How Will Taxes Affect My Income in Retirement?

When you picture retirement, you may think about how much you have saved, when you can retire, and how much income you will need each month. But there is another important question:

How much of that retirement income could be taxable?

The decisions you make while saving for retirement can affect how your money is taxed when you eventually begin using it. That is why retirement planning should include more than reaching a savings goal. It should also consider how taxes may affect the income those savings provide.

Is Retirement Income Taxable?

It depends on where your retirement income comes from. Money withdrawn from traditional IRAs and many employer-sponsored retirement accounts is generally taxable as income because those accounts typically allow taxes to be deferred until money is withdrawn.

Qualified Roth IRA distributions, on the other hand, generally are not included in taxable income because Roth contributions are made with after-tax dollars.Pensions may also be fully or partially taxable, depending on how contributions were made. Even Social Security benefits can become partially taxable depending on your overall income.

This means two retirees receiving the same amount of income could potentially have very different tax situations.

Why Do Today’s Tax Decisions Matter?

When retirement is still years away, it can be easy to focus on reducing your tax bill today.

But a decision that provides a tax benefit now can affect how your money is taxed later.

For example, choosing between traditional and Roth retirement accounts involves deciding whether you potentially receive a tax benefit today or contribute after-tax dollars in exchange for qualified tax-free withdrawals later.

That doesn’t mean one option is always better. It means the decision should be made as part of a broader retirement and tax strategy.

Is Your Current Tax Professional Looking Beyond This Year’s Taxes?

Your tax professional may do an excellent job preparing your return, but are they also discussing how the decisions you make today could affect your taxable income in retirement?

Are they asking about your retirement goals?

Are they considering your retirement accounts and other potential sources of retirement income when discussing tax strategy? Are they helping you think beyond this year’s tax return?

Tax preparation typically focuses on what has already happened. Retirement tax planning requires looking ahead and considering how your tax strategy fits into your broader retirement strategy.

If those conversations aren’t happening, it may be worth asking why.

What Happens When Required Withdrawals Begin?

Taxes can also become increasingly important later in retirement. Generally, owners of traditional IRAs and certain retirement accounts must begin taking required minimum distributions (RMDs) at the applicable age. Those withdrawals are generally included in taxable income, except for amounts that were previously taxed or otherwise qualify for tax-free treatment.

For someone who has accumulated substantial savings in tax-deferred retirement accounts, those required withdrawals can become an important part of future tax planning.

Thinking about that possibility before retirement can give you more time to evaluate how your retirement assets are structured.

Start Looking Beyond This Year’s Tax Return

Preparing an accurate tax return is important, but your financial life does not end on April 15.

If you are approaching retirement or actively building retirement savings, now may be the right time to look beyond this year’s taxes and start considering how today’s decisions could affect your future income.

Sentinel Tax Pros can help you look at your tax situation as part of the bigger picture and identify questions that should be considered as you prepare for retirement.

Schedule a consultation with Sentinel Tax Pros to start planning beyond your next tax return.