A common misconception by Americans is that their tax bills will reduce after retirement. While taxes are likely to be lower in retirement, retirees can lose up to 30 percent of retirement income to tax without efficient tax planning. While not all of your retirement income will be taxable, the introduction of tax-deferred options and the existence of new reporting requirements for real estate, wall street, and cryptocurrency investments means that it is now more important than ever that retirees have a tax plan in mind.
Explore Strategies To Amplify Access To Tax-Free Income Post Retirement
Planning ahead for your retirement income can help you set up ways to access tax-free income during those later years. One of the most popular ways is to contribute to a Roth IRA consistently from as early as possible. Currently, the annual contribution limit for Roth IRAs is $6,000 (or $7,000 if aged 50 and older). There is also a catch for those earning $125,000 or higher: the contribution cap begins reducing.
However, Roth 401(k) allows a contribution of up to $19,500 and has no income caps. If you already have a traditional IRA, you could also convert it to a Roth IRA. Other alternatives for accessing tax-free income during retirement include contributing to a health savings plan (contributions of up to $3,600 allowed in 2021), municipal bonds in your residence state, and permanent life insurance policies.
Max Out Your Allowances For Tax-Deferred Assets
It is also critical to recognize the differences (and advantages) of tax-deferred and tax-exempt accounts. Tax-deferred assets such as 401ks come with the tax deferral advantage while Roth 401ks entitle you to tax-free withdrawals in retirement. With a traditional 401k, the individual does not pay income tax on contributions but instead, pays income tax when you withdraw your money i.e. during retirement unless you live in a state without any income tax. Any withdrawals are taxed at normal income tax rates, even during retirement. Both Roth and traditional IRAs can also be used to fund IRA real estate investment options and allow portfolio diversification. Therefore, by striking the perfect balance between the 2 you can capitalize on the benefits of both tax deferral and withdrawals.
Check If You Qualify For Catch Up Contributions
Unfortunately, only 15 percent of those eligible utilize catch-up contributions according to Vanguard’s 2021 How America Saves report. Yet, it can be an incredibly tax-efficient way to improve your retirement finances for those who neglected to save when they were younger. One of the impending proposals in front of the House is an expansion to the catch-up contribution amounts. Currently, the law stipulates that individuals aged 50 and older are eligible to make catch-up contributions of up to $6,500 to their 401(k). They can also pay an additional $1,000 to their IRA.
The proposals for 2022 include plans to expand catch-up contributions up to $10,000 for anyone aged 62 to 64 years old. The proposal also includes a change to after-tax contributions which means any withdrawals would be tax-free.
Individuals should also be mindful of avoiding early withdrawal tax penalties which can be up to 10 percent. Finally, time your withdrawals in retirement. This involves estimating your retirement cash flow needs correctly and spacing out your withdrawals to avoid pushing yourself into a higher income tax bracket during retirement. Getting a jump start on your retirement income needs, the annual income needed and the lifestyle you want is the best place to start your tax-efficient retirement income planning.