One of our favorite pieces of advice in the retirement planning world is, “Save as much as you can!”. Since the IRS provides so many tax breaks for those who save for retirement, you might as well take maximum advantage of all possible savings opportunities.
But for some people, there might be a catch: When you retire and begin taking distributions from your retirement plans, you begin paying taxes on all that pre-tax money you set aside in earlier years. And the larger your annual distributions are, the more likely it is that you will end up owing taxes on the money. You don’t want to nullify all of the tax savings from your working years, so what can you do?
One thing you should do, while preparing for retirement, is to calculate your expected tax bracket once you begin taking these distributions. Will you be in a higher tax bracket during retirement than you are right now? This could cause you to pay more to the IRS each year. Not to mention, your Social Security benefits could be taxed, and income-based Medicare premiums may be set higher as well!
If you suspect you may be in a higher tax bracket once you reach retirement, you may need to changes your savings strategy toward the end of your career. It may be more beneficial to set aside after-tax money in a Roth IRA. The money is taxed now, as you earn it, and then it is not taxed when you take distributions from the account in retirement.
If this sounds confusing, you can see why periodic consultation with your financial advisor or a tax professional are so important. You should be meeting regularly to run a projection of your retirement income, discuss your goals, and work together to find solutions to complicated tax problems. If you take action now, you can shelter more of your retirement income from taxes before you ever have to worry about it.
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