As you plan for retirement, one big question that many people have is whether their income taxes will go up after their retirement or go down. The answer to this question is important because it affects how much you need to withdraw each month or year as well as how long your retirement funds will last.
So, how can you determine the effect you can expect to see when you stop working? Here are a few indicators that each might happen.
When Income Tax Is Lower in Retirement
Typically, your income tax bill will be lower in retirement if your monthly income is less than what it was when you were working. Remember that if a significant portion of your retirement income comes from tax-free accounts such as a Roth IRA, this income doesn't count toward your taxable portion. Your income tax obligation would be lower still.
In addition, where you plan to retire can have a big impact. If you want to retire, for instance, in a state like Texas or Washington that has no state income tax, you can cut out that portion of your bill entirely. The same would likely occur for retirees who move to a country with a lower cost of living.
When Income Tax Rises in Retirement
Of course, not all retirees see a lower tax bill if their income effectively remains about the same after retirement. If your retirement expenses are similar to your current needs, this may be exactly what you can expect. Also, if you placed much of your retirement savings into tax-deferred plans — like a 401(k) plan, pension, or traditional IRA — you will pay taxes on withdrawals (including any mandatory minimums).
Other events can also result in higher taxes. For example, a resident of a state with high state income taxes, like California or New York, will have a higher state bill. And if you have enough non-Social Security income (from pensions, tax-advantaged withdrawals, or part-time work), you may see up to 85% of your Social Security payments being taxable.
What You Can Do Now to Better Your Rate
The best way to understand your retirement income taxes is to work with a qualified accountant or tax preparer now. They can help you run "scenarios" involving different tax and income situations. For instance, an accountant might demonstrate the differences between contributing to a tax-advantaged IRA or a Roth IRA. Or they can help you learn how much to earn while avoiding taxable Social Security checks.
The additional knowledge from exploring your options now will help you plan a stable and secure retirement plan no matter what your goals and expectations.
For more information, contact a tax preparation service.