It is a common mistake for retirees to overlook the impact of taxes on their retirement savings until they are ready to withdraw funds from their pretax accounts. According to a Northwestern Mutual study, only 3 in 10 Americans have a plan in place to reduce taxes on their retirement savings. One way to minimize the tax burden on retirement savings is by utilizing the “bucket strategy”, as suggested by certified financial planner, Sean Lovison.
Lovison emphasizes the importance of strategically managing income in lower-earning years to reduce the lifetime tax burden. By filling “buckets” or federal tax brackets with more income during these years, retirees can potentially save on taxes later on. For instance, taking advantage of the 12% tax bracket before collecting Social Security can be an opportunity for Roth individual retirement account conversions, which allow for tax-free withdrawals in the future. While Roth conversions may require upfront taxes on the converted balance, it can help reduce pretax balances and prevent retirees from falling into higher tax brackets once Social Security and required minimum distributions kick in.
Financial experts like CFP Judy Brown stress the importance of tax planning during the “accumulation phase” of retirement savings. By diversifying accounts with pretax, Roth, and brokerage accounts, individuals can have a variety of options to manage their adjusted gross income in retirement. This tax diversification strategy provides retirees with different levers to pull in order to optimize their tax situation, rather than solely relying on pretax accounts.
It is crucial for retirees to recognize the significant impact that taxes can have on their retirement savings. Delaying tax planning until the distribution phase could lead to unexpected tax liabilities and a reduced retirement nest egg. By taking proactive steps to plan for taxes during the accumulation phase, retirees can better position themselves to minimize tax burdens and maximize their retirement savings.
Tax planning is a critical aspect of retirement savings that should not be overlooked. By implementing strategies such as the “bucket strategy” and tax diversification, retirees can effectively manage their tax liabilities and potentially increase the longevity of their savings. It is essential for individuals to work with financial experts and develop a comprehensive tax plan that aligns with their long-term financial goals. By taking a proactive approach to tax planning, retirees can secure a more financially stable retirement future.