Taxes can have a profound effect on a person’s financial security, even after retirement. Retirement savings are generally tax-advantaged, meaning a person does not pay taxes on the money until it is withdrawn from the account. Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s and 403(b)s are all examples of pre-tax retirement accounts.
Although pre-tax accounts are some of the most common options, there are other savings options. With after-tax retirement accounts, a person pays taxes on any contributions made in the same year that they are made. This means that no taxes are due at the time of withdrawal. Roth 401(k)s, Roth 403(b)s and Roth IRAs are all examples of after-tax retirement accounts.
The type of retirement account that a purchase chooses will ultimately dictate how and when they pay taxes, either before or after retirement. It is important to plan for taxes in retirement to keep the tax bill low.
There are many variables to consider when preparing for future financial needs, such as the amount of income that will be taxable and what the tax rate will be after retirement. Take the following steps to prepare for how to handle taxes and to work toward achieving a financially stable retirement.
1. Start Planning Early
The time in which a person begins saving towards retirement has a significant impact on their ability to save. It is best to start saving for retirement as early as possible, even if it is just small amounts. Ideally, a person should start saving in their 20s, but it is still possible to build a comfortable nest egg later in life. If a person is still young, it can be advantageous to have assets in riskier investments like stocks. It is also important to have returns that will surpass inflation to maintain purchasing power during retirement.
2. Calculate Future Spending Needs
How much a person needs in retirement will be highly dependent on their spending habits. When planning, a person should calculate how much they can realistically expect to spend post-retirement. Consider expenses like rent, mortgage, reoccurring utilities and unforeseen medical expenses. Retirees have more time to spend doing things they enjoy; therefore, a retirement strategy should include extra funds for travel, shopping, sightseeing and other activities.
Depending on the amount of taxes that will need to be paid at retirement, these costs may need to be adjusted accordingly.
3. Leverage Employee Matching
Some employers will offer a full or partial match to help employees save towards retirement. Employer matching of 401(k) contributions means that the employer contributes a specified amount towards a retirement savings account based on the amount contributed by the employee. Employer contributions are essentially free money and should not be disregarded. Any contribution amount matched by an employer is tax-deferred. Leveraging employee matching during employment can increase a person’s retirement savings for free without facing extra risks. It also reduces the threat of falling short of the funds needed for a secure retirement.
4. Contribute to an HSA
A Health Savings Account (HSA) appears similar to a personal savings account, but it can be used only for qualified healthcare expenses. Only individuals who are already enrolled in a High-Deductible Health Plan (HDHP) are eligible for this type of account. There are several tax advantages available with HSAs, making them a viable option for people who are planning for taxes in retirement. Contributions made to an HSA are not usually subject to federal income tax and any earnings in the account grow tax-free. Also, any funds left in the account at the end of the year roll over to the next year and are available for future health expenses.
5. How to Help Maximize Tax-Advantaged Savings
There are several ways to help maximize tax-advantaged savings based on a person’s current tax bracket. Individuals in a lower tax bracket may consider maxing out their Roth accounts as workers in a lower tax bracket may experience a higher tax bracket later in life. If a person is in a middle tax bracket, they may consider splitting their retirement savings between Roth and tax-deferred accounts to alleviate uncertainty about future tax rates. Those in a higher tax bracket now may experience a lower tax bracket in retirement and therefore maximize their tax-deferred accounts.
Request a Consultation Today For More Info On Taxes In Retirement
Many people work all of their lives to save for retirement and to secure a financially comfortable future. However, when retirement arrives, the amount of taxes due often comes as a surprise. It is important to understand what expenses await in retirement and how to best save for known and unexpected costs. To learn more about the necessary steps for planning for taxes in retirement or to speak with an experienced wealth manager about retirement planning services, contact the financial professionals at Campbell Wealth Management today.