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What do you think will be your biggest expense in retirement? Will it be the skyrocketing cost of healthcare and medical expenses? Will it be long-term care, your rent/mortgage, or food? It’s none of these!
Your biggest expense in retirement — (drum roll please) — will probably be taxes!
While you’re wringing your hands over the stock market, or your return on investment, you’re completely ignoring the one thing that could have the biggest impact on your savings and investments. And it’s taxes.
Below are five retirement tax traps that could needlessly cost you thousands of dollars, or possibly more!
Retirement tax trap #1: Social Security
Social security remains to be one of the critical pillars of retirement planning. But most Americans don’t understand they could pay taxes on as much as 85 percent of their social security benefits.
There’s a lot more to claiming your social security benefits than you know. Your decision could trigger an avalanche of taxes; double your Medicare premiums, and even cause you to forfeit additional benefits that are rightfully yours.
If you don’t take all these things into consideration, the money you were counting on to help support you in retirement could be a small fraction of what you thought it was going to be.
Retirement tax trap #2: Withdrawing money from your IRA or 401K
If you hate paying taxes now, just wait until you start withdrawing money from your IRA, or 401K in retirement!
Required Minimum Distributions (RMDs) could force you to withdraw money from your IRA, or 401K, whether you want to, or not! This could unnecessarily cause you to pay even more taxes. And every year it could get worse, and worse.
If you don’t have a strategy for withdrawing money from your retirement accounts, the government could take more than half of your hard-earned money in taxes, penalties and fees.
Retirement tax trap #3: Not using a Roth IRA, or life insurance to minimize taxes
A traditional IRA or 401K allows you to make tax-free contributions. But when you withdraw money from these accounts in retirement, don’t forget you must pay taxes on this money. This could be significant, especially if taxes go up when you’re retired.
A Roth IRA doesn’t allow tax-free contributions, but you pay zero taxes when you withdraw money in retirement. And you don’t have to deal with RMDs. This provides tax-free growth.
Depending on your situation, you could benefit from converting your 401K or Traditional IRA to a Roth. Or simply save a portion of your retirement savings in a Roth, so you could potentially reduce your tax bill in retirement.
Retirement tax trap #4: Not having an estate plan
One of the most important things you could do for the people you love is to have an estate plan.
Because if you don’t have an estate plan, everything you own (including your house, cars, investments, etcetera), could be tied up in courts for a year, or longer. It could cost your estate thousands of dollars in probate and legal fees. And your estate could even get double-taxed by the government.
Why erase what could be decades, if not generations of hard work and sacrifice?
Retirement tax trap #5: not having tax diversification
Tax diversification is one of the most underestimated tax traps in retirement planning.
Don’t confuse investment diversification with tax diversification! These are two totally different things. According to Kiplinger, “You don’t want to own too many assets that are taxed the same way, or at the same time. This accentuates the significance of tax diversification.”
There are three basic tax categories to diversify in:
- Taxed always: These include brokerage accounts, checking and savings accounts. You pay tax on the dividends, interest, or capital gains.
- Taxed later: These include 401K, Traditional IRA, 403(b), real estate, or hard assets.
- Taxed rarely: These include Roth IRA, interest from municipal bonds, and certain types of life insurance.
You may not know this, but you have more control over how much you pay in taxes when you’re retired than any other time of your life!
So, you have a choice — you can do nothing, and needlessly fork over thousands of dollars to the IRS every year. Or you can take advantage of the many legal strategies that are readily available to you, and potentially save yourself a small fortune.
If you have any questions about how you could personally pay fewer taxes in retirement, call us at (801) 829-9797, or click here.