Most people planning for retirement concentrate on growing their nest egg and accumulating as much as they can to live comfortably and enjoy their free time. However, that plan is flawed. It’s not just about how much money you’ve saved for retirement, it’s how much you get to keep after taxes.
To optimize your savings, you need to build a tax-efficient portfolio. It should contain the following:
- Tax-efficient investments. These are investments with the lowest taxes compared to their interest or dividend income;
- Tax-efficient withdrawal strategies. Use differently taxed accounts that offer flexibility for income purposes; and
- Tax-efficient planning. Get a long-term tax plan that focuses on lower taxes over your entire retirement, not a given year.
Don’t Pay Triple Taxes. Retirees who don’t plan effectively for distributions from IRAs or other qualified plan distributions could easily pay three times their tax rate. You can avoid this by taking control over how much income you pay yourself. Your spending needs may be less, so you can keep that amount low by managing your income sources effectively to get the most tax efficiency over your lifetime.
Understand Your Tax Bracket. As a retiree, you need to stay within the 15% tax bracket for the rest of your life. Effective tax planning must begin in your first year of retirement. Don’t assume your tax plan is ideal if you don’t “fill” the entire 15% tax bracket in your early retirement years. The goal is to “fill” every retirement year with taxable income to the upper limit, even if you don’t need that income.
Retirees are converting qualified money (pre-tax dollars) into nonqualified money (savings on which taxes have been paid). This has been done at a very low tax rate, and the growth associated with these will no longer be taxed.
Make tax planning a priority to keep more of that nest egg.
Reference: Kiplinger (July 2017) “Keep More of Your Retirement Savings with Tax-Bracket Planning”