by Jason Vitucci, CFP®FOUR STAGES OF RETIREMENT - Pre-retirement (50-60) - work and save years
- Early retirement (60-70) go-go years
- Middle retirement (70-80) go-slow years
- Late retirement (80+) no-go years
People often pay more in taxes than expected because a confusing system treats various income types differently, and contains hidden taxes and penalties.
Retirement Surprises - Inflation: People view their future costs in current dollars and don’t anticipate how those costs will grow with inflation.
- Longevity: People may end up living longer than they expect, which requires more money.
- Expenses: People underestimate how much they need to maintain their pre-retirement standard of living.
- Health care: People don’t realize how much of their savings will be spent on health costs.
Key #1: You have to know what your after-tax retirement savings picture looks like BEFORE retiring.
- If you save $500,000 in your 401(k)/IRA, it’s not really $500,000. Taxes must be paid.
- If you’re already retired, you’ll want to start evaluating next year’s potential tax bill before you start tapping assets in the new year.
Key #2: Social Security and Medicare have “tax traps” and you need to plan for them, too.
- IRA withdrawals can cause the taxation of Social Security benefits, and push taxpayers into a higher marginal tax rate.
- Higher income (i.e. withdrawing assets) can cause potentially hundreds of dollars a month extra in Medicare premiums.
Key #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.
- Consider starting to draw down IRAs now, so that your required minimum distributions (RMDs) won’t have as large an effect on Social Security taxation and Medicare premiums.
- Also consider “filling your tax bracket” in lower income years through Roth conversions or selling appreciated stock, to take advantage of a lower tax rate.
- 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).
Key #4: Organize your assets for your family’s benefit - estate planning still matters!
- 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.
Solution: Because your tax exposure will change throughout retirement, you need a tax strategy that:
- Anticipates how and when you tap assets to cover your personal expenses.
- Understands the range of taxes you will face at various stages.
- Manages your actions so you pay as a low a tax rate as possible.
