Strategize Now to Avoid a Nasty Tax Surprise in Retirement
If you did most of your retirement saving in 401(k)s and IRAs, unless you have a plan, you may end up paying a lot more in taxes than you bargained for.


Americans worry a lot about saving enough money for a long and happy retirement. What they don’t seem to spend as much time figuring out is how to keep more of what they have managed to save while working so hard.
No one can prepare for every expense that might crop up in what could be a 20-, 30- or even 40-year retirement. No matter the timeline, you can always plan for taxes … and should. Whether your savings are mighty or meager, Uncle Sam is going to want his share and will take as much as you’re willing to hand over, so it’s up to you to be sure the amount is fair.
To do that, you’ll have to think beyond the basics — beyond today and your tax-deferred IRA or 401(k). Your goal should be to get yourself into the lowest tax bracket possible every year in retirement. That means divvying up your nest egg into different tax “buckets”:

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The taxable bucket
This includes the investments and savings you pay taxes on upfront and annually on the growth, including your bank accounts, non-qualified brokerage accounts, certificates of deposit, interest on bonds, etc.
The tax-deferred bucket
This holds your IRA and 401(k) accounts. You don’t pay taxes when you deposit the money or while the money is growing. However, you will pay taxes on 100% of the money you withdraw from this bucket. Once you turn 70½, you are forced to withdraw according to an IRS calculation through RMDs (required minimum distributions), whether you need the money or not.
You will pay taxes according to your tax rate at the time of withdrawal. This could be a higher rate in the future, meaning you could pay more in taxes than you saved when you initially deposited the funds. Therefore, if you’re highly invested in this bucket, you’ll have more taxable income on your 1040, which could push you into a higher tax bracket in retirement and cause your Social Security to be taxed accordingly.
The tax-free bucket
This includes Roth IRAs and Roth 401(k)s, along with specially designed life insurance policies and municipal bonds, where you pay the taxes upfront and accumulate the growth tax-free. For older savers who have contributed for years to the popular workplace 401(k), getting those buckets balanced usually includes converting some tax-deferred dollars into a Roth, which has tax-free earnings and withdrawals.
One client’s tax-saving strategy
Other strategies can further diversify your income streams and add even more tax efficiency to your retirement plan. Here’s how one of my clients recently cut her future tax bill down to size:
Michelle is in her mid-50s and plans to retire at 65. At that time, she’ll turn on three income streams: an $18,000-per-year pension benefit, a $30,000-per-year Social Security benefit, and $32,000 from an overfunded permanent life insurance policy. (She’ll do the latter through a strategy known as max funding, which allows the owner to withdraw the policy’s excess cash tax-free through loans that will be repaid with the owner’s death benefit.)
That’s $80,000 in income — but her adjusted gross income will only be $33,000 ($18,000 + half of her Social Security benefit). Assuming a standard deduction of $12,000, that leaves $21,000 of her $33,000 that will be taxed.
She also has a 401(k), which should be worth about $800,000 when she retires. She doesn’t need the income, but if she does, she should have a bit of a cushion before she hits the next tax bracket. She also can work on converting some of that money to a Roth account before she’s hit with required minimum distributions at age 70½.
The bottom line
Michelle’s money should last much longer than it would if it were all being taxed. She’d be taking out at least another $10,000 to $12,000 a year to get to the same net amount — the amount she’s decided she needs to live the lifestyle she wants in retirement.
Tax-deferred investment accounts can be a beautiful thing for savers. But they’re not the only way to go. The earlier you start, the easier it will be to find the balance you need with those three tax buckets.
Do your homework and preserve every dollar you can. The next time you meet with your CPA or financial adviser, talk about strategies that could help you avoid a nest-egg-nibbling tax burden in retirement.
Kim Franke-Folstad contributed to this article.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Gregory Ricks, is the founder and CEO of Gregory Ricks & Associates and is a licensed insurance professional. He is also the founder of Total Wealth Authority, a team of outside financial, tax and estate planning professionals, and is the host of radio show Winning at Life on News Talk 99.5 WRNO (10 a.m. to 1 p.m. on Saturdays and 7 p.m. to 8 p.m. on weeknights).
-
What About Those ‘Guaranteed’ Life Insurance Ads?
Guaranteed life insurance policies can sound tempting if you've been declined for insurance elsewhere. Here are four downsides and one alternative.
-
13 Answers to Pressing Social Security Questions
From smart claiming strategies for couples to tips on maximizing your monthly check, we have advice that can help you.
-
Eight Tips From a Financial Caddie: How to Keep Your Retirement on the Fairway
Think of your financial adviser as a golf caddie — giving you the advice you need to nail the retirement course, avoiding financial bunkers and bogeys.
-
Just Sold Your Business? Avoid These Five Hasty Moves
If you've exited your business, financial advice is likely to be flooding in from all quarters. But wait until the dust settles before making any big moves.
-
You Were Planning to Retire This Year: Should You Go Ahead?
If the economic climate is making you doubt whether you should retire this year, these three questions will help you make up your mind.
-
Are You Owed Money Thanks to the SSFA? You Might Need to Do Something to Get It
The Social Security Fairness Act removed restrictions on benefits for people with government pensions. If you're one of them, don't leave money on the table. Here's how you can be proactive in claiming what you're due.
-
From Wills to Wishes: An Expert Guide to Your Estate Planning Playbook
Consider supplementing your traditional legal documents with this essential road map to guide your loved ones through the emotional and logistical details that will follow your loss.
-
Your Home + Your IRA = Your Long-Term Care Solution
If you're worried that long-term care costs will drain your retirement savings, consider a personalized retirement plan that could solve your problem.
-
I'm a Financial Planner: Retirees Should Never Do These Four Things in a Recession
Recessions are scary business, especially for retirees. They can scare even the most prepared folks into making bad moves — like these.
-
A Retirement Planner's Advice for Taking the Guesswork Out of Income Planning
Once you've saved for retirement, you'll need your nest egg to support you for as many as 30 years. For that, you need a clear income strategy, not guesswork.