Saving for retirement is something that we all do (hopefully). But do you ever stop to ask yourself why? It’s not about accumulating “just in case” money or being able to travel the world, although neither of those is a bad thing. They’re certainly both parts of why we save. But if we get down to the root of retirement savings, it’s really about two things: security and freedom. We want to give ourselves peace of mind and the ability to enjoy a well-earned rest. The knowledge that sacrificing during our working years will pay off later is what keeps us motivated and diligent.
Unfortunately, there’s a significant risk that most people don’t know they need to plan for: taxes in retirement. IRAs (the tax-deferred retirement savings vehicle that most are familiar with) introduce significant risk to your future security and peace of mind. How? Let’s look at the downside to tax-deferred accounts in retirement, and then explore a better option.
Are Taxes In Retirement Really That Bad?
One of the most common financial myths is that you’ll be in a lower tax bracket in retirement. It’s understandable since theoretically, you aren’t earning any money; your tax liability should be lower than during your working years, right? Not necessarily.
If you have a traditional IRA, you’ve been saving for years through a tax-deferred account. You were able to write off contributions when you initially made them, but you’ll owe taxes when you withdraw and use the funds. Once RMDs kick in, you have no control over when you have to take at least some of that money out. And the more you’ve saved, the higher your RMDs and subsequent taxable income will be! Let’s paint three pictures of how this could play out:
- The retired couple saved diligently for retirement, skipping big expenses and vacations to put away more for their future. Their IRA is supplemented by Social Security for both and a pension from his work. Everything is fine for the first few years of retirement, but once their RMDs kick in and are added to their other taxable income sources, their gross income is just over $250,000–landing them in the same tax bracket as they were pre-retirement. Not only that, but they’re now subject to the Net Investment Income Tax (NIIT), a 3.8% surtax, as well as a Medicare surcharge. Their discipline in saving for retirement has ended up costing them more in the long run.
- The widowed woman gets less from social security and half of her late husband’s pension but has to take the same RMDs due to inheriting his IRA. Except now her filing status is single instead of married filing jointly, which increases her tax rate. She has the same gross annual income but is losing significantly more to taxes, so she can no longer afford the same retirement lifestyle.
- The children who inherit an IRA have 10 years to withdraw and use all of the funds within the account. Without the flexibility of spreading out distributions, they’re forced to make withdrawals within a relatively short window of time, pushing them into a higher tax bracket. They’re losing a substantial amount of their inheritance to the IRS.
Pay a Little More Now to Save a Lot More Later
As we mentioned, one of the greatest financial myths is that you’ll owe less taxes in retirement than you owed during your working years. As you can see from the above illustrations, that isn’t necessarily true, especially for those with significant retirement savings. When it comes to retirement and living off of a fixed income, we want as few surprise expenses as possible. It stands to reason that if you can do something now to minimize taxes in retirement, even if that means paying a bit more upfront, why wouldn’t you?
Most married couples are enjoying the lowest income taxes that they’ll pay at any time in their lives due to their filing status. If you want to get strategic about your taxes during retirement, even if that means paying extra upfront, now is the time to do it.
Tax-Advantaged Life Insurance
The good news is that you can use after-tax dollars to acquire tax-free assets, greatly reducing your tax liability in retirement. It just takes a little planning. One option is the Roth Conversion Strategy, which you can learn more about here. Another route we love to share with our clients is Modern Life Insurance™.
Life insurance is no longer a tool just for protecting your assets. With some of the newer products available today, it can create tax-free living benefits, death benefits, and protection for the rest of your savings against long-term care expenses.
Let’s say you purchase a Modern Life Insurance™ policy with accelerated benefits that can be accessed if needed for emergencies, such as long-term care. Life insurance premiums aren’t tax-deductible, so if you put your savings into life insurance instead of an IRA, you’re paying those taxes now instead of later. But remember, if you are married filing jointly, and not yet taking RMDs, you are likely enjoying lower tax rates now than you will be later; dollar for dollar, you’ll owe less taxes at the end of the day. If your policy has a cash value, you can access that cash tax-free. If you need to use the funds for long-term care, those funds will be tax-free. And when you pass, your loved ones will be left with a death benefit that is tax-free. Not to mention, of course, that life insurance policy provides insulation from market fluctuations that an IRA can’t offer.
There’s No Better Time to UnTax Your Retirement®
Many retirees get to their golden years only to have an unpleasant surprise once tax season rolls around. While IRAs are a generally accepted way to save for retirement, there is simply no reason to leave your savings vulnerable to the IRS. You’ve worked hard and saved diligently to make these years relaxing and as worry-free as possible, and we want to do everything we can to help maximize your savings through a tax-efficient strategy.
To learn more, get your complimentary copy of Greg Parady’s book, UnStress and UnTax Your Retirement™ by submitting a request here. There’s no reason why your retirement shouldn’t be everything you dream of!
