When we think about planning for our senior years, we generally tend to focus on a few key things: maxing out our retirement plan contributions, investing strategically, and figuring out when to sign up for Social Security benefits. But according to a recent Nationwide survey, 42% of current retirees made one major blunder in the course of their planning: They did not consider how taxes would impact their retirement income. And that’s a mistake you’ll want to avoid.
How taxes could wreck your retirement
You might assume that as a senior, you’ll be entitled to a host of tax-free income. But that’s not necessarily the case at all. In fact, here are a few key income sources that are absolutely taxable.
Social Security benefits
If Social Security is your only income source during retirement, then you probably won’t see your benefits taxed. But if those benefits only provide a portion of your total income, then you may not get to keep them all.
Whether your benefits will be taxed at the federal level will depend on your provisional income, and that’s calculated by taking your non-Social Security income and adding in half of your annual benefit. If your total comes to $25,000 to $34,000 and you’re single, you could be looking at taxes on up to 50% of your benefits, and beyond $34,000, you may be taxed on up to 85% of your benefits. If you’re married with a provisional income of $32,000 to $44,000, you could be taxed on up to 50% of your benefits, and beyond $44,000, you may be taxed on up to 85% of your benefits. Plus, there are 13 states that now tax Social Security as well. As such, you can’t assume that you’ll get that income tax-free.
Retirement plan withdrawals
If you opt to house your retirement savings in a traditional IRA or 401(k), then prepare to pay taxes on your withdrawals. Furthermore, once you turn 72, you’ll need to start taking required minimum distributions, or RMDs, from your retirement plan, and those, too, will be subject to taxes just like the withdrawals you decide to take on your own.
If you’d rather avoid taxes on retirement plan withdrawals, put your money into a Roth savings plan. Roth IRAs and Roth 401(k)s come with tax-free withdrawals, and Roth IRAs offer the added benefit of being the only tax-advantaged retirement plan to not impose RMDs at all.
Regular investment income
If you have investments in a traditional brokerage account, that income will be taxable as well. If you sell stocks at a profit, for example, you’ll be liable for capital gains taxes, and if you hold bonds that pay you interest twice a year, you’ll be taxed on that interest income as well.
That said, there are things you can do to minimize your tax burden on investments. First, hold stocks for at least a year and a day before selling them. That way, you’ll bump yourself into the long-term capital gains category, which comes with a lower tax rate than short-term gains. Secondly, consider investing in municipal bonds. The interest they pay is always exempt from federal taxes, and if you buy bonds issued by your home state, you’ll avoid state and local taxes as well.
Forgetting about taxes in the course of your retirement planning could put you in a tight spot financially down the line. Be sure to not only read up on the taxes you might face, but also aim to find ways to minimize them as much as possible so you can keep more of your retirement income.
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