Retirement today is very different from what is often shown in movies and TV shows. In the past, people were expected to work for one company for many years and then enjoy a simple retirement. But now, many people change jobs several times and continue working even after reaching retirement age.
People born between 1957 and 1964 are expected to hold an average of 12.9 jobs between ages 18 and 58, according to the U.S. Bureau of Labor Statistics, as cited by Kiplinger. Changing jobs frequently can create hidden tax costs during retirement. Many workers do not realize this while they are working, but these tax bills can become a major issue after retirement.
Start retirement planning early
Experts say one of the best ways to avoid future tax problems is to start retirement planning early. The more time a person has to prepare, the easier it is to make smart financial decisions. Planning ahead gives retirees enough time to study their future income sources, estimate expenses, and find legal ways to reduce taxes during retirement, as noted by Kiplinger report.
Watch your 401(k) taxes
Many Americans rely heavily on their pre-tax 401(k) retirement accounts. However, experts warn that these accounts should not be ignored after contributions are made. A common belief is that people will be in a lower tax bracket after retirement. But that is not always true because many retirees continue earning money through part-time jobs, consulting work, businesses, or investments. Because many retirees still earn income, some actually end up paying higher taxes during retirement than they expected.
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Another challenge comes from Required Minimum Distributions (RMDs). These are mandatory withdrawals from certain retirement accounts that retirees must begin taking at age 73. The RMD age will increase to 75 for people born in 1960 or later. Even if a person delays taking RMDs because they are still working for the company that holds their 401(k), the withdrawals cannot be avoided forever. The taxes are only postponed, as noted by Kiplinger.
Consider a Roth IRA conversion
Many workers roll old 401(k) plans into Individual Retirement Accounts (IRAs) after changing jobs. These IRA accounts are also generally subject to RMD rules. One strategy experts recommend is a Roth IRA conversion. This means moving money from a traditional retirement account into a Roth IRA and paying taxes on the conversion now.
Roth IRAs are often recommended for younger investors because their money can grow tax-free for many years. However, the Kiplinger report says Roth conversions can also be useful for older people, especially those who expect large taxable withdrawals later in retirement. Kiplinger notes that careful tax planning through Roth conversions can potentially save retirees tens of thousands of dollars over their lifetime.
Plan for your heirs
Traditional 401(k) accounts can also create tax problems for heirs after the account owner dies. Under current rules, children who inherit these accounts generally must take withdrawals and empty the account within 10 years.
This can become a problem because heirs are often in their peak earning years when they inherit the money. Additional withdrawals can push them into higher tax brackets. Converting retirement savings into a Roth IRA may help reduce this problem because heirs can inherit Roth assets tax-free.
Use low-income years wisely
Experts also recommend taking advantage of different stages of retirement when planning taxes. The years immediately after retirement can be especially valuable for tax planning because some retirees have lower incomes during this period. For example, some people retire between ages 60 and 62, before they begin receiving Social Security benefits, via Kiplinger.
During these years, retirees may rely on personal savings and part-time work while waiting for Social Security payments to begin. Because income is often lower during this period, it may be a good time to complete Roth IRA conversions and pay taxes at a lower rate. Kiplinger notes that simply contributing to a 401(k) is not enough. Without proper retirement tax planning, retirees and their heirs could face large tax bills later.
Overall, starting retirement planning well before age 65, managing 401(k) accounts carefully, considering Roth conversions, and planning for heirs can help retirees keep more of their money and enjoy a more financially secure retirement.
