If you want a retirement free of financial regrets, it's helpful to consider what current retirees wish they'd done differently. And a recent survey conducted by Nationwide Financial can shed some light on that.
According to Nationwide's data, 41% of current retirees — or approximately 22 million seniors — regret that they weren't better prepared for one specific retirement expense. Here's what it is.
Retirees wish they'd prepared better for this huge cost
So what's the expense that retirees overlooked? It's an unavoidable one for many: taxes.
Nationwide found that 42% of current retirees neglected to consider how taxes would affect their retirement funds when they were making plans for their later years. And 41% of retirees admitted they wish they'd prepared better for fulfilling their obligations to the government after leaving the workforce.
Unfortunately, taxes can take a huge bite out of your retirement accounts.
If you have your savings invested in a traditional 401(k) or IRA, you'll be taxed on all of your distributions from your investment accounts as ordinary income. And as if that's not bad enough, your Social Security benefits and any pension money you receive could also potentially be partly taxed on both the federal and state levels (depending on where you live and how much you earn).
Sadly, far too many people forget that both the IRS and their state will take cuts when they're considering how much income their retirement portfolios will produce — especially those who don't think much about their current taxes because their employers just withhold the money from their paychecks.
Future retirees may also not be aware that the government requires them to withdraw money from some tax-advantaged retirement accounts starting at age 72. The idea is that after a lifetime of offering tax-deferred gains, the IRS wants to make sure it gets its cuts eventually. Because of these required minimum distribution rules, seniors have less control over how much money they take out of their retirement accounts, and they often have little ability to lower their tax bill after reaching retirement.
How you can prepare for taxes in retirement
If you want to minimize the impact that taxes will have on your senior years, you'll want to act as early as possible.
One of the best options is to invest in a Roth IRA. Roth IRAs are not subject to required minimum distribution rules, so you have a choice on when and how much money to take out. Withdrawals are tax-free provided you followed certain rules for your account. And the income you earn from a Roth isn't considered when calculating how much you earn for purposes of determining your Social Security benefit taxes.
You'll want to begin investing in a Roth early if you don't want to worry about taxes in retirement. While you can roll over a traditional account to a Roth, you'll have to pay taxes on the converted funds, and a five-year rule could prevent you from taking money out of your new Roth account penalty-free for a half-decade after you've done a rollover.
If you're already nearing retirement and a Roth conversion doesn't make sense for you because of these downsides, it's important to understand exactly what your tax burden will be as a retiree before you quit working.
If it turns out that you can't live the lifestyle you expect on your after-tax retirement income, you'll have some tough choices to make about whether to continue working and saving for longer before retiring. It can be disappointing to discover this, but it's far better to find it out early while you still have time to change course than to find yourself living with financial regrets after leaving the working world for good.
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