Reaching retirement age can be pretty scary if you’re unsure about exactly what to expect with your changing finances. After retirement when you don’t depend on an income but instead on money from your retirement account, you may feel a bit nervous about being sure that you are living within your means and in a sustainable way. To be prepared to live in a financially efficient way, it’s helpful to have a good understanding of exactly how you will be taxed from here on and how you can keep your finances under control to reduce your taxes. There are many ways you can find to make sure that you lose less when paying taxes on your retirement income.
Here are a few highlights to consider:
1) Understand the Difference Between Roth IRAs and Traditional IRAs
Depending on the kind of retirement plan or plans you chose when you were younger, you will be taxed in different ways. If you chose a Roth IRA plan, then you will have paid the tax on your contributions as they went in, which means that when you do start taking money out of that account, you won’t have to pay any new income tax on it. On the other hand, if you chose a traditional IRA, then when you do start taking money from that account, it will be taxed as income at some level. However, there are some exceptions to this that you should be aware of.
If you have money in both types of accounts, you may be in the best position for choosing how you want to split up your withdrawals. You can start taking from your Roth, for example, before you start taking out of your traditional IRA, or you can take only small amounts out of your traditional IRA. However, once you reach the age of 70 ½, withdrawals from your traditional IRA become mandatory, so you should be prepared for the effect that will have on your income tax when you reach that age.
2) Know How to File Your Taxes
One of the best ways to save money on your taxes right away is to make sure that you are filing in the way that makes the most sense for your situation and income level. Retirement income tax is based on all of your sources of income, which includes your benefits from Social Security. You can help keep this expense under control by taking as little out of your retirement funds as possible as this will keep your total income tax lower. As a result, this will keep your tax on your Social Security benefit lower. If you are filing jointly, you could also be paying too much on your benefits. Make sure to talk to a tax professional about how to know which way you should file.
3) Diversify your portfolio.
Having multiple types of retirement accounts can give you more options when it comes to taking out money, which can give you greater flexibility in drawing money from accounts with differing degrees of tax penalty.
4) Invest early and wisely.
Smart investments made early can provide an ongoing source of income after you have stopped working. While your earnings from these investments will be taxed, they will at least decrease your dependence on retirement accounts that may have higher tax penalties associated. These earnings may also be able to sufficiently increase your income level in which you are less concerned about losses from taxes.
5) Deal with all of your debts before you retire
These payments are going to sting much more once you are on a fixed income. Pay off your mortgage, credit card, car payments, etc. right away. If you have any lingering income tax debt, look into income tax debt relief right away. You do not want to be facing these problems on fixed income.
6) Live as frugally as possible.
The less you are able to take out of your retirement, the less you are going to pay taxes on.
7) If you find you need money, sell off your assets first.
By selling them directly, rather than using them for a loan, you stand to potentially gain more flexible income.
8) Consider choosing to live in a state with a lower income tax.
This is part of the explanation behind Florida’s popularity with the 60+ crowd.
As with most financial issues, getting the most bang for your buck depends on early planning and careful decision making. At whatever stage of planning you are at right now, make sure you are thinking realistically about your needs and expenses once you are living on a fixed income.