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Balancing Income & Taxes in Retirement

retirement, financial planning, taxes

You’re ready to make the transition to living on income from savings instead of income from work. You’ve followed your savings plan, figured out your budget, your retirement nest egg is substantial. But have you thought through the tax implications? Tax planning is often overlooked, which can be an expensive mistake, and it has implications for other retirement benefits.

Total Taxable Income

Depending on your income from other sources, up to 85% of your Social Security benefits may incur Federal income taxes. Additionally, withdrawals from a 401(k) and traditional IRAs are taxable, since the money you funded them with was tax-deferred. Pension payments are also considered taxable income. If you have taxable investment accounts, you should be aware that dividends, interest income and capital gains from stock sales will all create tax liabilities.

Your new retirement tax bracket is derived from your combined income, which is your adjustable gross income, nontaxable interest income and some portion of your Social Security.

Strategies to Lower Your Tax Bill

The first step to reducing your potential tax bill is to lower your income needs. To do this, one strategy is to try to pay off or pay down as much as possible on mortgage and other debts before retirement. This means you won’t have to withdraw as much income, which will lower your tax liability. If you’re planning to move in retirement, consider moving somewhere with lower taxes. This can include lower state income taxes or even states that don’t tax retirement income.

Investment Strategies for Managing Your Income

Asset allocation is a strategy for diversifying your accounts across investment types. Asset location refers to a strategy for placing investments in accounts where they have the potential to lower your tax liability.

Taxable accounts, such as brokerage accounts, should hold tax-efficient investments. These include stocks you will hold for more than a year; tax-exempt municipal bonds; and index funds. Tax-deferred accounts are good homes for tax-inefficient investments, and might include fixed income, commodities, some alternatives, and other actively managed strategies.

If you have a Roth IRA from which you can withdraw tax-free, along with a traditional IRA, you may want to be thoughtful about your total income picture when determining which account to withdraw from. Taking from the appropriate account can lower taxes.

The Bottom Line

Retirement planning doesn’t stop with creating an investment strategy to generate the income you want. Working with your financial advisor or tax professional to evaluate tax implications and make tactical moves to keep income as tax-advantageous as possible can significant impact on your bottom line. Interested in working with Invariant to create your retirement strategy? Please reach out to!


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