There’s an old saying, “you can pick your friends but you can’t pick your family!” Even if we could, no one would pick Uncle Sam because he always wants your money; even when you retire. Have you thought about paying Uncle Sam when you retire? If you’re like most people, taxes probably aren’t the first thing that comes to mind when planning your retirement. However, taxes during retirement can significantly impact your income.
Paying Uncle Sam
When your paycheck stops, you need to know where your income will come from. At a minimum, you will probably have Social Security benefits, and some type of retirement account (such as a 401(k), 457, 403(b), or an IRA.) Depending on various factors, Uncle Sam may be holding his hand out for his share. To help illustrate this point, assume you and your spouse have a goal of $75,000/year (net) retirement income. You receive a combined total of $40,000 in Social Security benefits, and withdraw $35,000 from your pre-tax retirement accounts. You need to consider how much it costs to reach your future income goal.
Social Security Taxes
Using the scenario above, you have a total income over $44,000/year. This means 85% of your Social Security benefits, or $34,000, are taxable income. Also, paying Uncle Sam reduces you annual income which means you didn’t meet your goal of $75,000/year (net) income.
While state tax laws vary, North Carolina currently requires you to pay taxes on withdrawals from pre-tax retirement accounts. Because you took $35,000 from a 401(k) account, you have to pay state taxes on that amount. Paying state tax further reduces your annual income amount meaning you missed your $75,000/year (net) goal by an even larger margin.
Federal tax rates change. Unfortunately, there isn’t a way of knowing what the tax rate will be when you retire. However, it’s probably safe to assume they won’t be any lower than they are right now.
Your Retirement Plan
Hopefully you see the importance of tax preparation for retirement and how it impacts your income. It’s never too early to start planning for your future, and a comprehensive way to do that is to consult with three professionals you trust: a Certified Public Accountant, a Certified Financial Planner (CFP), and a Tax/Estate Planning attorney. Having these three professionals work together for your future gives you the best chance of achieving your retirement goals.