Think about all the money you have in your tax-deferred savings accounts (like IRAs) and in company-sponsored plans, such as 401(k)s and 403(b)s.
Now think about having a loan against them. That loan is the money you will owe the IRS when you start taking distributions from those accounts.
Year-End Tax Planning Comes with a Twist in 2021
How much interest will you pay on that loan? In other words, what tax rate will you pay on the money you take out of your tax-deferred accounts in retirement? With proper planning, you can have a say in that number. If taxes are not part of your financial plan for retirement, then your plan is incomplete, and perhaps it’s time to interview a financial adviser who prioritizes tax planning.
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Taxes will go up by law when the Tax Cuts and Jobs Act of 2017 expires after 2025. There’s a good possibility taxes will increase further because of the huge national debt we’ve accumulated. Therefore, you need to ask yourself these questions:
- Do you know your tax liability?
- Do you know how much the amount that you owe the IRS will grow in the near future?
- Do you know what the tax impact will be when your spouse inherits your tax-deferred accounts, or when your children inherit them?
If one spouse passes away and leaves those tax-deferred accounts to the surviving spouse, that surviving spouse becomes a single taxpayer, and their rates are significantly higher. And when children inherit a tax-deferred account, their tax burden can increase as well. Due to the SECURE Act, most beneficiaries are required to withdraw assets within 10 years following the death of the account holder, rather than over the rest of their lifetime. So, at the age at which most children inherit their parents’ money, they’re probably in the highest tax bracket of their lives.
Generation-Skipping Transfer Tax Basics
On the plus side, when working with a tax-licensed financial adviser, you can create tax-free accounts for retirement, reduce your tax load overall and lessen the burden on your beneficiaries. Here are some effective ways of tailoring your retirement plan to tax considerations:
- Roth IRA. The best way to have tax-free income is to pay the taxes on retirement accounts before withdrawing the money. And the best way to do that is by contributing to a Roth during your working years. While your contributions to a Roth IRA are not tax-deductible as they are with a traditional IRA or an employer-sponsored 401(k) plan, distributions made after age 59½ are generally tax-free. The specter of higher taxes in the future compels many people to do Roth conversions — taking some money from a tax-deferred account and putting it into a Roth IRA. The maximum annual Roth contribution in 2021 and 2022 is $6,000, plus $1,000 if you turn 50 by the end of the tax year.
- Health Savings Account. HSA contributions are tax-deductible, gains in the account grow tax-free and withdrawals used to pay for qualified medical expenses are also tax-free. You can contribute $3,600 to an HSA in 2021 ($7,200 for family coverage). If you’re 55 or over, you can contribute an extra $1,000. For 2022 those limits rise to $3,650 and $7,300, respectively.
- Municipal bonds. These are issued by counties, cities and states to fund public projects. The interest you earn on municipal bonds generally is not subject to federal tax. And if the bond is issued in your state of residence, it may be tax-free at the state level.
- Gifting. A smart way to ensure your money stays in the family is to give it to your heirs while you’re alive. For 2021, the IRS allows individuals to give a maximum of $15,000 per person, per year in gifts, and in 2022 that number rises to $16,000. That money is tax-free for recipients.
- Charitable donations. This is another effective way to reduce one’s estate value and related taxable amount. The Qualified Charitable Distribution (QCD) rule allows traditional IRA owners of at least 70½ years of age to deduct their required minimum distributions on their tax returns if they give the money to a charity. Any traditional QCDs must be made directly to the charity and are capped at $100,000 annually per person.
Learning the tax rules and strategies ahead of retirement can make a significant difference in how much you owe the IRS, how much you keep and how much you enjoy your retirement.
Dan Dunkin contributed to this article.
Tax Planning Opportunities You Might Not Be Aware Of
Disclaimer
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.Networth Advisors LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
Disclaimer
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Topics
Building WealthTax Cuts And Jobs Act Of 2017
FAQs
Failing to Plan for Taxes Could Mean Planning to Fail in Retirement. If the bulk of your retirement savings is in a traditional IRA or 401(k) or other tax-deferred account, you've got a problem. The good news is, there are plenty of things you can do about it.
What does it mean that failing to plan is planning? ›
As Benjamin Franklin said, “failing to plan is planning to fail”. If you don't have a plan to reach your savings goal, you're just putting away money without any idea of whether or not it's enough, or when or if you're going to reach your goal.
Is it better to defer taxes until retirement? ›
Some of the best retirement plans, including traditional IRAs and traditional 401(k)s, are tax-deferred. These accounts are considered an ideal place to park long-term investments, since you can escape paying taxes on realized gains for decades.
Do investment and tax planning have a role in retirement planning? ›
Selecting tax-smart accounts may help your retirement savings last longer. Diversification isn't just for your investment portfolio. If you're actively saving for retirement, it's also a good idea to diversify how and when your savings will be taxed.
How does a retirement plan affect taxes? ›
You have to pay income tax on your pension and on withdrawals from any tax-deferred investments—such as traditional IRAs, 401(k)s, 403(b)s and similar retirement plans, and tax-deferred annuities—in the year you take the money. The taxes that are due reduce the amount you have left to spend.
Did Benjamin Franklin really say if you fail to plan, you are planning to fail? ›
Apparently, there is no substantive evidence that the quote widely attributed to Benjamin Franklin “Failing to plan is planning to fail” was ever said by him! Nonetheless, it is a wise adage and still as relevant today as it was in 1790 when Mr Franklin wasn't saying it.
What is the disadvantage of failing to plan? ›
It can result in inefficiency and a lack of productivity, as tasks may not be properly organized or prioritized . Without planning, it becomes difficult to anticipate and prepare for potential challenges or obstacles that may arise, leading to increased stress and difficulty in meeting deadlines .
What is the disadvantage of using a tax-deferred retirement plan? ›
The drawbacks of tax-deferred retirement plans are limited access to funds, minimal investment options, and additional taxation upon the death of of a contributor.
Should a retired person file taxes? ›
Some seniors must pay federal income taxes on their Social Security benefits, depending on their income and filing status. If you have a source of income that is substantially more than what you receive from your Social Security benefits, you will pay federal income taxes on up to 85% of your benefits.
Is it better to have retirement taken out before or after taxes? ›
Both pretax and Roth contributions have potential tax advantages. If you anticipate being in a higher tax bracket in retirement than you are now, making after-tax Roth contributions may help you because you'll be able to take out the contributions and earnings tax free.
According to the $1,000 per month rule, retirees can receive $1,000 per month if they withdraw 5% annually for every $240,000 they have set aside. For example, if you aim to take out $2,000 per month, you'll need to set aside $480,000. For $3,000 per month, you would need to save $720,000, and so on.
What is the 4 rule in retirement planning? ›
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
What are two pitfalls to retirement planning? ›
Some common retirement mistakes are not creating a financial plan and not contributing to your 401(k) or another retirement plan.
At what age is social security no longer taxed? ›
Yes, Social Security is taxed federally after the age of 70. If you get a Social Security check, it will always be part of your taxable income, regardless of your age. There is some variation at the state level, though, so make sure to check the laws for the state where you live.
How do taxes impact retirement income? ›
How some income in retirement is taxed. Social Security Benefits: Depending on provisional income, up to 85% of Social Security benefits can be taxed by the IRS at ordinary income tax rates. Pensions: Pension payments are generally fully taxable as ordinary income unless you made after-tax contributions.
How much can a retired person earn without paying taxes in 2024? ›
Unless your combined income for 2024 is less than $25,000 (less than $32,000 for married couples filing jointly), a percentage of your Social Security payments will be subject to income tax.
What is the failure of planning? ›
The shortfall of planning for the performance of duty in controlling and directing the organisation, team or function is known as a failure of planning. Planning and organising help complete your tasks correctly and prevent costly blunders.
What does the Bible say about failing to plan? ›
You've probably heard the saying “If you fail to plan, you plan to fail.” This idea is reflected in proverb after proverb throughout God's Word (Proverbs 15:22; 16:3; 9; 19:21; 20:18; 21:5) and has got to be one of the most important principles to live by in college ministry.
Who said failing to plan means planning to fail? ›
Quote by Benjamin Franklin: “If you fail to plan, you are planning to fail!”
What happens when you fail to plan? ›
“If you fail to plan, you plan to fail”. Quote - Benjamin Franklin 1790.
