Retirement Mistake #3

We’re talking about the big mistakes people make. Mistake #1 is not protecting your income. Mistake #2 is taking on too much risk, especially as you’re nearing retirement. Today, we’ll talk about the third big mistake that we see repeatedly, regarding taxes. Mistake #3: People ignore the effects of taxes on their retirement savings.

If you’ve been saving and contributing to lovely accounts like 401Ks, IRAs, 403Bs, 457s, or any tax-deferred account, then you’ve probably heard and have been playing along with the myth that it’s smart to defer now and you’ll pay less in taxes in the future. It’s made to sound like you can save today, pay taxes later in retirement in a lower tax bracket and it’ll all work out great.

Unfortunately, these types of accounts can create problems when you’re retired. Imagine you’re retired and you’re sitting on money in a 401K. If you take out some money to spend and enjoy, what happens from a tax perspective?

First, you’re taxed on the full gross distribution, which typically affects tax on other income sources, such as Social Security. You would be shocked at how many clients and people I meet that think that Social Security is supposed to be tax-free. They assume that when they paid taxes, it goes into the system, and it’ll be tax-free when it comes out. If you’re a young retiree, and you take out $10,000, you pay tax on that at whatever your highest tax rate is, and you pay more tax on Social Security. You get taxed double.

That’s not the only place you’re impacted. It becomes a domino effect and another way it impacts you is through Medicare. If you’re on Medicare premiums, the more you make, the more you pay. If you take $10,000 out of your IRA, you pay tax on that, on Social Security, and if you’re on Medicare, that distribution may put you over the limits. The next thing you know you’re paying more premiums on Medicare. They call it premiums, but it’s just more tax.

Additionally, if you have an investment portfolio and you receive dividends and interest, that distribution from your IRA or 401K might make that more taxable. If you own a rental house, and you’re getting rental income, suddenly you can’t deduct stuff on your rental income like you used to.

When you take money out of a 401K or an IRA it’s like pushing that first domino. Not only do you pay tax on what you take out, but it sets off a bunch of other dominoes that affect you in ways you might not expect. If you’re in the 15% tax bracket or the 20% tax bracket, you might think you just pay 15-20% but you end up paying closer to 25-30%.

I had a recently retired client come in who did a great job of saving, but about 99% of it was in deferred accounts. It is very common for people to have most of their savings in these supposedly tax-advantaged accounts. A lot of people operate under the false assumption that they should save as much as they can in these deferred vehicles. I like to call it bad money because you have a lot of it, but it’s the worst type of savings/money to have, at least from a tax standpoint. It’s awesome when you’re working, but the minute you retire you have a problem.

However, we do an analysis for all our clients that shows them the status quo for continuing along like they’ve been doing. We’ve all heard of that three-letter word, RMD: required minimum distribution. That’s what the IRS has planned for you if you do nothing else. We look at that and quantify that and come up with a plan.

For example, if we have someone retiring with a lot of money in an IRA or 401K, instead of letting them sit back and get hit by the IRS, we plan strategically to reduce those taxes over time. Now is a great time to look at this because we are in a historically low tax-rate environment. We want to transition our clients out of these IRA accounts and deferred accounts, and have our clients pay the tax today. One common method would be exploring Roth conversions. It’s the short-term pain to get the long-term gain. If people don’t do it, when required distributions come, they’re going to get hammered big time.

Another issue can come up in the case of a married couple who files their taxes jointly to get the best tax-rates. If one of them passes unexpectedly, the living spouse can end up with a bad deal; suddenly they have less income and are now a single tax filer. The surviving spouse is also responsible for those same mandatory distributions for their retirement accounts but at a much higher rate. They go from being in the best tax bracket to less income, no spouse, and higher taxes. Having money left in a regular IRA or 401K in this type of situation is like pouring grease on a fire.

Very few people have someone who can look at their future and tell them what tax road they’re on. For most people, when they’re shown that future, it’s not where they want to go. One of the benefits of calling in and getting that Retire, Right Report is the T, which stands for taxes.

We can help you look down the road you’re on and do some smart planning like Roth conversions or other types of planning to get you on a better road. It’s a free and personal analysis. All you have to do is give us a call.





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