NEW YORK (2/4/14)--Baby boomers are headed into retirement with unprecedented tax liabilities unless they look ahead with careful pre- and post-retirement tax planning (Reuters
While tax-deferred retirement accounts such as 401(k)s and individual retirement accounts gave pre-retirees a welcome tax deduction when they were putting money in, those accounts may turn into a tax curse later. Boomers who concentrate all retirement savings in tax-deferred accounts will be paying income taxes on most of the money they live on.
Social Security benefits also are taxed, under a complicated formula. For single taxpayers with earnings (including half of their Social Security benefits) over $25,000, 50% of benefits are taxed. For joint filers, the threshold is $32,000. At incomes above $34,000 for singles and $44,000 for joint filers, 85% of benefits will be taxed. Bottom line: You'll pay a tax on at least some of your Social Security benefits unless your income is very low.
Ease your future tax burden by planning ahead:
Diversify your tax buckets. Do this before you retire: Continue feeding your 401(k) at least up to the level of your employer match, but also take advantage of a Roth IRA if you qualify. Once you retire, you want some investments in an after-tax account for tax-free withdrawals.
Leave it to Roth. If your estate plan includes children, leaving them with a Roth IRA is better tax-wise than a traditional IRA.
Set a steady pace. Although spending in retirement won't be even-keeled your withdrawal rate should be, to a point. You may take expensive trips or purchase a new car in some years, but keeping withdrawals steady avoids pushing yourself into higher tax brackets with tax-deferred withdrawals during those high expense years.
Take advantage of low tax brackets. For 2014, a single person is in the 15% marginal tax bracket until her income reaches $36,900, then she jumps to the 25% marginal tax bracket until she reaches $89,350 in income ($73,800 and $148,850 for couples filing jointly). For example, a married couple who typically is in a high tax bracket and has only $50,000 of taxable income in a year may decide to withdraw an additional $23,000 from a tax-deferred IRA so it's only taxed at the low 15% level that year.
Protect your tax breaks. Generally, for many retirees the most efficient strategy is to take withdrawals first from taxable accounts, then from tax-deferred IRAs, then from Roth accounts. However, rather than emptying your taxable accounts just to protect all of your IRA, consider generating just enough withdrawals from the IRA to keep your tax rate low.
For related information, read "Retirement: More to Prepare Than Finances" and "Inherited IRAs, Gifting, and Taxes" in the Home & Family Finance Resource Center.