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Retirement Tax Reality Check: Higher Earners and Savers May Face Surprise

When planning for retirement, many Americans assume their tax burden will decrease. However, this may not be the case for higher earners and big savers, who could face a significant impact on their financial plans.

Lower Tax Rates in Retirement: The General Rule

Research suggests that retirees typically enjoy lower tax rates than during their working years. This is due to several factors, including:

• No longer paying payroll taxes
• A decrease in household income, resulting in less taxable income
• Only paying tax on a portion of Social Security benefits

The Exception: Higher Earners and Savers

However, those who have built up a sizable nest egg through disciplined saving may face larger required minimum distributions (RMDs) from traditional retirement accounts. These RMDs add to taxable income, increasing the total tax bill. In contrast, distributions from Roth accounts are not taxable, with some exceptions.

Inherited Retirement Accounts and Lifestyle Spending

Investors who inherit a retirement account may need to empty the account within 10 years of the owner’s death, further adding to taxable income. Additionally, big savers may choose to withdraw ample sums from their accounts to fund their retirement lifestyles, potentially exceeding their working-year income.

The Importance of Tax Assumptions

Financial advisors stress the importance of considering income-tax assumptions in retirement planning. Assuming a lower tax rate than reality may increase the risk of running out of money in retirement. Planning conservatively and accounting for potential tax changes can help mitigate this risk.

Tax Uncertainty and Long-Term Planning

While it’s impossible to predict future tax rates, advisors recommend planning for a range of scenarios. Even if Congress increases marginal income-tax brackets, most retirees will likely still see their personal tax rates fall versus their working years.

A Call to Action: Review Your Retirement Plan

Don’t assume your tax burden will decrease in retirement. Review your financial plan, considering tax assumptions and potential changes. By planning ahead, you can ensure a more secure and sustainable retirement.