Death and taxes are two facts of life that one must accept. Based on that, understanding taxes in retirement can help you put in place tax-efficient strategies that will minimize their impact.
The first key to understanding the answer is to know that in retirement, all those years of saving into tax-deferred accounts (401Ks, IRAs, SEP IRAs, etc…) still have a tax consequence. At some point, the government requires that money be withdrawn, and taxes paid, known as a required minimum distribution (RMD). Under recent legislation, the required age for taking distributions changed from 72 to 73 for 2023. Adding a year to the RMD age can be a double-edged sword as it allows you to defer taking money out but also provides additional time for your account balance to potentially grow, resulting in a larger tax bill once RMDs start. By 2033, the RMD age is set to increase to 75, allowing an additional two years beyond the current required age for the balance to continue growing. Also, larger distributions can trigger Medicare’s income-related monthly adjustment amount, leading to higher premiums for Medicare Parts B and D.
In addition to any tax-deferred accounts with RMDs, retirees are usually surprised to find how many other sources of income they may have in retirement. These forms of income include pensions, part-time work, passive income, and social security. With social security, up to 85% of the benefits are taxable on top of the previously mentioned other sources of taxable income.
Another overlooked aspect of retirement is that distributions are often not taken out evenly over time. You may often experience significant one-time expenses that push you into a higher tax bracket based on the distribution needed to pay for that expense.
Finally, it is essential to remember that the tax code is subject to change. Historically speaking, we are in a low tax rate environment. Tax rates are scheduled to increase after 2026 with the expiration of the Tax Cuts and Jobs Act. Even if Congress decides to extend or adjust keeping the rates the same or lower, it is likely a matter of time before rates change.
As you can see, taxes in retirement can be complicated. Working with a local CERTIFIED FINANCIAL PLANNER™ professional ensures that you work with someone with the education, experience, and ethics necessary to answer this question. Take the first step in building a financial plan today by reaching out and scheduling an appointment, or learn more about Why Valiant Wealth is the right fit for you.