Managing Income Taxes in Retirement

When you retire, many aspects of your life will change. But as the saying goes, nothing is certain except death and taxes… So for most of us, taxes will always be a part of life, no matter what we do.

However, that doesn’t mean you must resign yourself to a high income tax liability in retirement. Part of retirement planning involves anticipating and potentially reducing income tax liability. In fact, one of the of the major choices you will face involves the dilemma between paying taxes on money now, so you can enjoy tax-free income in retirement, or setting aside pre-tax money now but paying taxes on distributions from that account later.

In the first situation, you save after-tax money in a Roth account. Later, when you take distributions from that account, you won’t owe taxes on that income.

In the second situation, you set aside pre-tax money in a traditional IRA or 401(k). You don’t pay taxes on the money now, and in fact you can earn a tidy deduction on your income taxes for doing so. But when you begin taking distributions from that account in retirement, the money will be taxed as regular income according to your tax bracket.

You’re paying taxes either way, so what difference does the timing make? The answer comes down to tax brackets, and the right answer for your situation will involve more variables than we can cover in a single blog. But it boils down to this: If you expect to stay in the same tax bracket or even move up to a higher income bracket, a Roth account is often the beneficial choice. If you expect your income to drop in retirement, the traditional account is usually the right move.

But because individual situations can vary, we would urge you not to make this decision alone. Plus, some people even save money in both types of accounts! To receive more in-depth, personalized advice on your situation, meet with us. We can look at both your current and future tax situations, and decide how to proceed with retirement planning so that you can effectively minimize your income tax burden.