Tax Efficiency in Retirement

Will you pay higher taxes in retirement than you did or currently do during your career? Well, it’s possible. Anything is. But the truth is that it will largely depend on how you generate income, where that income will come from, and the tax ramifications for your different saving and investing vehicles. For example, will that income come from that job you picked up to stay social and active while still collecting income? Will it be from retirement plans, whether those are employer-sponsored or your own personal accounts? And if it does come from retirement plans, what type is it coming from? Each of these different accounts has different implications for your taxes, necessitating a comprehensive plan that gives you a clear picture of your potential tax outlook.

Another factor our team at Prime Capital always encourages our clients to consider is the role Social Security plays in your retirement. When do you plan to start to take Social Security benefits? If you have a spouse, when do they plan on taking benefits? You might be surprised to learn that you may have to pay taxes on your Social Security benefit depending on your income. That makes it critical to answer key Social Security benefits questions so you have a better understanding of how it will affect your taxable income.

So, to give you a better understanding of what your tax obligation might be, let’s go over a few key concepts. First and foremost, let’s define a pre-tax investment. Some examples of pre-tax investments include traditional IRAs and 401(k)s designed to help you save for retirement. They’re called “pre-tax” investments because you won’t pay any taxes on the contributions you make to these accounts until you start to take distributions. Pre-tax investments are also called tax-deferred investments, as the money you accumulate in these accounts can benefit from tax-deferred growth. That’s because growth is typically compounded with a higher amount that has not yet been impacted by your tax obligation.

For individuals covered by a retirement plan at work, the tax deduction for a traditional IRA in 2024 is phased out for incomes between $123,000 and $143,000 for married couples filing jointly, and between $77,000 and $87,000 for single filers ^[1].

Keep in mind that once you reach age 73, you must begin taking required minimum distributions from a traditional IRA, 401(k), and other defined contribution plans in most circumstances. Withdrawals are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. All of these rules have the potential to either increase your taxable income or slice the money you can actually use for income, making it pertinent to work with someone who understands how taxes are calculated and how your income is affected by these different vehicles. At Prime Capital, we specialize in offering tax consultation to help you make the most of your retirement funds, and we can analyze your needs to determine if you’re on track to meet your goals.

Now let’s go over after-tax investments. A Roth IRA is probably the most well-known after-tax investment, and just as it appears on the surface, contributions are made with after-tax dollars. Like a traditional IRA, contributions to a Roth IRA are limited based on income. For 2024, contributions to a Roth IRA are phased out between $230,000 and $240,000 for married couples filing jointly and between $146,000 and $161,000 for single filers ^[1].

But what’s the draw to Roth IRAs? Well, because you contribute after-tax dollars, your account grows tax-free. You also get tax-free withdrawals if you qualify, giving you a much better idea of how much you have while also helping you avoid uncertain tax landscapes when projected decades into the future. But again, it’s important to be sure you qualify for tax-free and penalty-free withdrawal of earnings. To do that, Roth IRA distributions must be held for five years, and withdrawals must occur after age 59½. Tax-free and penalty-free withdrawals can also be taken under certain other circumstances, such as the owner’s death. Furthermore, the original Roth IRA owner is not required to take minimum annual withdrawals like they might be with traditional IRAs and 401(k)s.

Remember, this article is for informational purposes only and is not a replacement for real-life advice, which is why we encourage you to work with our team and our network of tax professionals before modifying your retirement strategy. We have studied tax implications, regulations and tools, and we can help you find a custom approach with the goal of allowing you to keep the most money possible.

If you have any questions about your tax obligation in retirement, or the tools you can use to potentially mitigate that obligation, give us a call today at (417) 447-3500.