While many people tend to think of retirementas binary—either they are retired or they are not retired—retirement, in general, is usually better understood as something that occurs in distinct phases. Each of these phases presents unique financial challenges and opportunities that will need to be addressed throughout the process of retirement planning and tax planning.
If you are retired or are approaching retirement, it is important to recognize the variables that make these years unique. For example, while younger professionals are generally more concerned about amassing wealth, retirees will need to consider things such as the liquidity and diversification of their current holdings. Furthermore, retired individuals will need to think about how their wealth is being taxed and anticipate possibly hidden retirement taxes. In fact, taxation is often one of the reasons people end up with a much smaller nest egg than they originally anticipated.
Below, we’ll discuss the four distinct stages of your retirement and the financial challenges each of these stages might create. We’ll also specifically discuss phase-specific taxes to be aware of and how tax planning today can positively impact retirement tomorrow.
By taking the time to understand what makes each of these stages unique, you’ll be most more likely to have the retirement you deserve.
Pre-Retirement Tax Planning
The pre-retirement phase begins at the onset of your working career and extends up until the day you retire. During this period of time, your goal is to accumulate enough wealth to retire comfortably, while also being able to address various financial challenges, obligations, and opportunities that occur over the course of your life.
If you are years, or even decades, away from retirement, it can be difficult to make long-term saving a priority. Putting a down payment on your home, paying for your children to go to college, and simply paying your monthly bills are just a few of the things that might seem more urgent. However, to the greatest extent you possibly can, it is important to begin contributing something every month as early as possible.
That being said, you want to make sure you are contributing to your retirement savings strategically. If your employer offers matching retirement contributions, you should always try to take advantage of it—this is about the closest thing to free money you’ll find over the course of your career. If your employer doesn’t match contributions or you max out your contributions but still have funds to contribute to your retirement, then you will need to consider carefully how best to invest those funds.
Some retirement accounts are funded with pre-tax dollars, like 401(k)s, while others are funded with after-tax dollars, like Roth IRAs. Ultimately, you will want to have a diverse array of accounts to draw from in retirement in order to have greater control over your annual tax bill. As you decide when to open different accounts and how much to contribute (or whether to contribute at all) each year, you should consider your past, current, and anticipated future tax brackets.
Finally, during the pre-retirement phase, take advantage of deductions and credits available to people who are actively saving for retirement. For example, the Saver’s Credit can be claimed by eligible taxpayers to offset a portion of their contributions.
Tax Planning for the Go-Go Years
The term “go-go years” is used to describe the first decade or so of your retirement. You have been working hard for decades, carefully saving, and have finally reached a major life milestone. You deserve to take some time to celebrate and enjoy the fruits of your labor.
Whether you’re moving to Florida, traveling the world, pursuing a life-long interest, or anything else, it is very likely that these years will consist of relatively large amounts of spending. Be sure to think about whether and how withdrawals from your retirement accounts could affect the tax bracket you’re in. If possible, try to minimize withdrawals and access capital from sources that have already been taxed. Even better, try converting some or all of your IRA into a Roth account, helping to reduce future taxes.
You might also need to think about new expenses, such as healthcare coverage. If you are no longer covered by your employer’s plan and are not yet eligible for Medicare, you may need to purchase some additional coverage. Other expenses you might be surprised by include capital gains taxes that come from selling your home, taxes that come from liquidating stocks, and other possible expenses. If you haven’t already, be sure to speak with a financial advisor so you can develop a comprehensive plan.
Tax Planning for the Slow-Go Years
After a decade or so of retirement, your pace of living will begin to slow down. This usually means that luxury expenses will decrease, but other, less-glamorous expenses might begin to appear. Eventually, there will be a tax penalty for not taking your social security, which means this is the time of your life you should rely on social security as a leading source of retirement income.
Social security withdrawals can affect which income tax bracket you fall into. Your job will be to carefully minimize your tax liabilities while still making sure you are taking at least the minimum withdrawals. During the slow-go years, you might also need to consider things such as Medicare taxes, pension expenses, liquidation complications (and corresponding taxes), and supplementary insurance policies.
You may also find that it’s time to sell your vacation home during the slow-go years, as you begin to travel less and less frequently. Talk with your advisor about strategies to minimize your capital gains taxes.
Tax Planning for the No-Go Years
None of us know with certainty just how long we will live, which is why planning for the very distant future can be difficult. If you retire at 65, living an additional thirty years instead of an additional twenty years can create a complicated financial picture. Investing in annuities, long-term care insurance, universal life insurance, and other perpetual assets can help reduce the risk of running out of money before you run out of life.
Each of these unique financial assets will be taxed, which is why—once again—it is important to think about your after-tax wealth, rather than what you are able to see on paper, right now.
Furthermore, during these years, you’ll want to plan your legacy. Meeting with an estate attorney to address final costs such as funeral expenses, late medical expenses, and inheritance taxes will make it much easier for you to pass your wealth on to those you love most.
Retirement can last for decades—without planning in advance, you are much more likely to run into various financial challenges. However, by making an active effort to address the different stages of retirement and the unique financials that come with each, you will be in a much better position to enjoy your golden years without added stress.
Tax planning is a critical but complex part of the retirement planning process. That is why the financial advisors at Advanced Retirement Strategies help our neighbors in and around Bountiful, Utah make the most tax-efficient choices as they plan, transition into, and live through retirement.
If you are within ten years of retirement and have over $250k in assets, click here for a free retirement review from Advanced Retirement Strategies to gauge the efficiency of your investments, income plan, and tax strategies.