'Golden Decade' Offers Golden Opportunity to Get Taxes Under Control
If you are between the ages of 60 and 70, the time could be right to pump some money out of big, fat 401(k)s and traditional IRAs into tax-free Roth accounts.
If a financial professional planned your 60th birthday party, the balloons and streamers wouldn’t be black.
They’d be gold.
Some advisers even refer to the ages between 60 and 70 as the “golden decade,” because those years are filled with opportunities to make meaningful moves to protect your retirement savings.
You’ll be making decisions about when to file for Social Security benefits, of course, and how to maximize your pension. And you should be checking out your Medicare options before you turn 65.
Time to Get Serious about Tax Diversity
But it’s also a critical time to do something about the tax efficiency of your retirement plan. At age 59½, you’ll no longer have to deal with that intimidating 10% tax penalty when you withdraw money from tax-deferred retirement accounts. And you’ll still have years before those unpleasant required minimum distributions (RMDs) kick in at age 70½.
If you haven’t already done so, it’s a good time to get some tax diversity into your plan — and to better balance the amounts you have in tax-deferred, taxable and tax-free accounts. For many retirees and soon-to-be retirees, it should be a priority.
That’s because these days so many savers keep all or almost all of their nest egg in a tax-deferred retirement account, such as a 401(k) or 403(b), which means they still owe taxes on the hundreds of thousands or even millions of dollars they’ve been stashing away for years. And whenever they take income from that account, they’ll have to pony up to the IRS at whatever the current tax rate is.
Taxes are on Sale Now
But here’s the good news: Thanks to reforms that start this year, most folks will be in a lower tax bracket through 2025.
No matter what your age, these next few years likely will offer a sweet opportunity to reduce the tax bite you’re bound to experience in retirement if you’re a big-time 401(k) saver. But if you’re in your 60s — and can avoid the tax penalty and take advantage of a lower tax rate while converting 401(k) and traditional IRA funds to a tax-free Roth account — you’re looking at some powerful motivation to get moving.
You can convert a little each year for the next few years, “filling up” whatever tax bracket you land in, or even bump yourself up a bracket if it isn’t too painful. Of course, you’ll have to pay taxes on the amount you convert, but the money will never be taxed again, no matter how much it grows. That’s the beauty of a Roth. And you won’t be forced to take RMDs, either.
Chances Look Good for Taxes to Rise, So Roths Make Sense
Your financial adviser and CPA can help you run the numbers to determine what’s best for your situation. But you can be pretty confident that the individual tax rates we’ll have for the next few years will be lower than what’s down the road.
Of course, no one can predict what tax rates will be after 2025, but the expectation is that taxes will have to go up in order to deal with the nation’s growing debt and to continue funding popular programs, such as Social Security and Medicare. And historically, tax rates have been much higher than what they are currently.
Now, it’s possible you haven’t given much thought to what tax rates will be in the future. You may have been told your taxes will be lower in retirement because you’ll be spending less and require less income.
And maybe your taxes will be less. But there’s no guarantee.
Other Reasons Retirees Face Tax Pressure
If you keep your lifestyle pretty much the way it’s always been (or even take it up a notch, given all the extra free time you’ll have), you’ll need money to pay for it. Your income sources won’t be the same as when you were working — that’s true — but if the total amount you’re bringing in from your pension and investments is similar, your income likely will stay close to what it was.
A percentage of your Social Security payments also could be taxed, if your combined income (your annual Social Security benefit divided by two, plus any other taxable income you receive during the year, plus tax-exempt interest earnings) exceeds the designated thresholds. Currently, those thresholds are pretty low: If you’re married filing jointly, up to 50% of your benefit will be taxable if your combined income exceeds $32,000. And up to 85% will be taxable if your combined income exceeds $44,000.
Meanwhile, you’ll probably lose some significant tax deductions. Your kids will be all grown up, so you won’t be claiming them as dependents anymore. If you have your mortgage paid off or you’re close to it, your mortgage interest deduction will be nothing or negligible. And you might even decide to give to your favorite charity by volunteering instead of donating money, so you could lose that deduction.
That is, if you’re even itemizing your deductions anymore. With the standard deduction nearly doubling to $12,000 for single filers, $18,000 for heads of household and $24,000 for married couples who file jointly, experts estimate that only 10% of Americans will itemize on their 2018 return. (Taxpayers 65 and older can claim an extra standard deduction: $1,600 for single filers and $2,600 for married couples who are both at least 65 and filing jointly.)
The Bottom Line
There’s an old saying: It’s not what you make, it’s what you keep. Understanding the impact taxes can have on your nest egg — and not overpaying — is key to a happy retirement.
If you’ve been hyper-focused on the investment diversity in your portfolio and not on tax efficiency, it’s time to change up your game plan.
If you’ve been obsessing over the dollar amount at the bottom of your 401(k) statement every month, it’s time to get real: It isn’t all your money.
And if you’ve been winging it so far without any plan at all, it’s absolutely time to take a look at where you stand and where you’re going from here.
If you’re celebrating your 60th birthday this year — or any birthday between 60 and 70 — give yourself a gift and create a tax plan that will better secure your future.
Kim Franke-Folstad contributed to this article.