One important aspect of retirement planning that is often overlooked is the impact taxes can have on someone’s nest egg. Taxes can significantly reduce the value of a retirement portfolio, whether it is held in a 401(k) plan, traditional IRA, or a regular taxable brokerage account. To minimize the impact of taxes on retirement savings, individuals can save and invest more during their working years, be tax-smart with investments, and choose accounts that reduce tax liability.
While many sources of retirement income are subject to taxes, there are some that are not taxable. One way to avoid taxes on retirement money is to use a Roth account, which allows for tax-free withdrawals after age 59 ½. By paying taxes upfront on contributions to a Roth account, individuals can avoid owing taxes on distributions. Additionally, inheritances are tax-free for the recipient in most states, although some states impose inheritance taxes. Municipal bond income is also tax-exempt at the federal level and may be exempt from state taxes if the bond is issued in the investor’s state.
Health savings accounts (HSAs) combine features of traditional and Roth IRAs, offering tax deductions on contributions and tax-free growth within the account. Withdrawals from an HSA for qualifying healthcare expenses are tax-exempt, and at age 65, funds can be withdrawn for any reason without penalty. Social Security payments are generally tax-free, but income levels may determine the taxability of those payments. The taxation of Social Security benefits varies based on income and filing status, with up to 85% of benefits potentially subject to tax for certain income levels. Life insurance proceeds, like inheritances, are tax-free to the recipient and may provide a significant source of retirement income.
As individuals plan for retirement, it is important to consider the impact of taxes on their nest egg. By being aware of taxes on various sources of retirement income, individuals can make informed decisions about their savings and investment strategies. Utilizing tax-advantaged accounts, such as Roth accounts and HSAs, can help minimize tax liability in retirement. Inheritances, municipal bond income, Social Security payments, and life insurance proceeds are sources of retirement income that are generally not taxable, providing additional options for funding retirement. Planning for taxes in retirement can help individuals make the most of their savings and enjoy a financially secure retirement.
