How You Can Face Dire Consequences Not Planning For Taxes In Retirement
After saving up as much as possible for retirement, it is understandable that you want to keep as much money as possible to support you when you are no longer working. In the process of planning for retirement, I am sure you have budgeted or ballparked a number that you will need to spend each year when a retiree, but many people tend to forget about the taxes they may be liable for, which can eat up a good amount of your savings.
We will go over some very common errors people make that can hurt your retirement fund.
One big mistake is that people do not calculate what they will have to pay in taxes for their tax-deferred accounts such as a traditional IRA or 401(k). You receive the tax-deductible the year that you contribute the money to your account, but you will need to pay the income taxes on it when you touch these accounts during retirement.
Not planning out an estimate on what you might owe on taxes can be very dangerous because you might have to make more money than what you had budgeted to cover your expenses so that you can also take care of your taxes. This can have you end up with no money for the later years that you expected to have money for.
To prepare yourself for taxes, you will not only need to estimate what you would pay federally but at the state level as well. Be sure to do some research on what your state taxes for retirement income and how much as this can vary from state to state. After this, you will have to consider what tax rate you will be facing in retirement. If you think you might be spending more than you do now, you may have a higher tax bill than you do now. If you believe your expenses will be mostly the same as it is now, you should expect a very similar tax amount to pay.
There are many financial experts that believe that tax rates will go up in the future due to deficits we have regarding our national budget, so many investors are rolling over their traditional IRAs to Roth 401(k)s or Roth IRA. This has them pay taxes now on the current tax rates so that when they make withdrawals during retirement, they do not have to worry about taxes.
Another source of income during retirement–for many, the one that they rely on the most–is benefits from Social Security. If you are receiving a significant amount of income during retirement, a portion of your benefits may be subject to federal income tax. There are also states that will tax your Social Security payments, so be sure to do some research on your state tax laws. There are also calculators out that can estimate what your SS benefits will be and how much you may be expected to pay taxes on them.
You can also calculate on your own how much you may be expected to pay on federal income tax. The formula to calculate your benefit amount is based on your combined income, which is 50% of your annual benefits and 100% of any other income you may receive. Those that are single filing retirees and have an income of less than $25,000 a year are exempt from paying federal taxes on their SS benefits. Those that are married and are filing jointly are exempt from paying taxes on their benefits if they only have a combined income of $34,000 a year. For single filers that have a combined income between $25,000 to $34,000 may be liable to pay taxes on up to 50% of their SS benefits. For joint filers, this will be from $32,000 to $44,000. And if single filers bring in more than $34,000 in combined income, they can be subject to pay taxes on their benefits up to 85%. The range for joint filers is if they have a combined income of more than $44,000.
If your annual combined income in retirement will be more than the limits above, you can breathe easily to know that the tax cap is at 85% of your benefits.
However, it is crucial to plan for how much you may have to pay for these taxes so that you know where you need to be for your annual retirement budget.
Another common mistake for retirees is not fully knowing and understanding how required minimum distributions (RMDS) work. Once you reach the age of 72, you are required by the IRS to take a certain minimum amount of money from your traditional IRAs or 401(k)s. This is so that the government can start receiving the tax payments that you have deferred for these accounts.
Even if you do not need to access these accounts at age 72, you will have as it is required by law. If you do not take RMDs by the required age limit, you could face a penalty of 50% of the amount that you needed to withdraw. For instance, if you have an RMD of $15,000, you would have to pay $7,500 in penalty fees if you did not take the required amount that year.
The first year that you have to take an RMD, you will need to make the withdrawal until the 1st of April the following year that you reach age 72. After the first RMD, you will have to take this minimum amount out of your account(s) each year before the 31st of December.
For those first-timers, if you withdraw your first RMD right around the deadline of April, you will have to take another RMD before the 31st of December of that same year. This can have an expensive consequence as having to take out two RMDS within a year could place you in a higher bracket for taxes. So be sure to time things correctly, so that you did not get hit with lofty tax rates.
Be sure that in your retirement planning that you really research what kind of taxes and how much you may have to pay so that you can be sure that you have enough money to cover your expenses and enjoy your retirement years.
