by Cristin Harris Rigg, CFP®, CDFA™
Postponing taxes might sound good today, but if you’re successful in growing your nest egg and tax rates increase, you could be looking at higher taxes in retirement.
Conventional wisdom has long held that in retirement you should tap taxable accounts first, followed by tax-deferred accounts such as IRAs, to help preserve your tax-deferred assets as long as possible. However, in practice, too much tax deferral can cause an IRA to grow so large that future withdrawals in retirement can actually drive you into higher tax brackets when you least want it to.
When you reach age 59 ½, you enter what we call the “tax sweet spot”. This is when you are allowed to make withdrawals from tax-deferred accounts penalty-free… but you aren’t required to actually make those withdrawals until age 70 ½. It’s the financial planning you do during these critical years that may have the greatest impact on your future level of retirement income.
1) Delay Social Security and Begin IRA Withdrawals
If you need income from 59 ½ – 70 ½ to help cover your expenses, consider delaying your Social Security start date to age 70 and use IRA withdrawals instead during this period. This will allow you to maximize your Social Security income in retirement and avoid falling into the tax trap of waiting to take IRA withdrawals only when you are forced to, after age 70 ½.
2) Begin Annual Roth Conversions
If you don’t need the income from 59 ½ – 70 ½ from IRA withdrawals for your expenses, still make annual IRA withdrawals, but instead of spending that money, make IRA-to-Roth IRA conversions each year to help manage your taxes and convert those taxable IRA dollars to tax-free Roth dollars for future retirement spending needs.
Remember to explore these and other tax strategies with your financial advisor and CPA each year to optimize your retirement income during your years in the tax sweet spot. Sometimes aging may not be much fun, but it can be sweet!