Three Tax Mistakes That Retirees Need to Avoid

What is your main concern when you retire? Most people want to know if they will have enough money to maintain the lifestyle they want to have through retirement. When considering whether they will have enough money to last through retirement, many people think about their return on investment but fail to consider taxes. They underestimate how much they will pay in taxes. Taxes are a huge deal and can be the most significant expense many retirees will have. Say, for example, that you get a 7% rate of return on your investments. However, if you fail to manage your tax bracket and your effective tax rate is 3% higher than it needs to be because of a lack of planning, your return is reduced to 4%.

I can’t stress enough how vital taxes are in your long-term retirement planning and the potential adverse long-term effects of not planning appropriately for taxes. Most people will not run out of money. However, with careful tax planning, you can travel on the path to live the life you want to live during retirement. Let’s look at three tax-related mistakes that you could be making.

Mistake #1: Not Having a Tax Plan

Ask yourself if you have a tax plan for retirement. More than likely, the answer is no. Having taught dozens of classes, having participated in thousands of conversations, and successfully running hundreds of plans, I know people are not tax planning for retirement. The result is that it’s costing them tens of thousands, if not hundreds of thousands of dollars of their hard-earned savings in the retirement season of life. The main reason is that they do not have someone helping them with their tax planning. Talking to your account won’t necessarily help as he is not forward-looking but preparing tax returns from the previous year. For information on a proactive approach to tax planning for retirement, click here.

Mistake #2: Not Managing Income Needs

You need to plan to determine your income needs in the future. The foundation of a tax plan starts with how much income you will need and when you will need that income. You need to determine these key factors to put a tax plan together. A big part of your tax plan is determining where you will receive your yearly income, now and in the future.

Mistake #3: Improper Roth Conversions

Improper Roth conversions result from converting the wrong amount at the wrong time and unnecessarily paying more taxes than you need to on the conversions. People often focus on maxing out their current marginal tax bracket but need to consider their future income levels and the tax rate increase, which will take effect in 2026. All these factors must be considered so you can avoid overpaying taxes. Ed Slott, one of the nation’s leading experts on tax planning, focuses his teaching on two aspects of tax planning. He reminds people that the IRS has one tax plan for you. But, through tax planning, you can create a tax plan that suits your needs and minimizes the taxes you pay. He further teaches that your goal should be to pay as little taxes as possible over your entire lifetime through planning instead of trying to minimize taxes for the current year. By following this framework, you can lessen the burden of potentially running out of money or not having the money you need to live the lifestyle that you’ve always dreamed of during retirement.

The Two-Step Solution

Two parts of a proper tax plan should work together: a long-term tax plan and a year-by-year forward-looking tax plan. Begin by identifying your yearly income and living needs. Then, determine additional expenses like travel, remodeling, special events, and other significant purchases. Once these have been established, determine and assess your sources of income. Start with calculating guaranteed income streams like Social Security, annuity payments, and pensions. Next, consider current and future tax rates to determine which supplemental resources you have at your disposal that represent the best option from which to draw funds. From a tax planning standpoint, consider also when to draw from these accounts.

Once you have your tax plan foundation in place, the next step is determining how to implement a tax plan to reduce your current and expected tax liabilities. There are so many possible options to consider that it is virtually impossible to do so without using a tax software program. We use Tax Clarity, which allows us to enter your income streams and adjust current and future tax rates to discover the most tax-efficient way to reduce your current-year tax liabilities and the taxes you will pay throughout your lifetime.

The End Result

Following a two-step solution of creating a tax plan and using software to implement your tax plan can help you reduce not only your current year’s tax liabilities but also the total amount of taxes you will pay during your lifetime. With proper planning, the tax benefits can also carry forward to your heirs. Most people strive to be good stewards of their money. While this includes paying taxes, who wouldn’t want to minimize the taxes they’re required to pay through careful tax planning, leaving more money to enjoy life’s pleasures?


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