Lower Taxes in Retirement? Submitted by Larry Frank Sr. on Mon, 04/21/2014 - 3:00pm Like many, you might think, “Why save so much for retirement when my taxes will be much less?” This supposed truth is a myth, a recipe for financial disaster in your golden years. Let’s start with your tax return. First, the top total earnings line does not include what you contribute to your 401(k), 403(b) (for school and tax-exempt organization employees), 457 (for employees of state and local governments and tax-exempt governments and employers) and other individual retirement plans. You may think that because you contribute toward retirement, say 15% of your salary, in tax-free or tax-deferred accounts, your taxes or taxable income drops 15% when you retire. Wrong: You pay taxes throughout life on your standard of living level, the money you earn and spend. (You do get a break in retirement from no longer paying into Medicare and Social Security; eventually Social Security also helps support your retirement standard of living. Don’t reduce standard of living for Medicare when calculating for retirement because you will need funds to continue to co-pay for health care once you retire.) The income tax rates below show how much you need to reduce spending to get into a lower tax bracket and to what degree higher brackets actually hit your wallet. See, for example, that even if you enter a higher bracket, all your money below that upper bracket’s trigger point gets taxed at the lower rate – only the money over that trigger amount incurs the higher tax rate. Let’s say you file taxes as single and your taxable income hits $90,000. Your tax (estimated for the 2014 tax year) is $18,193.75 plus 28% of $650 (that dollar figure is the difference between your $90,000 and the bracket trigger amount of $89,350), or only $182 in extra tax. Contrast that with how much you need to reduce your taxable income all the way to less
Transcript
Lower Taxes in Retirement?
Submitted by Larry Frank Sr. on Mon, 04/21/2014 - 3:00pm
Like many, you might think, “Why save so much for retirement when my taxes will be much less?” This supposed truth is a myth, a recipe for financial disaster in your golden years. Let’s start with your tax return. First, the top total earnings line does not include what you contribute to your401(k), 403(b) (for school and tax-exempt organization employees), 457 (for employees of state and local governments and tax-exempt governments and employers) and other individual retirement plans. You may think that because you contribute toward retirement, say 15% of your salary, in tax-free or tax-deferred accounts, your taxes or taxable income drops 15% when you retire. Wrong: You pay taxes throughout life on your standard of living level, the money you earn and spend. (You do get a break in retirement from no longer paying into Medicare and Social Security; eventually Social Security also helps support your retirement standard of living. Don’t reduce standard of living for Medicare when calculating for retirement because you will need funds to continue to co-pay for health care once you retire.) The income tax rates below show how much you need to reduce spending to get into a lower tax bracket and to what degree higher brackets actually hit your wallet. See, for example, that even if you enter a higher bracket, all your money below that upper bracket’s trigger point gets taxed at the lower rate – only the money over that trigger amount incurs the higher tax rate. Let’s say you file taxes as single and your taxable income hits $90,000. Your tax (estimated for the 2014 tax year) is $18,193.75 plus 28% of $650 (that dollar figure is the difference between your $90,000 and the bracket trigger amount of $89,350), or only $182 in extra tax. Contrast that with how much you need to reduce your taxable income all the way to less
than $36,900 to reduce your tax rate to 15% (as you see in the third left-hand line).
Only if you are on the cusp with your taxable income does spending less change your tax rate; most people I see are well within their bracket or near the top of it. Look at where you sit in your bracket. If in the upper part of your bracket, you must cut your spending quite a bit to lower your taxes. Beware: You may need to cut spending at retirement if you don’t save enough. Save more now toward what you need to sustain your present standard of living. Saving more also generally means spending less. Saving more feels better than cutting spending – even though the effect is the same – because saving more feels like accomplishment. (Cutting spending often just feels like denial.) If you keep your present standard of living in retirement, your taxes remain the same, too. For an idea of your likely retirement standard of living, calculate your current standard of living based on expenses and income and deduct what you pay into Social Security. Most important, plan on paying taxes in retirement a lot like you pay today. Follow AdviceIQ on Twitter at @adviceiq. Larry R. Frank Sr., CFP, is a Registered Investment Adviser (California) in Roseville, Calif. He is the author of the book, Wealth Odyssey. He has an MBA with a finance concentration and B.S. cum laude in physics with which he views the world of money dynamically. He has peer-reviewed research published in the Journal of Financial Planning. http://blog.betterfinancialeducation.com/
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