As financial advisors, our job at Price Financial Management is to help individuals and families prepare for retirement and ensure their financial well-being in the years ahead. Once you reach retirement, though, it’s not time to stop thinking about your finances completely. In fact, retirement finances can be even more complicated, with people receiving many different types of income, all taxed at different rates. Fortunately, by coming up with a strategy ahead of time, it’s possible to avoid some of the common tax pitfalls during retirement.
Here are some major tax challenges people encounter during the retirement years — and how to avoid them.
Failing to Have Diverse Income Sources
Many retirees are reliant on income sources like 401(k)s, which are taxed as ordinary income. There is frequently an advantage to having sources of post-tax income like a Roth IRA, whose distributions are tax-free. By having a mix of income sources, you can lower your overall taxable income and minimize your tax burden.
Paying Unnecessarily High Capital Gains Taxes
The amount you pay in long-term capital gains tax depends on your annual income. A retiree might choose to draw less money from sources like a 401(k) in a given year, for instance, so that they end up in a lower income-tax bracket. This would allow them to then sell long-term securities at a lower capital gain tax rate. (Capital gains are taxed at either zero percent, 15 percent, or 20 percent, depending on income, which is why it can be advantageous to sell long-term securities in years when ordinary income is low.) This is another reason why having diverse income sources is so important: It can help ensure you’re in the most advantageous tax bracket for your current financial state.
Not Thinking Strategically About Your Withdrawals
Retirees should be thinking strategically about when to start taking withdrawals from retirement savings or claiming Social Security. While it’s possible to begin receiving Social Security payments as early as 62 years old, this is often not the best option. Income tends to be higher at this age, meaning you’ll be paying a much higher tax rate on this money you receive than if you had waited until age 73, when required minimum distributions begin.
Failing to Take Your Minimum Distributions
For many plans like traditional 401(k)s and IRAs, you are required to take minimum distributions once you reach a certain age — usually 73 years old. It’s important to take these distributions, otherwise you could be subject to a penalty tax.
Have other retirement questions? Price Financial is here to help.
As you can see, there’s a lot to keep track of when it comes to retirement finances. At Price Financial Management, we help set clients up for retirement. We also provide advice once they reach retirement on how to minimize their tax burden. Contact us today to learn more about how we can help your finances at all phases of your life.