The average retirement age for men is 65 and for women is 63. But, does this mean that you’re financially ready to retire at the average age?
When you think of retirement, you usually think about spending more time with family, finally picking up a new hobby, or traveling more. You don’t think about what happens if you are not financially ready for retirement. On the other, maybe you spend too much time worrying about whether you will be financially ready for retirement.
If you’re worried about how the rising tax rates will impact your retirement taxes, you’ve come to the right place. Add to that inflation, low-interest rates, and the fluctuating stock market, you have your plate full of topics to stress about. Let us help you take one worry off your plate.
Keep on reading if you want to know about retirement taxes and how you can deal with rising tax rates.
How Much Will Taxes Rise?
That’s a hard question to answer. The better question is whether you think taxes will fluctuate when you retire. The answer is always going to be yes.
Tax rates are always changing based on political reasons beyond our control. Especially in this pandemic era with increased health care expenses, the government can turn to increase tax rates in the future to pay for their spending.
Let’s face it, our taxes today look nothing like the taxes we paid in 1913. The tax form was 4 pages long. In 1913, the top tax bracket was 7% on all income over $500,000 or $11 million based on today’s value.
The top federal tax rate rose to a whopping 94% during World War II, dropping to 50% in the 1980s and then again to 28% in 1986. In 2013, the top federal tax rate was 39.6% which was reduced to 37% which is the current tax rate.
It’s a safe bet to assume that the tax rates will fluctuate during your retirement. There is no guarantee about how much the tax rate will rise. But, if you manage your retirement income correctly, you won’t worry about rising taxes as much.
How Much of Your Income Is Subject To Retirement Taxes?
Before you take steps to minimize retirement taxes, you need to understand how much of your income is subject to taxes. Your retirement taxes depend on what type of retirement accounts and other savings you have. It also depends on the type of investments you have.
These accounts are designed by the government to defer your taxes until you retire. This means that you get a deduction for any amounts you put into a tax-deferred account while you’re working and in a higher tax bracket. When you take the money out upon retirement, you will pay taxes on those amounts.
Your pre-tax money can grow tax-free in these accounts. Remember you have to start withdrawing from these accounts at age 72, at which point they’re subject to normal tax rates. Tax-deferred accounts include 401(k), 403(b), and traditional IRA accounts.
These tax-free retirement accounts are the reverse of tax-deferred accounts. You pay taxes on the amounts at ordinary rates when you put them into the account. You don’t get a deduction when you transfer the amounts into these accounts.
But you’re able to take them out tax-free. This means you have less post-tax money invested, but you don’t have to worry about taxes upon retirement. These include Roth 401(k) and IRAs.
Health Savings Accounts
These are not traditional retirement accounts but can be used to save money for retirement. When you contribute to a Health Savings Account, you get a deduction. So, it’s pre-tax income that grows in your account tax-free.
You can withdraw the money tax-free for qualified medical expenses. As you age, your medical expenses also increase, so this is a benefit you want to take advantage of. Remember that when you turn 65, you can start withdrawing the money for non-medical reasons, but these will be subject to ordinary taxes.
Social Security Retirement Income
You may also receive social security retirement income. The average social security benefit was $1,543 per month in January 2021. If you earned a maximum of $142,800 over 35 years, you can get the maximum social security retirement income of $3,148.
You can calculate your social security using the online calculator provided by the federal government. Your social security retirement income may be subject to income taxes depending on your other sources of income, including pension and IRA withdrawals.
If your other income is less than $25,000, then your social security retirement income will be tax-free. If you have other income between $25,000 and $34,000, 50% of your benefits will be taxable. If you have other income over $34,000, 85% of your benefits will be subject to taxes.
If you have a pension through your work, you did not pay taxes when you contributed to your pension plan. Pensions are treated similarly to tax-deferred accounts. This means that you will be subject to taxes at ordinary rates when you withdraw from your pension.
Taxable Accounts Including Investment Accounts
These accounts are taxable at ordinary rates before you transfer them into your taxable account. If it’s just a savings account, you can withdraw funds at any time.
If it’s an investment account, you may also hold stocks, bonds, ETFs, and mutual funds in your account. You will be subject to taxes on any income and appreciation on those investments. The tax rates are dependent on the type of income you earn.
For example, you’ll pay long-term capital gains tax on any appreciation in real estate or stocks held for more than a year. The long-term capital gains tax rate is 0%, 15%, or 20% depending on your taxable income. In 2021, you have a 0% tax rate if you have income up to $40,040 if single ($80,800 if filed jointly).
Short-term capital gains are subject to taxes at ordinary income tax rates.
Any dividend income you receive is subject to taxation. The tax rate depends on whether the dividends are qualified or non-qualified. Non-qualified dividends are subject to taxes at ordinary tax rates.
A qualified dividend is a dividend from a U.S. company, a company in U.S. possession, and a foreign company traded on the U.S. stock market held for more than a year. These dividends are more common and are subject to preferential long-term capital gain rates.
Municipal Bond Taxation
Municipal bonds are issued by the government to raise money for spending needs. They tend to be more secure than other bonds from corporations. Municipal bond interest is exempt from federal taxation. You will be subject to capital gains tax when you sell those bonds.
Whole life insurance is a form of permanent life insurance that you a steady premium for. Any payment made to your beneficiaries upon your death is not taxable.
These policies also have a cash value that you can use during your lifetime. You can take loans or withdraw the cash value amount tax-free. Consult your tax and insurance advisors to plan this correctly so you can take the cash value out tax-free.
Schedule a 30-minute consultation with a financial professional.
What Are the Best States to Retire for Taxes?
Federal taxes are just one element of retirement taxes you should consider. State taxes can also make a huge difference for your retirement plan. As part of your retirement strategy, you may want to consider where you want to retire or at least understand where your state falls on the spectrum.
States range from very tax-friendly to not tax-friendly. But, remember that the best state to retire is a decision that includes more than income taxes. You should also keep property taxes, sales taxes, and estate taxes in mind. The weather, mortgage, and rental rates will also play an important role in your decision.
States That Don’t Tax Retirement
Certain states don’t tax retirement income. Some states are more tax-friendly than others. Some of the states don’t have income taxes, which means they don’t tax social security income or pension income as well. Other states provide a deduction for social security retirement income. Keep on reading for some tax-friendly states for retirement.
Georgia does not tax social security income and provides a deduction of up to $65,000 per person for all retirement income for any 65 years or older. It has moderate sales and property tax. Georgia doesn’t have any estate taxes.
For example, if you had $30,000 of social security income and $30,000 of other income, you would pay $0 of taxes on the social security income and $1,121 of taxes for the year on other income.
Georgia is ranked #1 by Bankrate because of its affordability.
Florida has no state taxes, social security, and pension income not taxed. This means any income from your retirement savings accounts will also not be subject to state taxes. Florida doesn’t have any estate taxes either.
For example, if you had $30,000 of social security income and $30,000 of other income, you would pay $0 of taxes on this income.
Florida is ranked #2 because of its weather and culture. You can also make a lot of friends here because 21% of the population is 65 years or older.
Wyoming does not have a sales tax so your retirement income and social security income will not be subject to state taxes. Also, Wyoming has some of the lowest property and sales tax in the country.
Wyoming is ranked #6 because of its weather and a low wellness score. Wellness includes access to health care, food, and economic security.
Alaska is a very tax-friendly state with no state taxes or estate taxes. It has a low sales tax rate of an average of $1.76. If you had $30,000 of social security income and $30,000 of other income, you would pay $0 of taxes on this income.
It’s still not known as a tax haven for retirees because of its high property taxes. You also have to pay high tax rates for beer and alcoholic drinks. It’s ranked lowest on BankRate.com because of its low scores on weather and crime rate.
A fun fact if you choose to stay in Alaska – every permanent resident who lives there for more than a year will receive an annual dividend check from the government from its oil wealth savings account. In 2020, residents received a check for $992.
Mississippi also doesn’t tax any retirement income, social security income, pension income, or retirement savings accounts. It has low property taxes. It has a higher sales tax of 7.07% and charges sales tax on groceries.
If you had $30,000 of social security income and $30,000 of other income, you would pay $0 of taxes on this income. It’s ranked lower at #34 because of its low scores on wellness, culture, and weather.
Nevada has no state taxes so all your income will be tax-free. It also has relatively low property taxes. Also, there are no estate taxes.
If you had $30,000 of social security income and $30,000 of other income, you would pay $0 of taxes on this income. Nevada is ranked #25 because of lower scores on affordability and crime rates.
Nevada has no state taxes so all your income will be tax-free. It has low sales taxes, but relatively higher property taxes. There are some property tax relief measures in place for low-income residents.
If you had $30,000 of social security income and $30,000 of other income, you would pay $0 of taxes on this income. It’s ranked #13 because of some lower scores on wellness and weather.
States That Not Tax-Friendly
Some states are not tax-friendly at all. This can mean a difference of around $10,000 per year for some people, so it is important to keep these states in mind.
New Jersey is one of the least tax-friendly states with high tax rates and the highest property tax in the country. It does offer a generous tax exemption for retirement income of up to $75,000 ($100,000 filing jointly). It also has a high inheritance tax from 11% to 16%.
All types of retirement income are subject to tax in Connecticut. Tax rates range from 3% to 6.99%. It also has some of the highest property taxes in the U.S., ranking third in the country.
Social security is exempted for seniors in certain circumstances. 25% of any social security benefits over $75,000 a year is subject to taxation. Anything under $75,000 is not subject to taxes.
If you have a pension that is less than $75,000, you won’t have to pay taxes on 28% of that sum. The government is planning to increase that exemption by 14% every until 2025 when they intend to exempt the full $75,000 of pension income.
Kansas taxes private retirement plans like IRAs and 401(k) plans. They also fully tax out-of-state public pension. Kansas exempts up to $75,000 of pension income, but anything above that gets fully taxed.
Nebraska has high income and property taxes. They tax retirement plans including IRA and 401(k) plans and pension income. The top income tax rate of 6.84% applies to any income over $31,750, which is a pretty low threshold.
Vermont has a high-income tax rate and they do tax social security benefits over $45,000. The tax rate range from 3.35% to 8.75%. They also have some of the highest property taxes
Other states that are not considered very tax-friendly include Wisconsin, Iowa, New York, Texas, and California.
Ways to Minimize Taxes on Retirement
As you know now, most income will be subject to some type of retirement tax. There are ways you can minimize taxes on retirement. You can also read about some common retirement planning mistakes and how to avoid them at My Guaranteed Income.
Tax Bracket Threshold
The tax bracket that you fall in determines the tax rate you’re subject to. Moving from a lower bracket to a higher one can lead to a large bump in taxes. You can figure out which tax bracket you’re in using this online tax bracket calculator.
For example, if you make less than $40,525, then you’re subject to a lower tax rate of 12%. But, any amount over $40,525 up to $86,375 will be subject to almost double the tax rate of 22%. This higher tax rate can make a huge difference in your retirement income.
Remember just because you move to a higher bracket doesn’t mean that your total income will be subject to higher tax. It’s only the amount over the threshold that will be subject to higher rates. Any amount over $40,525 per year will be subject to the 22% rate.
By managing which tax bracket you fall into, you can minimize your retirement taxes.
An easy way to minimize taxes is to reduce your expenses. This means you’ll withdraw less from your accounts and have to pay taxes on a lower amount. Your expenses may automatically reduce upon retirement, but you can also make a budget and lower your expenses.
Municipal bonds are tax-free, so it’s a good way to minimize taxes on your interest income. Rental income is taxable, but it can be offset by rental expenses including depreciation. So, renting your home or purchasing an investment property is a good way to minimize your taxes.
Investing in stocks including dividend-paying stocks and holding them for a year gives you the long-term capital gains tax rate. This is a much lower rate than ordinary income tax rates and can be a good way to minimize your taxes.
Use a Retirement Tax Calculator
Many companies offer retirement tax calculators to help you figure out how much tax you’ll be paying on your retirement income. The IRS has a tax withholding calculator that can also help figure out how much taxes you owe.
Knowing how much taxes you’ll pay can help you manage your retirement income and plan for the future.
Enjoy Your Retirement Without Worrying
At the end of the day, your retirement is something you’ve worked hard for. It’s a time for you to relax, slow down and enjoy yourself. You can spend time on your family or a fun project that inspires, motivates, or challenges you.
It’s not the time to spend stressed out and worrying about money. You can make your money go further with all the options available to you, or cut down your expenses to meet your needs. Knowing the right states to live in can also make a huge difference for your mental, emotional and financial health.
Contact Your Trusted Experts Today
Now you know everything there is to know about retirement taxes. You know about the different types of income that are subject to retirement taxes and how they’re treated differently. You also know ways to minimize those retirement taxes.
Tax planning for retirement can get complex and stressful. You want experts by your side helping you through your retirement plan. If you’re a federal employee, you also have additional federal benefit options to consider.
Unlike My Guaranteed Income, most financial advisors may not have the level of expertise to help you through your retirement planning. Contact My Guaranteed Income to schedule a free 30-minute strategy session for your retirement planning now.