As you’re planning for retirement, you will likely hear one piece of advice over and over: Save as much as you can! You need to save enough money to support you through 20 or 30 years of retirement, for one thing. And as long as the IRS provides tax breaks for saving, it makes sense to take advantage of these opportunities.
But in some cases, you could run into one complication. Remember when you were taking advantage of those “tax deferred” retirement savings options? Once you have retired and you begin taking distributions from your retirement income account, you will pay taxes on all the money you set aside in previous years. If your annual income is high enough, you may end up owing a significant amount of taxes on the money.
To avoid this situation, calculate your expected tax bracket. Will you move up to a higher tax bracket once you begin taking distributions from your retirement income fund? If so, you might pay more to the IRS each year, your Social Security benefits could be taxed, and income-based Medicare premiums may even be set higher.
If you think this situation could affect you, it might be wise to make changes to your savings strategy as you near retirement. Toward the end of your career, it might make more sense to set aside after-tax dollars in a Roth IRA. The money will be taxed now, while you are in a lower income tax bracket, and then it won’t be taxed later when you take distributions from the account.
Does this sound confusing? It’s easy to see why it’s important to schedule regular consultations with your tax accountant or a financial professional. As your expected retirement date draws closer, make sure to run a projection of your retirement income, discuss your goals, and identify possible tax problems. Taking action now could mean that you can shelter more of your retirement income from unnecessary taxation.