When it comes to planning for retirement, one of the key factors to consider is the impact of taxes on your savings. Whether you are in the middle of your career or getting ready to retire, understanding where you are investing your money and how those accounts will affect your taxes in the future is crucial. Many individuals have the majority of their savings in tax-deferred accounts such as pretax 401(k) plans or traditional IRAs, which means they will have to pay regular income taxes on their withdrawals based on federal tax brackets.
Utilize a Diversified Strategy
Financial experts suggest using a diversified approach by incorporating a mix of pretax, after-tax Roth, and taxable brokerage accounts to provide more flexibility in retirement. By diversifying your investment accounts, you have more options to manage your adjusted gross income effectively. Certified financial planner Judy Brown explains that having a variety of accounts gives you different levers to pull when it comes to handling your taxes.
Understand the Tax Implications of Different Accounts
Pretax distributions from accounts like traditional IRAs or 401(k) plans can potentially push you into a higher tax bracket, leading to increased Medicare Part B and Part D premiums. On the other hand, after-tax account distributions from Roth accounts do not incur taxes and do not impact your income. Taxable brokerage investments are another alternative, with capital gains tax rates ranging from 0% to 20%, depending on your taxable income. Although higher earners might face an additional 3.8% tax on these investments, it is still usually lower than the tax rate on pretax account distributions.
A diversified portfolio of pretax, Roth, and taxable investments allows you to adjust your strategy to changing tax laws and personal financial circumstances. This flexibility is essential for managing your withdrawals and taxes efficiently in retirement. Alyson Basso, a certified financial planner, emphasizes the importance of customizing your investment mix based on your goals, risk tolerance, and timeline.
If you are considering retiring before the age of 59 and a half, having brokerage assets can be particularly beneficial. Unlike traditional retirement accounts, which usually have penalties for early withdrawals, you can access your brokerage account at any age without incurring penalties. This can be useful for funding major expenses such as a down payment on a second home or covering a child’s wedding before reaching retirement age.
Balance Tax Benefits with Financial Goals
While building a brokerage account may mean sacrificing certain tax benefits like tax-free growth or upfront deductions for contributions, it can help you achieve specific financial goals. The right mix of pretax, Roth, and taxable investments will ultimately depend on your individual circumstances and objectives. It is crucial to weigh the potential tax implications against your long-term financial plans to ensure that you are making the most tax-efficient choices for your retirement savings.