Retirement Warning: How Much Your Savings Will Actually Cost You In Taxes
Written by
Adam Palasciano
Edited by
Ashley Barnett
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Retirement should be a stress-free and enjoyable period of your life. You certainly don’t want to worry about taxes, but many retirees could be in for a surprise.
CNBC reported that those who are “great savers” could potentially face a “tax time bomb” in retirement when required withdrawals kick in. Starting in 2023, as per the passage of the Biden administration’s Secure 2.0 Act, retirees must start taking required minimum distributions (RMDs) by age 73. These required withdrawals will be subject to regular income tax rates, depending on where you live. In some cases, these withdrawals can push retirees into higher tax brackets, which means more tax liability.
Northwestern Mutual’s 2024 Planning and Progress Study explained that only 30% of Americans have a plan to reduce taxes owed on their retirement savings. For those savvy enough to think ahead, there are two smart methods to consider to effectively reduce tax liability when you retire.
2 Ways To Reduce Taxes In Retirement
Here are two ways to reduce tax liability on retirement savings withdrawals, according to CNBC:
Withdrawals from retirement funds sooner
In most cases, retirees can start making penalty-free withdrawals from their 401(k)s and IRAs at age 59 ½. Withdrawing funds earlier could help avoid greater tax liability once required RMDs kick in. For example, making withdrawals before you start collecting Social Security can result in lower taxes. Once you’re collecting Social Security and you’re taking RMDs, you could be pushed into a higher tax bracket.
Consider a partial Roth conversion
A Roth conversion transferring pretax or non-deductible IRA funds to a Roth IRA. This results in tax-free future growth of your money, thus reducing your future tax liability. The only caveat is that you’ll owe regular income taxes on the converted balance in the year you elected to make the conversion.
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