Taxes - a warning

[Cadence]

One thing I think not enough people are considering in future expenses is taxes, particularly for those with 401k's.

Let's say you retire and live off taxable accounts and gains on those taxable accounts for some number of years. During this time your taxes will be low, probably below 1K annually, since most of the dollars you are spending have already been taxed.

At some point things change dramatically if you begin living off 401K - all your spending money is taxed. It seems to me to be best to use all taxable accounts before using any 401K money, but I have no proof. Should some 401K money be used earlier to keep realized income in lower tax brackets? How are people handling this transition and what are some strategies?

 

[Rich_by_the_Bay]

Cadence, while there are some exceptions, the vast majority of retirees that I know draw down their nonsheltered dollars first for the reasons you mention. I've not seen any popular investment book that doesn't go along with that as general advice. The longer you leave your sheltered money to compound tax-exempt, the better the bottom line. And, yep, you need to take out more to net the same spending money once you start tapping into your qualified accounts.

Sometimes people draw down the sheltered money to tax-manage their mandatory IRA withdrawals prior to age 70.5, and there are a few other scenarios where. Someone will probably chime in with a few others.

 

[jdw_fire]

However NewThinking's approach to increasing your SS by delaying until 70 uses tax sheltered dollars for the bridge from age 62 to 70. Also several posters are converting tax sheltered dollars to Roth dollars while their tax bracket is low. Both of these techniques are ways to reduce future taxes by using tax sheltered dollars (and therefore paying more taxes) now. I think doing some planning of your income sources by taking into consideration the tax consequences of said sources is prudent.

 

[LoveNumbers]

Not an expert but we probably will try to convert some of the IRA money to ROTH during the low tax years before starting SS.

Jenni

 

[kaudrey]

Hi Cadence,

Well, I doubt most people on this board have omitted this issue!

Although I am quite a ways from retirement, my spreadsheet has a significant increase in taxes once I start drawing from my retirement accounts.

I'll see what the tax laws look like in 10-15 years when I retire, and take advantage of Roth conversions or whatever is available at the time as needed.

Karen