Wealth Management & Financial Planning

Wealth Management & Financial Planning

How Taxes Impact Your Retirement

Taxation is as much a part of retirement as it was during your working years. The basics remain consistent but how your money is taxed annually changes dramatically. We have devoted the last seven weeks and the next three weeks to walk you through how to retire on $500,000. There is nothing we have witnessed that can separate you from your retirement faster than misunderstanding the Internal Revenue Service (IRS) policies.


Eventually, you will begin to collect Social Security benefits. The longer you wait – up until age 70 – the greater the benefit grows. Taking it early at age 62 reduces your monthly benefit for life. Regardless of the strategy you use – there are several available – the taxation remains the same.


Social Security is not subject to the FICA taxation you paid while earning income. That would be a tax upon a tax in the eyes of recipients. The payments are subject to the marginal tax rate but only up to 85% of the amount you receive is taxable. The less you make including all income, the less your Social Security is taxed.


The money coming out of your investment accounts that are inside of IRA’s and your Defined Contribution plans (401k’s, 403b’s, etc.) are going to be fully taxed at your marginal tax bracket. You will not pay FICA taxes on those dollars, but you will pay 100% of the marginal rate after your standard or itemized deduction on that income.


Marginal rates are like stair steps ascending into the air. The higher the total income the higher you climb and the larger the percentage you pay to Uncle Sam. The top bracket is currently 37%. Most families in central Indiana that we represent have the $500,000 in retirement accounts we are discussing are at the 12% marginal rate.


Taking your Social Security earlier than required can force the rest of your retirement to be taxed at a higher percentage. Families without professional assistance often opt to take Social Security early and wait to tap their tax-deferred accounts until age 70.5. This in many cases creates a nightmare delivered by the tax Grinch in April next year.


Money saved outside of your tax-deferred accounts will be taxed differently. Interest earned at a bank is taxed like your other income. Money from an annuity is taxed like your IRA money above. Stocks that you have bought may have dividends, they may be qualified, and you may sell or keep those stocks until needed.


The dividend is taxed at a lower rate if the company that issues the dividend is qualified. Long term capital gains rates – coming from selling an investment for more than the price you purchased it – are also taxed a rate lower than your marginal rate and can even be zero!


Ignoring taxes in your retirement is akin to not paying attention to termites in your house. They may not be a problem today, but your future becomes far less steady without a great long-term strategy.


Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see our Disclosure page for the full disclaimer.

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