Over the years, you have worked and amass enough savings for your retirement. Many people, when planning for retirement, however, do not consider how taxes affect their retirement savings.
Savings for a traditional IRA or 401(K) will make your dollars deductible upfront. When you withdraw on retirement, however, you will have to pay income tax. There are, however, some smart moves and strategic decisions that can help you save on tax.
The amount of income tax you will pay on your retirement account is a factor of the tax bracket you fall to. When you make strategic withdrawals from your traditional IRA and 401(k), you can make sure you are not paying in excess.
Tax Rate | For Unmarried Individuals, Taxable Income Over: | For Married Filing Jointly Income over: |
10% | $0 | $0 |
12% | $9,700 | $19,400 |
22% | $39,475 | $78,950 |
24% | $84,200 | $168,400 |
32% | $160,725 | $321,450 |
35% | $204,100 | $408,200 |
37% | $510,300 | $612,350 |
DATA SOURCE: IRS.
Let us assume that you are married, for instance, and both of you need $180,000 per year when retired. Withdrawing the exact amount of $180,000 from your retirement account will put you in a higher tax bracket than making ends meet on just the $78,950
Bear in mind that these brackets take care of all taxable retirement income, which could include Social Security benefits. The amount you will, however, pay on your social security benefit will depend on many things. The summary of it all, however, is that your extra retirement income can bring you into a higher tax bracket.
There are many types of retirement account, and they come with pros and cons. One of the significant benefits of a Roth IRA is that when you retire, it can be tax-free. When you contribute to your account, it is taxed upfront; hence you do not owe any money on withdrawal.
If you will be stretching every dollar when you retire, a Roth IRA is preferable. This is because you will only be able to spend what is in your account. Thus, you get what you see. You, however, will not get the up-front tax break on making the initial contributions.
Roth IRA is also advisable in that you do not have to take the required minimum distribution. As soon as you are 70.5 years of age, you should start withdrawing from a 401(k) or a traditional IRA, if you like or not. This could pose some issues if it is in your desire to work beyond that age.
Roth IRA comes with no required minimum distribution; hence your money can be in your account for how long you want. If, after careful consideration, you discovered that a Roth IRA is the best move, you can convert a traditional IRA into a Roth IRA.
At times, you get to enjoy a form of the tax break by merely living in a specific state. Seven states in the U.S. do not have state income taxes are:
Tennessee and New Hampshire will not tax your earnings, only income from dividends and interest. Thus, living in any of these nine states might exclude you from paying state income taxes.
This, however, does not exclude you from federal income taxes on your distribution. You could save a couple of thousand dollars, depending on what you earn as retirement income and the nature of your savings.
Be sure, however, to examine the pros and cons of moving to a new state in terms of finance. It might not make sense to move to a place with a higher standard of living, even if you get a considerable saving on tax every year. With this in mind, if based on your research, you will live comfortably in another state, you should make the leap.
While you might not be able to avoid taxes, you can take helpful steps that will help you reduce them. With strategic planning and actions, you can make the most of your money when you consider how taxes will affect your retirement income.
