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4 Ways to Manage Taxes in Retirement

Think you’ll pay less in taxes during retirement? Careful, it’s not always the case. If you haven’t planned your spending and income sources right, you just might have an unexpectedly high tax bill.

So how can you plan for lower taxes in retirement? You can’t know for sure what the tax rates will be in your next phase, but a little knowledge about historical tax rates might help you to better understand today’s tax rates to make a more informed decision for tomorrow.

If you Google the historical top marginal tax rates, it will become very clear that today’s rates are nearer the historical lows than the highs. In years like 1944, the top marginal tax rate peaked over 90% then down to 70% in 1965, yikes! Juxtapose those rates to the 2019 top marginal tax rate of 37% and you’ll see how today’s rates might be considered low. In addition to tax rates potentially changing, what else should you consider for retirement?

There are a few important changes that occur for most at retirement that can initially cause the tax bill to be higher.

  • Mortgage interest deduction is small or non-existent.
  • Children are grown so the exemptions or credits for kids are gone.
  • Charitable deductions are typically less as the checks we’re writing in retirement typically get smaller.

Loss of deductions is an important change to be aware of, but did you realize that your Social Security check can be taxed?

The IRS tracks something called provisional income to determine the percentage of your Social Security that will be taxed. Here are a few common sources of provisional income (not all are listed here):

  • Distributions taken out of your Traditional IRAs, 401Ks, etc.
  • Interest from Municipal Bonds.
  • Any rental income.
  • One-half of your Social Security income.

If you are a married couple filing a joint return and your provisional income is over $44,000 you may have up to 85% of your Social Security subject to tax. If you are an individual and your combined income is more than $34,000, up to 85 percent of your benefits may be taxable.

So what can you do today to impact your tax bill of the future? 

How about the Roth IRA or a Roth Conversion. Yes, there’ll likely be taxes to pay today, but, it just may be worth another look. When you withdraw from a Roth IRA in retirement, those withdrawals aren’t increasing your taxable income.

Consider the Roth 401k. While you pay tax prior to contributions today (post-tax contributions), it allows you to take withdrawals during retirement free of tax on both the contributions and the growth on your money, similar to a Roth IRA.

Lowering expenses in retirement means you’ll need to remove less from a source like a Traditional 401k or IRA where your withdrawal is likely to be included in your taxable income. Planning to have your mortgage paid off (one of the biggest expenses) can help to reduce your tax bill in the future.

Consider whether or not making “Back Door” contributions to a Roth IRA is a viable option for you. This simple strategy has the potential to provide you with significant tax savings down the road.

Planning today for tomorrow’s potential tax burden is easier once you understand the strategies available to help you implement your plan.

Important Note: The views expressed in this post are as of the date of the posting and are subject to change based on market and other conditions. This post contains certain statements that may be deemed forward-looking. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Please note that nothing in this post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and should not be taken to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Lenity Financial, Inc. unless a client service agreement is in place.

Source: Wolters Kluwer CCH.com, The Power of Zero, David McKnight, www.ssa.gov/planners/taxes , Ed Slott & Company, LLC – irahelp.com, Lenity Financial, Inc.