Why Retirement Tax Planning Is About More Than Your Savings Balance
We usually spend our working years focused on one number, how much we have saved, and that matters. But don’t forget about a second number: how much of that savings you actually get to keep after taxes. Keep in mind, a lot of retirement savings sits in accounts you have never paid taxes on yet.
And in retirement, that bill comes due. Let me walk through three places it tends to show up.
How Traditional 401(k)s and IRA Withdrawals Are Taxed
Start with where most of your money probably lives, the 401(k) or the traditional IRA.
Every dollar you put in there got a tax break on the way in. That was the deal. You skip the tax then with the understanding that you’d pay it later when you pull the money out. So a million-dollar balance may not fully translate to a million dollars of spendable money after taxes.
Some share of that belongs to the IRS, and you have not settled up with them yet. In many cases, the question becomes when taxes are paid and at what rate, depending on your situation.
When you take that money out and how much is one of the variables a plan can look at ahead of time. It’s an area that many people don’t think about until later in retirement.
What Are Required Minimum Distributions (RMDs)?
Here is where the deadline kicks in. The IRS does not let that money sit untaxed forever. Starting at age 73 or later, depending on your age, you are required to withdraw a certain amount each year, whether you need the income or not. This is called required minimum distributions or RMDs.
And for someone who’s saved well, they can be larger than expected. A big RMD can push you into a higher tax bracket, and it can raise other costs too, like the taxes on your Social Security or your Medicare premiums.
So the irony is real. The better you saved, the bigger this can become. The good news is that the years before RMDs, especially early in retirement when income may dip or often when there is the most time to plan ahead.
Understanding the Widow’s Penalty in Retirement
This next one catches couples off guard, so be aware before it happens. When one spouse passes away, in some cases, the surviving spouse may have a similar level of income, but the next year they file taxes as a single person instead of as a couple. The brackets are tighter and the standard deduction is smaller. So the same income can land in a higher tax bracket simply because there is now one person instead of two.
People sometimes call it the widow’s penalty and it often arrives at an already difficult time. Knowing about it ahead of time gives you a chance to plan for it.
Three Retirement Tax Issues to Keep in Mind
So three things to keep in view. The taxes you have deferred and not yet paid, the required withdrawals that start at 73, and this shift that can hit a surviving spouse.
None of these mean you did anything wrong. They’re just the parts of the picture that get forgotten until they’re already here.
Reviewing Your Retirement Tax Strategy
With some planning and the right years, there are often options worth looking at. If you want to look at where your own plan stands, we would be glad to talk it through. We are the Baker team at Parkway Wealth Management Group.
