Even if you don’t plan to retire for years, it’s still a good idea to think ahead about where you decide to live, the source of your income and how it all interacts with Social Security and Medicare. Here’s why: Getting a better feel now for the way you could get taxed later can help you find ways to help minimize the future impact. It might also spur you on to making bigger contributions to your IRA while you’re working – and help you close the gap between the nest egg you’ve saved so far and the retirement income you want to generate down the road.
Here are some points to consider:
Where you live in retirement
Where you live in retirement could have a big impact on your bottom line. When you retire, it’s likely that your main source of income will be your retirement accounts. So finding ways to minimize your taxes is like giving yourself an instant raise. One easy way to do so: Consider your address carefully. Very few people move specifically to lower their state income tax. But if you’re trying to decide among a few places to retire – or you already have homes in more than one state — it’s a great tax-saving strategy to keep in mind.
A handful of states have no state income tax whatsoever, including such popular retirement destinations as Florida, Nevada and Texas. A few others only tax income from dividends and interest. And still others exempt Social Security and pension payouts. (Use our guide to learn more.) Warning: If you have homes in more than one state, there are many rules you must follow closely to prove that you spend enough time each year in the one you’re claiming as your permanent residence.
What you tap and when
Think about what you tap and when. By the time most investors near retirement, they have a hodgepodge of retirement accounts from various careers and personal investments. You might have two, or even three, 401(k) accounts, along with traditional IRAs with pre-tax and after-tax contributions, and maybe also Roth 401(k)s or Roth IRAs. If you’re lucky, you might even have a traditional pension.
Having a bunch of retirement accounts is better than not having them, of course, but figuring out the most tax-efficient way to tap them generally should not be left to amateurs. Consider consulting a financial advisor and tax professional with extensive experience working with people transitioning into retirement as you make decisions about how much to withdraw each year – and from which place first.
If you’re married, the decisions could get even more involved. Is your spouse still working, meaning your joint income could hit higher tax thresholds faster? If your spouse has retired already, does he or she also have a pension, or mandatory withdrawals coming from IRAs? Different types of accounts are treated differently when it comes to taxes, so, again, it’s a good idea to discuss your plans with a tax expert.
Social Security and Medicare gotchas
Watch out for Social Security and Medicare gotchas. Retirees who exceed certain income thresholds wind up owing federal tax on up to 85% of their Social Security benefits. And income above certain amounts can lead to higher premiums for Medicare Part B, or possibly a Medicare tax on investment income, as well. But if you’re lucky enough to have accounts from which you can draw tax-free distributions, such as a Roth IRA, you might be able to take a combination of pre-tax and after-tax withdrawals that keep your taxable income under those thresholds. Again, you’re best off consulting a professional for such complicated tax planning.
Awareness is the key. By understanding the complex nature of the retirement-tax landscape in advance, you can start making strategic investments now that can help lower tax bills later.
Chip Castille, Managing Director, is head of the BlackRock Global Retirement Strategy Group. You can find more of his posts here.
This material is provided for educational purposes only and does not constitute investment advice. The information contained herein is based on current tax laws, which may change in the future. BlackRock cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. The information provided in these materials does not constitute any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice.
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