Getting to a low-tax or no-tax retirement income status takes work, and the sooner you can start on it, the greater the chance will be that you can be successful. Success takes organization and intent.
Let’s try to make thinking about funds in retirement simple. To do this, imagine that your retirement money falls into these categories, or buckets:
a taxable bucket
a tax-deferred bucket
a tax-free bucket
Your assets fall into each of the buckets. What is where?
This bucket provides liquidity and consists of investments on which you pay taxes based on the growth each year:: CDs, money markets, mutual funds, stock, bonds and so forth. You are taxed on the gains.
The reality is that as the total amount in this bucket grows, and therefore income form the returns on the investments increases, the tax bracket you will find yourself also increases. This means you will pay more in taxes due to being in a higher marginal tax rate bracket.
From the perspective of minimizing taxes in the long term and in retirement, this bucket should contain the equivalent of about 6 months of income.
This bucket of investment contains investments for which earnings are deferred until gains are taken. The account most Americans are familiar with are 401(k)s, an employer sponsored retirement plan, and IRAs. Other tax deferred instruments are 403(b)s, SIMPLEs, SEPs, Keoghs and so forth. Some annuities have tax-deferred features, but do not generally offer regular contribution options.
Contributions are tax deductible in the year made. Distributions are taxed as ordinary income at the time the distributions are taken out of the account.
In the search for minimal taxation in retirement, it is calculated by expert tax planning specialists that by the time required minimum distributions begin (at age 72), distributions should be equal to or less than your standard deduction.
To be actually totally tax free, these investments must not be subject to any tax, at any level. They also need to be free of the provisional income classification. Instruments such as Roth IRAs and LIRPs (life insurance retirement plan) are examples. An increasingly recognized instrument that can also fit into this bucket are reverse mortgages.
Finding the correct, or perfect, balance in each bucket to achieve a state of zero or minimum taxes during retirement requires the use of an experienced retirement income and tax planner, and the discipline to make adjustments over time to the buckets and their contents. Moves of assets between the buckets will have to made as required to maintain the planned pathway to low taxation.
Contact us to start the process of planning for your retirement and protecting your assets and income in the manner best suited for your future.