By Joseph McManus, RICP®, Financial Planner, Prudential Advisors
Like most people, you’re likely focused on how to save money on your tax returns, but don’t lose sight of how the tax decisions you make today can affect your retirement plans tomorrow. If you are within five years of retirement, it’s time to fine tune your future finances. For example, have you thought of how taxes will affect you after you say goodbye to your job? Securing retirement income and understanding how taxes apply to your money is crucial to helping you afford to live the life you want throughout your golden years.
When you look at retirement assets through a tax lens, it becomes clear that decisions regarding the appropriate level of guaranteed lifetime income, maximizing Social Security, working in retirement and how you deploy your assets are very much linked. You should consider all of these elements in a holistic manner because, ultimately, the goal is to help make sure your assets support your desired standard of living for the rest of your life.
For those planning for retirement, following are some tax considerations to discuss with your tax and legal advisors:
1 — Personal income tax
Most people assume their personal income taxes will be lower after retirement because they won’t be generating as much income and, therefore, will be in a lower tax bracket. But due to the recent economic downturn and losses in retirement assets, the dismal personal savings rate over the last decade, the decline of traditional pension plans, and the increase in the full retirement age under Social Security for those born after 1954, many retirees are choosing to take on part-time jobs.
Regardless of the reason for working in retirement, the income earned, combined with use of retirement savings, might create a situation where you will be taxed at the same level or an even higher rate than when you were working full time. With this in mind, it’s important to have both taxable and non-taxable retirement assets upon which you can draw in retirement so you can manage taxes and maximize your income in the long term.
2 — State and local taxes
There’s a reason, besides warm weather, that people retire in states like Florida and Texas. Where you retire can have a significant impact on your after-tax income because state and local taxes can affect how long your retirement savings will last. Florida and Texas have a state income tax rate of zero, so they are attractive to many retirees who want to maximize their retirement assets. California, on the other hand, state income tax ranges from 1 – 12.3%.
In addition to state income taxes, there are sales and property taxes to consider. Some states derive more of their revenue from these taxes than from income taxes. You should understand how all of the taxes in the state and town in which you plan to retire will affect your income.
3 – Future tax rates
Another thing to consider when figuring out your post-retirement income is how federal and state taxes might change in the future. It’s hard to predict whether they will remain the same, be lower or increase. A good indicator of future federal income taxes is to look at history and take an educated guess. Doing so suggests that rates are at historic lows right now, which likely means an increase in the near future. An indicator of future state taxes might be the current budget position of the state, which, at the moment, suggests that many states may be looking to increase their income, sales and/or property taxes in the short term.
What does this mean for retirement planning strategies—especially in those critical five year periods just before and just after retirement? Basically, if federal or state taxes go up, your retirement savings and assets will be depleted sooner. You will have to save more to make your money last longer or you will have to adjust some of your spending habits.
As you finalize your taxes for this year, think ahead to how taxes will affect you down the road when you retire.
Prudential Financial, its affiliates, and their financial professionals do not render tax or legal advice. Please consult with your tax and legal advisors regarding your personal circumstances.
For more information, contact Joseph McManus, RICP®, a Financial Planner with The Prudential Insurance Company of America’s Greater New England Financial Group, located at 293 Boston Post Road West, Suite 110, Marlborough, Mass. McManus can be reached at [email protected] and 508- 382-4904.