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No Guarantees: Lower Taxes in Retirement?

194Many people assume that they will drop down at least a tax bracket once they retire. That assumption, similar to many assumptions about retirement, may not hold true when the actual event arrives. This article explores why it is not safe to assume that retirement tax rates will be lower than your current one.

First, several deductions that you have now will likely not be available once you retire. Consider your children. Will they be adults who have graduated from college when you stop working? If so, strike off education credits and dependent deductions you could normally take. Also, since you will no longer work, strike off your contributions to your retirement plan. Will your mortgage be fully paid when you retire? Strike off the deduction for that.

Here’s an additional consideration: retirees who primarily rely on Social Security for their income may be eligible to receive up to 50 percent of that income tax-free while those who have saved well for retirement will be taxed once they begin to take distributions. Our government may also decide that a tax increase is necessary as some future point. So, tax rates could actually increase.

If you have been responsible and have invested for retirement at a rate at which you feel comfortable, you would do well to examine how well your portfolio is sheltered from taxes. Some investments may shield your wealth better than others. Tax-deferred and tax-advantaged options should be considered.

Most people know about the tax-deferred options, including traditional IRAs and 401K plans. Such accounts allow investors to delay the payment of income taxes on the amount of the contributions made to- and generated in- them. However, taxes will be paid when withdrawals are made from these funds.

Tax-advantaged options, on the other hand, include Roth IRAs. No taxes are due upon withdrawal from these accounts if IRS procedures are followed correctly. Since taxes are not required for these withdrawals, it is possible to lower your retirement income taxes through proper usage of tax-advantaged accounts.

Given the advantages of tax-deferred and tax-advantaged retirement planning options, it might be wise to consider utilizing them both. Having both at your disposal in retirement gives you the flexibility to adjust your income source in the event of a tax increase or decrease. Your situation dictates whether utilizing both is advantageous.

The bottom line is that your marginal income tax rate in retirement may not fall as much as you think it will. You may be overlooking several exemptions and deductions that you will no longer receive when considering your retirement tax outlay. Careful planning can help you mitigate losing those deductions. Tax professionals and financial advisors can often help you steer clear of some of those tax issues.