Nobody like talking taxes (except accountants). However, it's important to plan ahead or else you may end up paying much more than necessary. This is especially true if you're nearing retirement. You may have to make your retirement assets last for 20 or 30 years, so it's vital that you pay as little as possible in taxes and keep as much money as possible to fund your lifestyle.
Tax planning is an important part of the retirement process because so much of your financial viability in retirement is dependent on your take-home income. Income from sources like pensions, Social Security, investments, and rental property are all subject to taxation. Without proper planning you could take home much less income from those sources than you would otherwise be entitled.
Start Tax Planning for Retirement Early
It's important to start tax planning for retirement early, as much as one year before you actually plan to retire. A tax planner can sit down with you before your retirement, review your assets and income sources, and advise you on how you should structure your income to mitigate tax liabilities.
Starting early is important because you may need to make some financial decisions before you actually retire. For example, you may have a pension with multiple payment options. After consultation with a tax expert, you could make a fully informed decision on whether to maximize your pension payment or take a lesser amount so your spouse can continue the benefit if he or she outlives you.
These kinds of decisions about income and assets are best made once you know the full tax implications of each possible decision. In many instances, decisions could be permanent. Often, decisions about Social Security benefits and pension payouts can't be reversed. If you decide a different option would have been more favorable from a tax perspective, there may be nothing you can do about it.
Retirement Decisions That Have Tax Implications
Tax planning for retirement is so important because taxes affect nearly every income source available to you in retirement. Below is just a sampling of some important retirement decisions that could have serious tax implications:
- Where to take income from? You've likely spent decades contributing money to your 401k, IRA, and Roth IRA. While you should feel good about the amount that you have saved, it's important to take income from the right places at the right times. A Roth IRA will provide you with tax-free income while an IRA and 401k provides taxable income. A tax preparation firm could help you decide how to allocate your income to minimize your income taxes every year.
- Which pension option is best? Pensions often pay benefits in several ways, depending on whether you want as much income as possible or whether you want to save income for your beneficiaries after you pass away. A tax accountant could review the options and also estimate your tax bracket and those for your beneficiary. With that information, the professional could recommend which option would result in the most take-home income.
- When should I take Social Security? Contrary to popular belief, Social Security is subject to taxation. Just how much depends on your age and your income. Many people have lots of income in the first few years of retirement because they're selling assets. The income then tapers off in later years. If that's the case, a tax planner may recommend that you hold off on starting Social Security for a few years.
- Should I sell my house? Downsizing is a popular choice for retirees. While there are many factors to consider, taxes should be one of them. You can make up to $250,000 in tax-free capital gains from the sale of a home. A tax planner could forecast your tax liabilities and suggest when it may be most ideal to capture those tax-free capital gains.
What If You Start Late?
Considering all of the decisions you have to make, it's easy to see why tax planning for retirement should start early. If you've already retired and haven't reviewed your tax situation with an expert, there's still time. It's never too late to get professional advice. While you may have made decisions that can't be changed, the tax professional can still provide recommendations on future financial decisions.
When you meet with a tax expert, bring all documents and information that could be relevant to tax planning for retirement. That information will help them make the most of your time and provide fully-informed and valuable advice.
If you're planning on retiring soon, you undoubtedly have a lot on your plate. Taxes may not be an enjoyable conversation topic, but it's an important one. The decisions you make before retirement can impact your financial viability for the remainder of your life. Talk to an accountant today so you can be completely confident in your financial choices as you enter retirement.
