Tax Mistakes to Avoid in Retirement

Most of us look forward to retirement and the opportunity to start living life on our terms, and hopefully move into a lower tax bracket. Many retirees, however, are often surprised when they receive their tax bill. With careful planning, a good deal of these unpleasant “retiree-tax surprises” can be avoided or minimized with some advanced financial planning.

Never assume: Do not assume your taxes will be lower in retirement. Most forms of retirement income are taxable, such as pension and possibly Social Security income. You must also report interest, dividends, and capital gains on non-retirement accounts and any income you earn if you continue to work during retirement in some capacity. Working less in retirement, however, as well as utilizing certain tax deductions or postponing when you receive benefits can help lower your income, effectively reducing your retirement tax liability.

Plan early: Another common mistake is failing to plan for your post-retirement financial life. Before you cash that last paycheck, create an outline of your desired retirement lifestyle. Note your total income, and then add expenses to create a “balance sheet” comparing income against expenses. We can help you estimate how much you’ll need five, ten and twenty years in the future. Include your spouse’s/partner’s retirement plan, as well as how you plan to manage your retirement and each other’s Social Security benefits.

Understand RMDs: Confusion often arises regarding how much you must take in Required Minimum Distributions (RMDs) from traditional Individual Retirement Accounts (IRAs) or other retirement plans, like 401(k)s or 403(b)s. Withdrawal ​amounts are determined by a formula based on your age and account balance as of Dec. 31 of the prior year. By failing to take required distributions, you incur a penalty tax of up to 50% of the amount you were supposed to withdraw.* You could also be subject to a sizeable penalty if you do not have the right amount withheld from your pension during retirement. It is important to remember that RMDs are taxable as income, so you may want to specify federal and state withholding on your distribution.

Look for Opportunities:  You may have retired earlier than originally planned, resulting in temporarily lower annual income. A low-income year could actually present a tax-planning opportunity. You may be able to convert some of a traditional IRA to a Roth IRA and benefit in terms of taxes owed if you have low income and high tax deductions, such as mortgage interest or health-related expenses.

Do not go it alone: Long-term planning can be complicated, and your retirement future is at stake. Your financial advisor can work with your tax and other experts to develop an integrated tax strategy.

Southwestern Investment Group’s advisors can help you determine how much income you will likely need and how to design a strategy to minimize taxes during retirement. To start your plan, contact one of our advisors today.

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