Today’s retirees face many obstacles, from an unpredictable market to a lack of guaranteed retirement income. While these are important challenges that need to be addressed, they would be rejected from ignoring their future tax burdens. We are likely to see increased taxes in the future, and this will affect retirees today more than tax increases have affected retirees in the past.
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Pension then against now
Today’s retirees are the first generation of IRAs: while previous generations could rely primarily on social security and pension benefits to cover their retirement costs, many today’s retirees have to fund a much larger portion of their pension through their own pre-tax accounts. Read also : Still time for 2020 contributions | Lifestyles. While retirement accounts such as 401 (k) and the IRA have significant benefits, they also have disadvantages, namely that all retirement withdrawals are taxed as regular income at current tax rates in our country.
This means that if tax rates were to rise, retirees living off the IRA would have to pay more taxes and therefore live on a lower income after tax. Previous generations saved their money in accounts after tax, which means that if tax rates were to rise, it would not affect them in the same way as this generation of IRAs. When we look at the history of taxes and the proposals of the Baiden administration to increase taxes, it is clear that retirees must have a plan to reduce taxes.
Can we see a tax increase?
We need to plan tax rates for the future, not for the present. Earlier, tax increases primarily affected those who earn. See the article : Proposal would require businesses with 5 or more workers to offer retirement savings plan. The increase in payroll taxes and the increase in social security taxes had little effect on social security beneficiaries and retirees who saved on accounts after tax. However, this affects those who take over the distribution from a deferred retirement account and who invest in the market both increase in income taxes and new taxes.
This could include:
- Possible removal of the favorable long-term capital gains tax rates for the richest investors. This could mean that those with an income of $ 1 million or more can pay up to 39.5% on profits, instead of the current maximum rate of 20%.
- Reduction of the current standard deduction. Many retirees do not specify their deductions and rely on the standard deduction. Therefore, if the current standard deduction is reduced, taxes for people may increase.
- Introducing a payroll tax on social security for workers or households earning more than $ 400,000 a year. This tax – in which employers and employees pay 6.2% each and the self-employed pay a full 12.4% – helps pay social security benefits.
- Lowering the federal property tax exemption, which could affect properties above about $ 5 million.
Retirees should note that we may now have tax rates at the lowest centennial lowest rates and that this could end in light of recent increased government spending. Our already large government debt increased during the pandemic, and the CARES 2020 Act cost $ 2.2 trillion, and the U.S. Rescue Plan Act of 2021 cost $ 1.9 trillion. We will eventually have to pay for it, and retirees with large tax-deferred IRAs could be the ones to do it.
When we look at history, we see that after a period of increased government spending during World War II, income tax rates in the following decades were much higher than they are now. 1944 the highest rate reached 94%, and by 1964 it had shrunk to only 70%. This does not mean that an individual’s tax class will go from 22% to 70%, but in between there is a lot of room where retirees could feel the effects.
When preparing a financial plan, retirees need to calculate how much taxable income they will have and how much will remain after tax. If tax rates increase, retirees may have to withdraw more from their taxable retirement accounts to stay with the same amount of income, eventually drawing on savings faster.
RMD
Retirement income taxes can become more burdensome starting at age 72. This may interest you : 3 Social Security Secrets That Could Leave You Richer in Retirement – Nasdaq. Most retirees must take the RMD (required minimum distributions) from their traditional retirement accounts starting at age 72, and the amount they must withdraw is based on their age and account balance.
RMDs could force someone to withdraw more than is usual from their deferred retirement account, leading them to jump into a higher tax bracket. Retirees under the age of 72 should plan carefully so that they can reduce this effect by the time they reach this age. (Read the idea below on how to do this.)
Taxes and your inherited goals
RMDs can also potentially increase the tax burden on users due to the SECURE law passed in 2019. The “stretch IRA” has been completed, which has allowed beneficiaries to extend the distribution from the inherited pension account during their lifetime. Now most non-spouse users must clear traditional accounts within 10 years of the death of the original owner.
Those looking to forward their retirement accounts should consider tax reduction strategies when drafting a property plan. One possibility is charitable remnant of trust.
What can retirees do to prepare for higher taxes later?
Those who will deduct a significant portion of their retirement income from a taxable pension account should take this into account and work to reduce the overall tax burden. There are many strategies I can apply, including converting part or all of their traditional 401 (k) or IRA into a Roth IRA. This includes paying tax on the converted amount and its eventual withdrawal from Roth tax-free. If we see taxes increase in the future, Roth’s conversion at today’s rates could potentially be a good strategy for those whose tax burden will not be significantly reduced in retirement.
In addition to providing non-taxable income, Roth is also exempt from RMD. This means that money in a Roth IRA can grow during the owner’s lifetime tax-free. When inherited, the user will have to empty the account in 10 years, as with a traditional IRA. However, distributions from traditional IRAs, distributions from Roth IRAs are not taxable and will not have a penalty for early withdrawal as long as the account is at least five years old.
Bottom for retirees
Retirees who have both traditional and Roth IRAs can strategically withdraw from each to avoid entering a higher tax bracket, continue to reap the tax benefits of a retirement account after age 72, and transfer potential non-taxable wealth to their beneficiaries. Those who think they are on the verge of a tax increase and who do not plan to live on a significantly lower retirement income should consider tax minimization strategies, such as Roth’s conversion.
Investment advisory services offered by Epstein and White Financial LLC, SEC investment advisor. Epstein & White Retirement Income Solutions, LLC is a licensed insurance agency with the California Department of Insurance (# 0K53785). As of March 31, 2021, Epstein and White are now part of Mercer Global Advisors Inc. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm operates only in countries where it is properly registered or is excluded or exempted from the registration requirement. The information, suggestions and recommendations contained in this material are for informational purposes only and cannot be relied upon for any financial, legal, tax, accounting or insurance purposes. Epstein and White Financial is not a certified public accounting firm and no part of their services should be construed as legal or accounting advice. Please consult with your accountant and financial planning expert to determine how tax changes affect your unique financial situation. A copy of Epstein & White Financial LLC’s current written disclosure statement, which discusses advisory services and fees, is available for review upon request or at www.adviserinfo.sec.gov.
Founder and CEO, Epstein and White Retirement Income Solutions
Bradley White is the founder and CEO of Epstein and White. He is a Certified Financial Planner and holds a bachelor’s degree in finance from San Diego State University. He is a representative of an investment advisor (IAR) and a professional insurer.
