In the retirement income planning world, we often suggest people to save as much as they can for retirement. You might as well set aside as much tax-deferred funds as the law allows, because you're saving for retirement while often cutting your tax liability.
But when you retire and begin taking distributions from your retirement policies, you will begin paying taxes on that money. The larger your annual distributions, the more likely it is that you may owe taxes to the IRS each year. If you take especially large distributions, you risk paying more in taxes in retirement than you would have paid during your working years. No one wants to do that, of course, because it nullifies all of the tax savings from earlier years.
So how can you avoid overpaying taxes in retirement? It can be tricky to do, but you may want to calculate your expected tax bracket and compare it to your tax bracket from your working years. If it looks like you could be in a higher tax bracket in retirement, you may end up paying more in taxes. In some cases, your Social Security can also be taxed, and income-based Medicare premiums could be higher.
If it looks like you could be in a higher tax bracket in retirement, one strategy is to change your savings strategy as you near the end of your career. Sometimes it is beneficial to set aside after-tax dollars in a Roth IRA instead. The money is taxed now, as you earn it, and is not taxed when you take distributions later.
This tax problem underscores the importance of periodic consultations with your financial advisor or a tax professional. Meet regularly and discuss your goals and projected retirement income. If it looks like you may end up in a higher income tax bracket in the future, you should work together to create a plan to shelter your retirement income from excessive taxation.
14248 - 2015/3/10
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