Retirement is finally here! Your savings accounts are set, Social Security benefits are coming in, and your pension is ready. Everything seems perfectly planned. But are you prepared for the unexpected tax surprises that could disrupt your plans? Here are five common surprises that could affect your retirement:
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Health Emergencies and Long-Term Care
Unexpected medical expenses can quickly drain your savings. A simple procedure could cost thousands, and long-term care expenses could run into the tens of thousands per month. If your health insurance doesn’t cover these costs, you may need to withdraw from your retirement accounts. While you won’t face a penalty, you could still be hit with income tax if the funds come from a pre-tax account.
Tip: Consider enhancing your health insurance with supplemental coverage and prescription drug plans. Explore long-term care insurance or other strategies to protect your savings from unexpected healthcare costs.
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Taxability of Social Security Benefits
Social Security benefits can be subject to federal income tax depending on your “provisional income.” Provisional income is the sum of your adjusted gross income (AGI), tax-exempt interest, and 50% of your Social Security benefits. The IRS has set specific income thresholds that determine whether a portion of your Social Security benefits will be taxed. The thresholds vary based on your filing status. The IRS offers a free tool to help you determine if any of your benefits are taxable here.
Tip: Schedule a tax planning session to evaluate your options. You might benefit from delaying your Social Security benefits to minimize the tax impact.
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Pension Plan Considerations
Pension plans, whether offered by a private company, a government entity, or a union, are long-term promises to provide income during retirement. However, not all pension plans are created equal, and the financial stability of the plan is a crucial factor in determining whether you’ll receive the benefits you’ve been promised.
Lump-Sum Payout Pros:
- Control over investments
- Flexibility in spending
- Estate planning
Lump-Sum Payout Cons:
- Risk in longevity of funds
- Investment risks
- Loss of guaranteed income
Tax Implications:
A lump-sum payout is typically considered taxable income in the year you receive it, unless it’s rolled over into a tax-deferred retirement account, such as an IRA. Taking a large sum all at once could push you into a higher tax bracket for the year, significantly reducing the actual amount you receive.
Regular pension payments, on the other hand, are generally taxed as ordinary income in the year you receive them, which may spread out the tax liability and keep you in a lower tax bracket.
Tip: Review your pension’s annual statement closely. If there are risks to the stability of your pension, consider whether taking a lump sum or other alternatives could better secure your retirement.
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Required Minimum Distributions (RMDs)
RMDs are mandatory withdrawals that retirees must start taking from their tax-deferred retirement accounts, such as traditional IRAs, 401(k)s, and 403(b)s, once they reach a certain age. Failing to take these distributions on time can lead to significant penalties and tax burdens in the future, so it’s important to manage RMDs carefully as part of your retirement planning.
As of 2024, individuals must start taking RMDs at age 73 (recently increased from 72). If you miss taking your RMD in one year, you will still be required to take the missed distribution, along with the RMD for the current year. This could result in larger-than-expected withdrawals in a single year, pushing you into a higher tax bracket and increasing your overall tax liability.
Tip: Choose a memorable date, like your birthday, to review and manage your RMDs each year. This will help you stay on top of this requirement and avoid surprises.
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Future Tax Rates
With the federal government’s rising debt and states seeking more revenue, future tax increases are likely. This could significantly impact your retirement income, so it’s important to plan ahead. Start by diversifying your retirement accounts—having a mix of tax-deferred (traditional IRAs/401(k)s) and tax-free accounts (Roth IRAs) can help balance your tax burden. Consider Roth conversions to pay taxes now at current rates and avoid potentially higher taxes later.
Additionally, managing the timing of withdrawals from tax-deferred accounts, especially before required minimum distributions (RMDs) kick in, can prevent large tax hits. Staying flexible and reviewing your plan regularly with a financial advisor is crucial to adapting to changing tax laws. By taking proactive steps, you can protect your financial security and ensure your retirement savings are optimized, even in a higher-tax environment.
Final Thoughts
As we navigate an ever-evolving financial landscape, it’s essential to stay informed and proactive in managing your retirement strategy to avoid any tax surprises. Retirement should be a time to enjoy the fruits of your labor, and a well-crafted plan can help ensure that financial surprises don’t get in the way.
If you have any questions or need guidance on your personal financial strategy, don’t hesitate to reach out—we’re here to help you navigate the complexities and stay on track toward your goals.
