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Most Americans will have a lower one tax burden on retirement than during his working years.
However, this may not be the case for some retirees, particularly those on higher incomes and high savers, which could have a significant impact on their financial plans, according to financial advisers.
“Substantial evidence” suggests that retirees have lower tax rates than during their working years, according to 2024. paper published by the Center for Retirement Research at Boston College.
There are several common reasons for this, according to a 2017 joint study research paper from the Internal Revenue Service and the Investment Company Institute: People Leaving the Workforce No Longer Pay Payroll Taxes. Their household incomes often fall, which usually means less income is taxed. And only Social Security recipients I pay tax on part of their benefits.
The “vast majority” of people will have a lower tax rate in retirement, “hands down,” said Jeffrey Levine, a St. Louis-based CPA and CPA and chief planning officer at Buckingham Wealth Partners.
But this is not always the case.
Required minimum allocations can be large
Those who have built up a significant amount, perhaps with disciplined saving in a 401(k) plan or individual retirement accounts, may have large minimum distributions requiredLevine said.
For example, the IRS requires older investors to take minimum withdrawals annually from “traditional” (ie, pre-tax) retirement accounts when they reach a certain age. (Age is 73 for those who turned 72 after December 31, 2022)
The total amount is based on IRS formula. A larger egg generally corresponds to a larger RMD.
This matters because RMDs from pre-tax accounts thus add to the household’s taxable income increasing his total tax bill. In contrast, distributions from Roth accounts are tax-free some exceptions.
Investors conducted $11.4 trillion in traditional IRAs in 2023, about eight times the $1.4 trillion in Roth IRAs, according to the Investment Company Institute.
Additionally, investors who have inherited a retirement account, perhaps from a parent, you may need to empty the account within 10 years of the owner’s death, Levin said. Such withdrawals from a pre-tax account would further add to taxable income.
Retirees may not want to downsize their lifestyle
In addition to required withdrawals, big savers may choose to withdraw large amounts from their accounts to fund their retirement lifestyle, said Ted Jenkin, an Atlanta-based certified financial planner and founder of oXYGen Financial.
In such cases, their taxable income may exceed that of their working years, said Jenkin, a member of the CNBC’s Board of Financial Advisors.
“Most clients we sit with today don’t want to see a reduced income when they retire,” Jenkin said. “They still want to take the same level of travel, level of going to concerts and dinners, looking after grandchildren, and many of them are still carrying a mortgage for retirement.”
In fact, in the first three to five years after retirement, Jenkin finds that customers tend to spend more than they did during their working years due to what he calls a “glee period.”
“A lot of people just don’t want to downsize their lifestyle,” he said.
Consider your income tax assumptions
Investors should consider the income tax assumptions they make for retirement — or ask their financial advisor what tax assumptions they make in clients’ financial plans, Jenkin said.
Such assumptions could have a large financial impact, similar to the difference between using an average inflation rate of 3% versus 4% when modeling relative long-term financial success, he said.
He advocates conservative planning. Planning for a tax rate that is too low can increase the risk of running out of money in retirement, he explained.
“You should always plan everything on an after-tax basis,” Jenkin said.
Of course, it is impossible to determine future tax rates.
Congress can change the tax code, for example. Until then, there is a tax battle next year is set it can affect things like the amount of the standard deduction and marginal income tax rates.
However, even if Congress were to increase marginal income tax brackets in the future, most retirees would likely see their “personal tax rates” fall compared to their working years, Levine said.