Think about all the money you have in your tax-deferred savings accounts (like IRAs) and in company-sponsored plans, such as 401 (k) s and 403 (b) s.
Now think about having a loan against them. This loan is the money you owe the IRS when you start collecting distributions on these accounts.
How much interest will you pay on this loan? In other words, what tax rate will you pay on the money you withdraw from your tax-deferred accounts in retirement? With proper planning, you can have your say over this number. If taxes aren’t part of your financial plan for retirement, then your plan is incomplete and it might be time to speak with a financial advisor who prioritizes tax planning.
Taxes will increase by law when the Tax Cuts and Jobs Act 2017 expires after 2025. It is quite possible that taxes will rise further due to the huge national debt we have accumulated. Therefore, you need to ask yourself these questions:
- Do you know your tax payable?
- Do you know how much the amount you owe the IRS will increase in the near future?
- Do you know what the tax impact will be when your spouse inherits your tax-deferred accounts, or when your children inherit them?
If either spouse dies and leaves these tax-deferred accounts to the surviving spouse, that surviving spouse becomes a single taxpayer and their rates are significantly higher. And when children inherit a tax-deferred account, their tax burden can also increase. Because of SECURE Act, most beneficiaries are required to withdraw their assets within 10 years of the death of the account holder, rather than for the rest of their life. So, at the age when most children inherit money from their parents, they are probably in the highest tax bracket of their lives.
On the bright side, when you work with a licensed financial advisor, you can create tax-free retirement accounts, lower your overall tax burden, and ease the burden on your beneficiaries. Here are some effective ways to tailor your pension plan to tax considerations:
- Roth IRA. The best way to have tax free income is to pay taxes on retirement accounts before you withdraw the money. And the best way to do that is to contribute to a Roth during your working years. While your contributions to a Roth IRA are not tax-deductible as they are with a traditional IRA or employer-sponsored 401 (k) plan, distributions made after age 59 and a half are typically tax exempt. The specter of higher taxes in the future is forcing many people to make Roth conversions – taking money out of a tax-deferred account and putting it in a Roth IRA. Roth’s maximum annual contribution in 2021 and 2022 is $ 6,000, plus $ 1,000 if you turn 50 at the end of the tax year.
- Health savings account. HSA contributions are tax-deductible, account gains increase tax-free, and withdrawals used to pay qualifying medical expenses are also tax-free. You can contribute $ 3,600 to an HSA in 2021 ($ 7,200 for family coverage). If you are 55 or over, you can contribute an additional $ 1,000. For 2022, these limits are respectively $ 3,650 and $ 7,300.
- Municipal bonds. These are issued by counties, cities and states to fund public projects. Interest you earn on municipal bonds is generally not subject to federal tax. And if the bond is issued in your state of residence, it may be exempt from state tax.
- To give. A smart way to make sure your money stays with the family is to give it to your heirs while you’re alive. For 2021, the IRS allows individuals to give a maximum of $ 15,000 per person per year in gifts, and in 2022 that number will increase to $ 16,000. This money is tax free for the beneficiaries.
- Charitable donations. This is another effective way to reduce the value of the estate and the related taxable amount. The Qualified Charitable Distribution (QCD) rule allows traditional IRA owners who are at least 70 and a half years old to deduct their required minimum distributions from their tax returns if they donate the money to a charity. All traditional QCDs must be done directly at the charity and are capped at $ 100,000 per year per person.
Learning the tax rules and strategies before retirement can make a significant difference in how much you owe the IRS, how much you keep, and how much you enjoy in retirement.
Dan Dunkin contributed to this article.
Founder, Networth Advisors LLC
Beth Andrews (www.networthadvisorsllc.com) is the founder of Networth Advisors, LLC. She has more than 20 years of experience in the financial services industry as an investment advisor and insurance professional and holds the titles of CPA and CERTIFIED FINANCIAL PLANNER ™. She is the author of “Networth for Retirement: Everyone Deserves a Confident and Independent Retirement” and has her own radio show called “The Networth Financial Hour Radio Show,” which airs on WPGP, WJAS and WPIT.
The appearances in Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger has not been compensated in any way.
Networth Advisors LLC is a registered investment adviser. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to consult with a qualified financial advisor and / or tax professional first before implementing any strategy discussed here. Past performance is not representative of future performance.