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Retirement Planning Essentials - Planning for Income Taxes Thumbnail

Retirement Planning Essentials - Planning for Income Taxes

Insights Tax Planning Retirement Planning Social Security

One of the biggest retirement questions we hear from clients is about income taxes.  It is one of the biggest expenses you will face in retirement.  Income taxes can be confusing and intimidating and you need to have a plan.  In this episode of our Retirement Planning Essentials, we talk about how to start planning for income taxes in retirement.

Watch Now:  Retirement Planning Essentials:  Planning for Income Taxes


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How Investment Income is Taxed

The first thing you need t understand is how the money you have saved will be taxed when you start taking income.  Here are the three main types.

IRAs and traditional 401k's/403b's Distributions from these accounts are 100% taxable as ordinary income.  Ordinary income taxes are the highest rates you can pay.
Roth IRA's/401k's  Under current law, distributions from Roth IRA's are not taxed.  
Joint or Individual Accounts Income earned on these accounts is taxable.  This includes interest and dividends.

Sales of investments can result in a capital gain or a capital loss.

You won't be taxed on your original investment plus any dividends or interest reinvested.  (this is called your cost basis).

How Your Social Security is Taxed

Depending on your income, part of your Social Security benefits can be taxable.  To determine how much, you need to add half of your Social Security benefits to most of your other taxable income sources.   If it exceeds the amounts in the table below, a portion of your Social Security will be taxed.

Combined Income = Adjusted Gross Income + Non-Taxable Interest + 1/2 of Social Security 

if your combined income is...
Social Security Not Taxed
50% of Social Security Taxed
85% of Social Security Taxed
Single Filers
Under $25,000
$25,000 and $34,000
Over $34.000
Joint Filers
Under $32,000
$32,000 and $44,000
Over $44,000

Paying Your Taxes During the Year

One of the biggest adjustments retirees have to make is paying their taxes during the year.  The IRS requires all of us to pay our income taxes as we go.  If you haven't paid enough during the year, you can be penalized for the underpayment.  

If you are working, this is normally done through payroll deductions.  But when you retire, this isn't an option.  Here are some ways you can avoid the underpayment penalty.

  • Have income taxes withheld from your Social Security benefits or pension benefits 
  • Have income taxes withheld from your IRA distributions
  • Pay quarterly estimates.

How you do it is up to you, and you should consult with your tax advisor.

Planning for Taxes in Retirement.

Unfortunately, many people do not have many options to plan for their tax situation.  For many retirees, the only assets they have to create income is in a traditional 401k or IRA.  Those distributions are often fully taxable as ordinary income.  This leaves little room to plan your tax situation.

If you have multiple sources of retirement savings - Roth-type accounts, individual accounts, and traditional IRA accounts - you have the ability to plan more effectively.  You can pick and choose the types of accounts you use to create income to best manage your tax situation.

If you are younger, planning for tax diversity in retirement is important.  When advisors talk about "safe withdrawal rates" or the "4% rule," the withdrawal amounts are gross amounts.  This means before taxes.  The more of your distribution you can keep in your pocket, the better.

Having Too Much in Traditional IRAs or 401(k)'s

The 401k has been an incredible tool to save for retirement.  It has made saving for retirement easy and they have been around for a long time.  But you can have too much in these types of accounts.  If this is your only tool, it limits your ability to plan for taxes in retirement.  Required Minimum Distributions can cause a bigger tax liability than necessary as well.  

The Roth IRA is a Great Tool

Roth IRAs and 401k's are tremendous tax planning tools for retirement income.  Under current law, distributions are not taxed.  These will allow you to better plan your tax situation in retirement.

Have Questions, We Can Help...

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Appearing in this video

Julie Daley, RICP

Julie is a financial consultant in St. Clairsville, Ohio.

Andy Dollman

Andy is a financial advisor in Parkersburg, West Virginia.

Neal Watson, CFP

Neal is a Certified Financial Planner Professional in Marietta, Ohio.