As a CPA and Wealth Manager I meet with many clients planning for retirement. Often they express concerns about how they should be allocating portfolios, saving more, or spending less. What I rarely encounter is a client worried or making plans for taxes in retirement. A common response I receive from clients is "I don't worry about taxes in retirement because my income will be lower". Clients who fail to tax plan, or who think that because income will be lower that tax liabilities are guaranteed to be lower, are making a critical mistake.
First, it is critical that we establish our long-term outlook for tax rates. Currently the United States is running a significant budget deficit and the growing national debt is not sustainable. By 2020 it is projected that 92 cents of each tax dollar collected will go to 4 programs: social security. medicare, medicaid, and interest on the national debt. The government has to fund thousands of other programs and agencies with the remaining 8 cents. In terms of income tax history, from 1936-1981 the top federal income tax rate never dipped below 70% and peaked at 90%. Today the top marginal rate is 37%. In the near future the U.S. government will need to significantly slash spending or increase tax rates. We see it as unlikely that spending will decrease, so our outlook is a rising tax rate environment for the foreseeable future.
The next consideration is that during prime earning years individuals have dependents at home, and more deductions (mortgage interest for example). During retirement this is not the case, so even though you may make less you have fewer options to offset the income you do have.
Most Americans plan on a combination of distributions from IRAs or 401(k)s and social security for retirement income. They often fail to recognize that if they take too much income from IRAs or 401(k)s, or earn money elsewhere, social security can become taxable income as well. In conjunction with projected higher tax rates and lower deductions, many will pay more in taxes than they anticipate. To fund the unexpected tax bill they will have to take additional distributions from IRAs or 401(k)s which causes a snowball effect during retirement.
The only way to protect yourself from tax issues in retirement is to plan early. Funding ROTH IRAs or implementing a LIRP strategy can be helpful, At Harman Rogowski & Associates we help our clients target a zero tax retirement, which takes significant planning and preparation.
A great place to start is meeting with Harman Rogowski & Associates for a free financial plan. We will help you assess how prepared you are for retirement and assist with tax planning. Unlike most investment advisory firms, we also have a team of CPAs with the tax expertise to help you implement a plan for taxes during retirement.
"The Power of Zero" by David McKnight
We also highly recommend the book "The Power of Zero" by David McKnight, which introduces you to some of the complex strategies our advisors utilize to help clients prepare for retirement
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