Taxes in retirement: Discover tax strategies to empower your retirement dreams

As you say goodbye to the daily grind and welcome in your golden years, there is one unfortunate thing that follows you: taxes in retirement. Unfortunately, taxes are just as present in retirement as they were during your working years.

That said, a little planning nearing, entering and during retirement can go a long way toward extending the life of your savings—and keeping your wealth transfer options open.
 

Your tax-planning checklist

It’s easy to overlook the taxation piece of the puzzle when you’re focused on the accumulation stage of life. But just as you prepare for tax season well before April 15th, you should think about retirement tax planning before your arrival on retirement’s doorstep.

Here are some things to consider when looking at a retirement tax planning strategy:

• Your current and estimated future tax bracket
• The mix of retirement and non-retirement accounts in your portfolio
• Prudent retirement withdrawal amounts
• Taxes on Social Security benefits
• Required Minimum Distributions (RMDs) at age 73^*
   

How will your asset types be taxed in retirement?

When saving for retirement, we typically use a variety of investment types, which commonly include before-tax, after-tax and fully-taxable accounts. Here’s how they break down:
 

Before tax:

• Accounts may include an IRA or 401(k)
• No taxes are owed on the funds at the time of contribution
• Contributions compound and grow tax-deferred^†

But when you begin withdrawing on or after age 59½, Uncle Sam expects to receive his fair share.
 

After tax:

• Accounts may include a Roth IRA or Roth 401(k)
• Taxes are paid at the time of contribution
• Contributions compound and grow tax-free

On Roth IRA or Roth 401(k) accounts, because taxes are paid before contributions, withdrawals are generally untaxed; however, taxes and penalties may apply to earnings withdrawn before age 59 ½ or before the five-year holding period is met.
 

Traditional/fully taxed:

• Accounts may include individual or joint brokerage, or investments held in a trust or estate
• Any capital gains or dividend distributions are taxed when the income or gains are realized
   

Social Security

Don’t forget, Social Security is a taxable retirement income source! It’s a common misconception that your Social Security benefits are not taxable, but they most certainly are. Up to 85% of Social Security income can be subject to federal tax and may significantly impact your taxes in retirement.¹

For example, if your income exceeds $25,000 for individuals or $32,000 for couples, as much as 50% of your benefits are subject to taxation. It quickly climbs to the 85% threshold for folks above $34,000 for a single filer, or $44,000 for couples.² And when you consider that those thresholds haven’t been adjusted since 1984, growing numbers of retirees are seeing increased taxes on their Social Security benefits.
 

How and ‘in what order’ should you withdraw funds from your retirement accounts?

Whether fully retired or working a reduced schedule, for most folks, the impact of taxes in retirement will be significantly impacted by the amount of income taken from investments, and the order in which withdrawn.

Since the late 1990s, it has been widely accepted that a 4% withdrawal rate in the first year of retirement is largely sustainable, while also being adjusted upward annually for inflation. In recent years, that thinking has evolved, but only mildly so, with a more commonly accepted withdrawal rate of between four and five percent in the first year of retirement.³ However, the question of ‘in what order’ to withdraw funds from your accounts can vary significantly. There are several approaches used to choose what order to withdraw from the various account types. But which approach is right for you?

First and foremost, if you are over 73 and subject to RMDs, take them first. The logic is straight forward; you don’t want to pay unnecessary penalties on your investments.

Second, it is generally held that taking money from taxable accounts first is the best approach for most people. The strategy here is to allow your funds to continue to grow tax deferred. This can be particularly true for retirees with long-term gains taxed at lower rates than other income sources.

However, depending on your situation, that doesn’t always hold true. One competing approach is to take proportional withdrawals from each account based upon that account's percentage of overall assets. The effect is a more stable tax bill over the course of retirement and potentially lower lifetime taxes.
 

Retirement investments are not ‘set-it-and-forget-it’

Life has a habit of changing, so revisit and rebalance your investment portfolio accordingly. But remember, selling non-retirement assets will have tax consequences up front, so consult a professional throughout your decision-making process. A financial or tax professional can walk you through the ins and outs of creating a manageable retirement tax strategy.  They can suggest a variety of approaches and investment products suited to your journey toward and during retirement. To learn more about how an annuity from Jackson might fit into your retirement goals, learn more here.