Will My Taxes Go Up Or Down In Retirement?
Sneaky sneaky, asking such a loaded question, when everyone knows the answer to will my taxes go up or down in retirement is, “It depends”. But it’s a very interesting question to ponder, so let’s take a look at some key issues that could impact the answer.
Taxes in retirement centers on one word, income.
If you expect to have more income in retirement, your taxes in retirement may go up.
If you expect to have less or no taxable income in retirement, your taxes in retirement may go down.
Income is complex. There are several kinds of income, each taxed uniquely. Ordinary, capital gain (short/long-term) or tax-exempt; then there’s Adjusted Gross Income (AGI) and Modified Adjusted Gross Income (MAGI), which is some mystical calculation seemingly only software can compute for eligibility of credits, deductions, or other. In last month’s TCJOB article I wrote that it is good to talk to a tax pro – because what normal person really understands taxes, and I mean it. This can be complicated.
How much income will you have? And what kind of income is it?
Once you retire, you will have some control over how much and what kind of income you might have in any given year, even if you are one of the “lucky” employees at PNNL or some Hanford companies which still have pensions. A pension (taxed as ordinary income) doesn’t have to start right when you stop working, contrary to common belief and practice. Delaying the start of a pension by one or more years (Social Security benefit falls under this theory as well) you can create what I call a low- or no-income year which opens a window of opportunity for realizing income in a controlled manner, also controlling, and dare I say minimizing, your tax bill now and possibly your taxes in retirement.
These opportunities include doing Roth conversions and donating to charity or a Donor Advised Fund to offset some of the tax bill. Or selling off some of your big winners, realizing capital gains, then rebalancing, possibly being offset by some past losses. Or even just taking a taxable distribution from a Traditional IRA/401k, minimizing the size of your IRA, future RMDs and future taxes in retirement.
Why would I want to do these things?
This is the game you are trying to play. Pay taxes in the year it makes the most sense for you. There are many reasons you might want to realize income and pay taxes now vs paying taxes in retirement or vice versa.
Why pay now:
• I’m in what I think is a lower tax bracket now (a low-income year) and will have higher income later.
• I think tax rates in general are going to go up. We have to pay off that national debt somehow.
• I want to pay taxes now and leave tax-free money to my heirs.
• I want to diversify the types of accounts I have (pre, post, and tax-free) to have more flexibility in creating my retirement income.
• I want to pay a higher rate now on a smaller amount so that I might avoid paying even a low tax rate on a much bigger amount.
• I’m concerned that my higher future taxable income will increase my Medicare premiums (IRMAA surcharge) or the taxable portion of Social Security, especially when one of us dies, and we start filing as Single.
Why pay later:
• I expect to be in a lower tax bracket.
• I want to keep 100% of my money invested now instead of paying it out in taxes.
• I have no heirs. Or, I’ll leave appreciated assets to my heirs, who get a step up in basis.
• I will likely donate much of my appreciated wealth to charity by gifting assets or making Qualified Charitable Donations (QCD) thus paying no taxes.
• Because this is my life, my goals, and my decision!
By the time you turn 70, you will have started receiving Social Security, and at 72, receive and pay tax on required minimum distributions (RMDs) from retirement accounts. Both are taxable events and worth planning for.
Current vs Future Tax Law
The decisions we make today are made with an unclear image of the tax future. Uncle Sam is privy to making quick and impactful decisions that can make future tax projecting and planning tricky. Sometimes it makes more sense to make decisions based on the current law instead of what we think may happen in the future. That is a big benefit of having a diversified tax plan, that no matter what happens, you have options.
Saving On Taxes
Oftentimes the focus of tax planning is on saving taxes. I’d argue that the focus should be on making the best tax decisions for your situation and your short- and long-term goals.
Sometimes you have to just take a leap, commit and pay tax at the rate that seems the best option at that time unless you happen to have a crystal ball and can see into the future.
Right now, we sort of have a way to look into the future. We know that the Tax Cuts and Jobs Act will cause tax breaks to expire at the end of 2025. Unless Congress steps in and extends or modifies the law, for some, taxes will go up.
Taxes Are Something, But Not Everything.
Taxes certainly come into play when making financial and retirement decisions but need not be the only or even the key deciding factor. The main thing is to pay attention to opportunities throughout life that may impact taxation, be mindful of employer-sponsored tax-preferential programs and plan your tax strategy for the long term just like you do with your investment strategy. Making tax-smart decisions all along will ensure a great outcome while you are working as well as in retirement. And…you might even save on taxes.
Retirement is Scary!
Let’s talk! I offer a free consultation to see if any of these concerns are something I can help with, and I usually can. You can schedule that here. Retirement doesn’t have to be scary!
Read this article, Will My Taxes Go Up or Down In Retirement, in the October 2022 edition of Tri-Cities Area Journal of Business.
Angie founded Avea Financial Planning and is a fee-only advisor helping people retiring in 1-2 years, particularly PNNL employees, with tax-smart retirement planning, investments & fiduciary financial advice so they can be more confident and live life on their own terms.