Most people know that the sooner you begin saving for retirement the better, but not many people have thought ahead and prepared for the impact of taxes in retirement. To start, you need to understand the tax treatment of your different income sources in retirement. This article dives into understanding the tax
impacts on withdrawals, how to handle withdrawals under the CARES Act, and the benefits of tax diversification.
How to plan a withdrawal
Depending on the size of your withdrawal and your account type, the withdrawal can put you into a higher tax bracket.
Let’s start with traditional accounts – these are typically your traditional IRA and 401(k) accounts which are funded with pretax dollars. This means you are deferring paying taxes on the income you contribute to them until a later date. When you begin to make withdrawals, those amounts must be included in your taxable income for the year, when you add this to your other retirement income, this may push you into a higher marginal tax bracket. Roth accounts are different (which likely include Roth IRA accounts) and are funded with after-tax dollars. While you can withdraw your contributions from a Roth-type account at any time, with no tax implications, your investment earnings will only be tax-free if you are at least 59½ years old and have held the account for at least five years before your first withdrawal. Otherwise, any investment earnings you withdraw will be added to your income for the year and taxed at your normal income tax rate. You may also incur an additional 10% penalty.
If you have both traditional and Roth accounts, and don't want to pay any more tax than you have to, consider limiting your traditional account withdrawals so that they won’t be taxed at a higher marginal rate, then supplement that income as needed with tax-free withdrawals from your Roth accounts. However, don’t forget that you may not have total control once you reach the age when your traditional accounts are subject to RMDs.
Withdrawals Under the CARES Act
The Benefits of Tax Diversification
One of our priorities at Client First Capital is coming up with a plan that supports your goals. We specifically look at your short-term and long-term goals and make sure your financial plan aligns to them and then layer in how to maximize savings and minimize taxes. Please feel free to connect with us by sending an email or filling out our contact forms.