As many retirees are often unaware, taxes can have a significant impact on their savings when they begin to withdraw funds from pretax accounts. A study conducted by Northwestern Mutual revealed that only 3 in 10 Americans have a plan in place to reduce taxes on their retirement savings. One effective strategy to minimize the tax burden during retirement is the “bucket strategy.”
Certified financial planner Sean Lovison emphasizes the importance of strategically receiving more income in lower-earning years to optimize tax savings. For instance, individuals in the 12% tax bracket before collecting Social Security can take advantage of Roth IRA conversions to reduce future tax liabilities. By transferring pretax or nondeductible IRA funds to a Roth IRA, individuals can avoid taxes on withdrawals in the future, although they will incur upfront taxes on the converted balance. Aligning the conversion amount to land in the 22% or 24% tax bracket can be more advantageous than facing higher tax rates once Social Security benefits and required minimum distributions come into play.
With the Secure 2.0 legislation delaying the age for required minimum distributions (RMDs) to age 73 in 2023 and age 75 in 2033, pretax 401(k) and IRA balances are continuing to grow. This poses a significant concern for many individuals who fail to consider the implications of taxes on their retirement savings. Financial experts, including CFP Judy Brown, emphasize the importance of tax planning during both the accumulation and distribution phases of retirement planning to avoid unexpected tax liabilities in the future.
To effectively manage tax liabilities in retirement, it is essential to diversify tax-advantaged accounts, including pretax, Roth, and brokerage accounts. By strategically contributing to these accounts, individuals can create a tax-efficient withdrawal strategy in retirement. This tax diversification approach provides flexibility and allows retirees to adjust their adjusted gross income based on tax brackets, thereby optimizing their overall tax position during retirement.
Overall, the key takeaway from the insights provided by financial experts is the critical importance of tax planning throughout the retirement planning process. By proactively managing tax liabilities during both the accumulation and distribution phases, individuals can maximize their retirement savings and minimize the impact of taxes on their financial well-being. It is imperative to consider various tax planning strategies, such as the bucket strategy and Roth IRA conversions, to achieve tax efficiency and financial security in retirement.