sure there’s no other income coming in aside from Social Security to try and help save you money. Cash may be available for you to take to meet this obligation, and it may only be possible for a year or two.

If we begin in advance, we can find ways not to take money out and use cash to pay bills to reduce the risk of your benefits being taxed.

However, you need to begin as early as possible to reduce taxes. Waiting until late in the year can make it difficult to find viable ways to reduce your tax burden.

Taxes on Roth IRA and Traditional IRA 

Many people contribute to their 401(K) or IRA, and these are traditional accounts. When we say “traditional” accounts, we mean that these accounts have never had taxes paid on them. For example, if you have $1 million in a traditional IRA, you will need to pay taxes on these accounts when you take a withdrawal.

You take a tax break for your contributions, but all of your withdrawals add to your income and can be taxed.

Adversely, a Roth IRA or 401(K) is a beautiful tool that you can use for retirement. These accounts offer:

  • Tax upfront
  • Tax-free growth
  • No future taxes

You’ll pay taxes on your Roth account today, but it’s allowed to grow tax-free. For some of our clients, they’ll take some of their money from a traditional and Roth account to keep them in a lower tax bracket.

Roth accounts don’t provide an immediate tax break, but the money grows tax-free.

One method that is very popular in retirement planning is a Roth conversion.

Understanding the Benefit of a Roth Conversion

Roth conversions are a way to turn money from a traditional IRA over to a Roth. You will have to pay taxes immediately for the conversion, but when in the Roth account, it will grow for free.

Let’s look at an example of someone who has $300,000 in a traditional IRA and wants to convert $50,000 into a Roth IRA. In this case:

  • $50,000 goes into the Roth
  • $50,000 is claimed on tax returns

If you already made $75,000 and $50,000 was converted into a Roth account, it will lead to paying taxes on $125,000.

We use complex software on our end to identify your tax burden and any issues that may come up with a conversion that we overlook.

However, let’s assume the following:

  • You’re retiring in 2022
  • You’re not 72, so you don’t need to take out income from a traditional IRA
  • In 2023, you won’t have earned income
  • You have cash you can use for spending money

If you’re in the position above, you can convert some of your traditional IRA at 0% taxes. The government offers a standard deduction that you don’t benefit from unless you earn income. In this case, you can convert the amount of the standard deduction for free.

You can then consider whether you want to convert more money because you’re still in the lowest tax bracket at the moment.

Obviously, if you have a lot of income coming in, it may not be possible to pay such little taxes on your Roth conversion. We recommend that you tie tax and retirement plans into one because they work very well together.

Cash in the Bank and Taxes

If you have cash in the bank, there are no taxes attached to it. However, if you receive interest on these dollars, the taxes are typically low and negligible. You’ve already paid taxes on this money.

Brokerage Accounts and Taxes

Brokerage accounts are a bit more complex because some of the money may be taxed and the other money may not be taxed. There are also investments that have dividends that can cause you to pay taxes.

If you hold a short-term investment, you’ll need to pay taxes at your current tax rate if sold within a year.

Long-term capital gains are lower, so this can be used as an advantage. You can also leverage tax loss harvesting on these accounts to save money.

Tax planning can have such an impact on your retirement that it’s something you really need to consider. Taxes can also impact your IRMAA, or how much you need to pay for your health benefits in retirement.

Working with a CPA and financial advisor who are connected can help you save a lot of money in retirement.

Click here to schedule a call with us to discuss taxes and your retirement.