Many retirees overlook the impact of taxes on their retirement savings until it’s time to start withdrawing funds from their pretax accounts. However, financial experts warn that failing to consider tax implications can result in a significant financial setback. According to a study by Northwestern Mutual, only 3 in 10 Americans have a plan in place to reduce taxes on their retirement savings. One effective strategy to minimize tax burden is the “bucket strategy,” as suggested by certified financial planner Sean Lovison.
Lovison emphasizes the importance of strategically managing income to reduce the lifetime tax burden. By receiving more income during lower-earning years and filling each “bucket” or federal tax bracket, retirees can optimize their tax savings. For instance, converting pretax or nondeductible IRA money to a Roth IRA before entering higher tax brackets can be a tax-efficient move. While Roth conversions entail upfront taxes on the converted balance, they can help individuals save on future tax liabilities.
With the Secure 2.0 legislation delaying the required minimum distribution (RMD) age to 73 in 2023 and 75 in 2033, pretax 401(k) and IRA balances are expected to grow. This presents a potential tax challenge for retirees, as higher balances can result in tax implications when withdrawals are made. Certified financial planner Judy Brown also stresses the importance of tax planning during the accumulation phase, highlighting the need for tax diversification through pretax, Roth, and brokerage accounts.
Failure to consider taxes during the accumulation phase can lead to unforeseen tax consequences during retirement. Many retirees realize the impact of taxes only when they start withdrawing funds from pretax retirement accounts, which can significantly reduce the actual value of their savings. By implementing tax planning strategies early on, individuals can better manage their adjusted gross income in retirement and optimize their tax efficiency.
Tax planning is a critical component of retirement planning that should not be overlooked. By utilizing strategies such as the bucket strategy, strategically managing income, and diversifying accounts, retirees can minimize their tax burden and maximize their savings potential. Early consideration of tax implications during the accumulation phase is key to ensuring a financially secure retirement. It is essential for retirees to work with financial advisors and tax professionals to develop a comprehensive tax planning strategy that aligns with their retirement goals.
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