An often overlooked aspect of retirement planning is the impact of federal and state income taxes on individuals relying on fixed or pension income. Regardless of your tax bracket, unexpected tax deductions from your retirement accounts can significantly reduce your nest egg without proper planning.
For instance, a $1 million portfolio in a 401(k) or traditional IRA might be worth $800,000 or less after taxes. Similarly, income generated by investments in a regular brokerage account may also be subject to taxation.
To navigate this tax challenge, consider saving and investing more during your working years to have additional funds for tax payments. Additionally, make tax-smart investment decisions to minimize your tax liability once you reach retirement age.
While there are various hidden costs during retirement related to taxes, some types of retirement income are not taxable. Here are a few examples:
1. Roth Withdrawals: Utilizing a Roth account offers a tax-free way to access your retirement funds. Contributions to Roth accounts do not provide a tax deduction, but withdrawals after age 59 ½ are tax-free. While income limits apply for contributing to a Roth account, converting a traditional plan to a Roth is an option at any time, albeit with tax implications.
2. Inheritances: While relying solely on an inheritance for retirement is not advisable, it can serve as a helpful supplement to existing savings. Inheritances are generally tax-free, except in select states that impose inheritance taxes.
3. Municipal Bond Income: Municipal bonds, used to fund public projects, are typically exempt from federal taxes. Investing in bonds issued by your state can also offer state tax exemptions, making them advantageous for residents of high-tax states.
By understanding these tax considerations and planning accordingly, you can better prepare for a financially secure retirement.
Investment income is generally safe and tax-exempt. Health savings accounts (HSAs) offer a mix of benefits similar to traditional and Roth IRAs. Contributions to an HSA are tax-deductible, and the account grows tax-free. Withdrawals for qualifying healthcare expenses are tax-exempt, but non-healthcare withdrawals incur a 20% penalty before age 65. After 65, HSA funds can be withdrawn penalty-free for any reason, with income tax applicable for non-healthcare use. Social Security benefits may be taxable based on income and filing status. Joint filers with incomes over $32,000 may face taxes on up to 85% of benefits. Life insurance proceeds are tax-free when received as a lump sum.
