Good Morning.
Last week I asked if you might be sitting on a "retirement tax bomb" and that led to a few questions about what that means. In order to answer, I'm going to use part of what I present at my Taxes in Retirement presentations.
- In this email I will state what the problem typically is.
- In next week's email I will show how it creates a large lifetime tax liability if no action is taken.
- And in the following week I will show how it can not only create an income tax bomb but also a Medicare tax bomb.
Here’s the problem, if you've been saving for retirement over the course of your career you probably have a large chunk of your nest egg in a pre-tax account as the pie chart above illustrates. Your situation might not look exactly like this, but it probably looks similar.
As you save money through the years, you have to make a decision on where you’re going to put it from an investment perspective. How are you going to diversify this? What kind of allocation are you going to use and so on...
But whether you knew it or not, you were making tax decisions all along the way too, and there are really only three buckets of money when it comes to taxes: pre-tax money, after-tax money, and tax-free money.
The average person we work with looks like what you see above, the majority of their retirement money is sitting in a bucket that has never been taxed. This would be your IRA money, 401k money, 403b money, 457 plans, and plans like that. This is money you chose to put away on a pre-tax basis.
The problem is, when you retire, the majority of the money you’ve saved is going to be taxed when you take it out to spend it. Most people forget to account for the silent partner they have until they realize what they're going to have to pay Uncle Sam.
And this is going to cause your income streams in retirement to get taxed in complex ways.
Everyone approaching retirement talks about de-risking their portfolios from an investment perspective, but have you ever de-risked your portfolio from the IRS or from a tax perspective? Have you ever laid the tax code over your retirement situation and asked how to optimize and reduce your lifetime tax liability?
How do you get Uncle Sam out of that partnership in the most efficient manner possible and pay the least amount of taxes over your lifetime?
Often, your tax rate in retirement will be determined more by where your income comes from, rather than your actual income.
Now that I've discussed what the problem typically is, next week I will discuss how this can create a "tax bomb."
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