Why Does Tax Planning Matter So Much In Retirement?

Whenever anyone is in a pre-retirement stage, one thing that goes overlooked can become a major problem during retirement. Tax planning isn’t just something you should think about, but something you must actively manage while considering how it affects your post-retirement lifestyle. 

However, one Redditor is questioning why so many people are spending what they believe is too much time on tax planning. Posting in r/retirement, this 68-year-old Redditor believes “taxes” are “actually a proxy anxiety for worrying about retirement itself.” 

I’m not sure I wholeheartedly agree that it’s not okay to think about taxes before retirement or that worrying about retirement is bad. With everything happening worldwide, these considerations can and should be considered, especially if retirement is near. 

The Reddit Post

For some reason, this 68-year-old Redditor is amazed that “many people seem to think their fancy tax planning is the single most important retirement consideration.” 

Their concrete belief, at 68 years old and retired with enough saved and invested to live a comfortable retirement, is that tax concerns are a proxy for worrying about retirement. Adding to their thoughts, they believe that tax considerations should take a backseat to more important questions like who you want to be when you retire or how you want to use the precious time we’ve been gifted in retirement? 

Ultimately, everyone is entitled to their opinion on how others should think, but it’s a bit of a mixed bag to assume that everyone should be focused on the same questions. This said, it does lead to a question about how many tax planning concerns people should have pre and post-retirement. 

Unexpected Tax Concerns

This Redditor is underselling how much it pays to be entirely aware of the effects taxes can have on your lifestyle during retirement. To be more specific, taxes can and will erode the money you set aside for retirement, often more and faster than expected. 

For example, you can think that 401(k) and IRA withdrawals are taxed as ordinary income, and if this isn’t something someone is prepared for during retirement, it can be a major hit depending on the tax bracket. This could mean that a $50,00 annual withdrawal is only $40,000 post taxes, which represents one-fifth of the money someone thought they had to spend annually is already gone. 

There is an unfounded belief that I don’t think this Redditor is considering in that there is a wrong assumption that your tax burden is somewhat lighter during retirement. This isn’t accurate, but it can be tackled by working with a financial advisor and accountant to determine when a withdrawal should be made, for example, and how much should be taken out. Any proactive strategy will help reduce the overall tax burden and relieve some anxiety about handing money to the government. 

Required Minimum Withdrawals

One of the biggest red flags regarding taxes during retirement is the Required Minimum Distribution (RMD). Far too frequently, individuals post-retirement are unaware of the tax burdens associated with RMDs, which must start at 73 years of age. 

If you have a $500,000 IRA, for example, your first year RMD could be as much as $20,000, which is fully taxable and could impact your tax bracket. What’s notable here is that you have to take this tax hit as these withdrawals are mandatory and you have to pair with Social Security tax considerations, pensions, capital gains, and any other taxable income you receive every year. 

RMDs can also impact how much you pay with Medicare, which is often more expensive as your income rises, especially for Medicare Part B and D premiums. This is called a “stealth tax” because it’s not immediately obvious it will impact your taxable income. This “Income-Related Monthly Adjustment Amount” or IRMAA explains why tax planning is essential and what makes this Redditor’s approach incorrect. 

Smart Tax Planning

The hope is that by being proactive with tax planning and working with a financial advisor, you can consider things like converting traditional IRA funds to a Roth IRA pre-retirement, which would mean paying taxes up front but reducing the tax burden later. There is no question a financial hit would come at the time of the withdrawal, but the hope is that if this is done pre-retirement, there is enough income to offset any hit that happens. 

A good financial advisor would also inform you that you should withdraw from a taxable account or brokerage before withdrawing from a tax-deferred account like an IRA. Doing this will help your income stay low in your earliest retirement years, which allows you to delay taxes a few years, which enables you more time to plan correctly. 

You should also be working with an accountant to discuss what can be done around deductions, like charitable giving or property taxes. The Saver’s Credit is also a consideration if you are still earning income while in retirement, and is just another thing that needs to be considered. 

Tax Planning Is Crucial 

The ultimate answer is that this Redditor is wrong, very wrong. While the comments in the post are decidedly mixed, there is no question that tax planning is important and can help shape one’s entire retirement lifestyle. 

Any attempt to keep more money in your pocket can only be good and will only help give you the lifestyle and financial legacy you are hoping for. By not planning for taxes, you could see a chunk of your hard-earned cash slipping away, which is not how you want things to play out when you finally stop the full-time 9-5 grind. 

Better yet, you must be ready for updated tax policy changes, especially as a new Congress and presidential administration starts anew. Any rules that might have previously applied could be here one day and gone tomorrow, so it’s important to track that and changes to IRS tax brackets, which could also impact your overall tax burden. It’s the combination of everything here that the Redditor doesn’t seem to consider, which further validates the argument they aren’t putting enough emphasis on why taxes are worth worrying about. 

It’s an unfortunate reality, but my financial opportunities will largely influence what I want to do and who I want to be in retirement. If I want to do nothing but golf every day, I first have to be able to afford it.

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