Retirees’ Tax Puzzle: Pay Now or Later?
by Kim Blanton
Squared Away Blog, Center for Retirement Research at Boston College
December 1, 2016
“The majority of retirees pay no federal taxes. But taxes should be a concern for retirees who have retirement savings. That’s because the money they take out of their retirement accounts for living expenses will be treated as federal taxable income. It’s difficult enough to figure out how much money to withdraw – and when. Taxes are a separate but related issue.
In this blog, we interviewed Michael Kitces, a well-known financial adviser and partner with a Maryland financial firm, who writes the ‘Nerd’s Eye View‘ blog. He discusses the basics of navigating the tax code. The challenge facing retirees is to make tax decisions today that will minimize taxes now and in the future.
Question: Do you find that new retirees are surprised by their retirement tax situation?
Kitces: It’s usually not even on their radar screen. Pre-tax and post-tax income, different tax buckets – I don’t think most people even think about it once they’re in retirement. That’s why we’re still seeing people who are ‘surprised’ when they turn 70½ and the required minimum distributions (RMDs) begin, and their tax bill gets a whole lot higher. They say, ‘Why didn’t we plan for this?’ We say, ‘We’ve been recommending you plan for this for years!’
The reality is that while we’re working, we don’t think about taxes a lot – the first time you get your paycheck, you notice the difference between what your boss said you were going to get paid and what you take home. You get over that and then work for 40 years, and you just get used to your after-tax cash flow and lifestyle. But when you get into retirement, you have to think about whether accounts are pretax (traditional 401(k)s and IRAs) or after tax (regular bank accounts) or tax free (Roths), and how to draw them down. There’s nothing natural about it.”