Avoid Tax Surprises in Retirement

Too many people underestimate the effect of taxes on their retirement income. But with proper planning, there may be ways to help reduce your tax exposure.

Practice Tax Diversification

Tax diversification means dividing your assets into three different buckets:

1. Taxable. Examples include credit union or bank savings accounts and brokerage accounts. Gains and income are taxable in the current year. Long-term gains and dividends are taxed at lower rates.

2. Tax-deferred. These include traditional IRAs, 401(k)s and 403(b)s. In these accounts, income and capital gains are generally deferred until you take money out. Withdrawal amounts get taxed as ordinary income and if taken before age 59½ an additional 10% tax penalty may apply.*

3. Tax-free. You can build up your tax-free bucket by contributing to Roth accounts or by converting traditional IRA assets into Roth assets. You’ll pay income taxes on the balance you convert, but growth in your Roth account is tax-free from that point.

Avoid the Social Security Tax Trap

Many retirees are shocked to discover that up to 85% of their Social Security benefits are taxable if their income rises above a certain threshold. To help prevent this, minimize taxable income, and maximize any income that is tax-free, while taking Social Security.

Your financial and tax professionals may be able to help you to structure your retirement income, potentially reducing tax exposure while preserving your Social Security benefits.

*The CARES Act suspended the 10% early withdrawal penalty for 2020.