When thinking of retirement, many people don’t consider that the money in their 401(k) or IRA will be taxed. They also don’t consider the tax rate for these plans in the future. Many analysts believe that tax rates are very likely to go up over time. This likely increase is due to the currently rising national debt and unsustainable amount of today’s government spending. The growing national debt will have to be paid eventually and it’s likely that paying the debt will mean a higher tax burden for American citizens down the line.
But what if you could avoid paying these unknown tax rates on your retirement by paying taxes on these funds now? Congress has recently been looking into taxing deposits on retirement plans up front. Analysts have called this upfront payment “Rothification,” which is a reference to Roth IRA accounts, which already require payment with after-tax money.
Until we have upfront tax payment plans for 401(k) and IRA accounts, there are other ways you can plan to have a tax-free retirement now. There is, of course, the option of using a Roth IRA, which is tax-exempt. However, there is a limit to the amount of money you can put in a Roth IRA.
Another way of creating tax-free retirement funds is by using a high-cash-value dividend-paying whole life insurance policy strategically. Funds put into this policy come from already taxed income so they are not taxable when they are withdrawn, nor is your growth from the policy. You can use this policy this way by using a combination of loan withdrawals and loans against your tax value.
Having tax-free retirement funds is advantageous for several reasons. Firstly, there’s the obvious reason: that you won’t have to pay these taxes once retired. Paying now rather than waiting to pay later means that you’re paying at a time when you will likely have far more income, which will make the tax feel like less of a burden. Taxes on 401(k) and IRA accounts can be around a third to half of your retirement fund, which can be both a burden and a shock to those who didn’t expect the money to be taxed.
Secondly, if you pay taxes up front on retirement funds, you are more likely to have more deductions and exemptions that could help you pay less tax on the amount.
Finally, if you collect Social Security in retirement, as most people expect to, having tax-free retirement funds can help you avoid paying more tax on your Social Security. Taxable retirement accounts like 401(k)s and IRAs count as income according to tax law. Certain amounts of income affect how Social Security is taxed. If income for single payers is $25K or less (or $32K for joint payers), Social Security is not taxed. But if the amount of income for single payers is $25K to $34K (or $32K to $44K for joint payers) as much as 50% of Social Security benefits can be taxed. If the amount of income is $34K or above (or $44K or above for joint payers) the taxable amount of Social Security benefits can be up to 85%. Roth IRAs, however, do not count as income under tax law. So having a Roth IRA can help you avoid paying more taxes on your Social Security benefits.
Planning your retirement strategy carefully is important for the health of your financial future. If you’re interested in finding out more about having a tax-free retirement, contact Vanguard Tax Relief. Our expert accountants can create a retirement strategy for you that will reduce your tax burden during retirement. Considering the future of your taxes today can help you pay less when you retire and give you peace of mind about the future of your finances.