When people think about the biggest threats to their retirement plans, they often say outliving their wealth, health insurance costs, nursing home expenses and needing to help their children or grandchildren financially. All of these can be major threats to retirement plans, but the big one people forget is taxes.
Not having a clear plan to deal with higher taxes is one of the most critical threats to retirement-minded people, says Kiplinger in the article titled “Taxes Can Be a Real Threat to Your Retirement.”
You may have been told that when you retire, you’ll be in a lower tax bracket compared to when you were working full-time. We’re told to invest what we can in our 401(k)s or other plans, because we’ll get a nice deduction now. When we retire, we won’t need as much income. Because we won’t be earning a salary, our tax burden will be lessened. But that may be a myth for some.
There are three reasons why some Americans may not get a tax break when they retire:
Maintaining their current standard of living. Most people want to live the same way when they retire, so they need about the same amount of monthly income they had while they were working. That comes with similar tax consequences. Their expenses will change and retirees have extra time on their hands. That time usually gets filled with things that cost money, such as a new hobby or travel.
Tax deductions. When you retire, you won’t have all those same tax deductions, like a mortgage deduction. Retirees aren’t contributing to 401(k)s, so they receive no deduction. See how the deductions can disappear?
Higher tax brackets in the future. Our current individual tax brackets are about as low as they’ve ever been. Social Security, Medicare, and Medicaid are still unfunded liabilities that could lead to tax increases.
To help prepare for these possibilities, plan now to have as much money as you can in tax-free accounts, like Roth IRAs, Roth 401(k)s, and investment-grade insurance strategies. Contribute to your company 401(k) to get any possible match.
You can create some options for yourself sooner, like taking advantage of some of the available options, rather than waiting until you have to start your required minimum distributions (RMD) at age 70½. In some cases, just your RMDs can cause your Social Security benefits to be taxed.
Plan now to deal with your tax burden in retirement. It can be the difference between having a successful retirement and struggling to meet monthly expenses.
Reference: Kiplinger (June 2017) “Taxes Can Be a Real Threat to Your Retirement”