Hi there. My name is Mel Samick, thank you for reading ?Mel?s Retirement Blog?. Today?s discussion is called, “The Impact of Taxes in Retirement.”
I’ve been fortunate enough to ask these questions to thousands of different potential clients, and that is this, what do you think taxes are going to be like in the future?
Do you think taxes are going to go up, stay the same, or go down?
And before I can finish the question, people started yelling out, “Taxes are going to go up. Taxes are going to go up.” And an overwhelming majority of the people believe that taxes are going to go up in the future.
If I ask the same group of people a second question, which is, what do you think taxes are like today? Are taxes high? Are they average? Or are they low?
Again, everybody says that taxes are as high as they’ve ever been. They’re so high, they’re outrageous.
But the truth today is, taxes are about as low as they’ve ever been.
There’s only one time period in the recent past, in the 1980?s, when taxes were lower than they are today, and it’s just by a few percentage points.? The truth is taxes today are about as good as they’re ever going to be.
The point I would like to make today, is that planning for taxes in retirement needs to be one of your primary focuses.
Most people might say that’s ridiculous. I’ve always been told that the number one thing that I need to plan for in retirement is market risk.
So, why do people think that?
Think about this?
From the moment that you wake up in the morning, to the time that you go to bed at night, you’re being bombarded by the Wall Street marketing machine telling you that if you just have a perfectly balanced portfolio with the right Wall Street investments, that earn you a high rate of return, then all of your retirement problems are going to be solved.
You wake up in the morning, you go to the gym, there’s Mad Money Cramer on TV telling you about the hottest stock pick and the latest IPO.
You get in the car, you drive to work and Dave Ramsey or Ric Edelman are on the radio, telling you about the perfect five-star mutual fund that’s going to earn you a 12% rate of return or higher.
And then you get home at night and Suze Orman is on TV telling you that Wall Street products are the best, everything else is bad and to put all your money into a 401(k).
So, we’ve been told for our entire lives that this is the number one risk.
But the truth is that taxes might be your number one risk in retirement, and at the very least a close second.
Biggest retirement expense
If I go to the same group of people and I ask them what do they think the biggest retirement expense that they’re going to have the day that they retire? Do they think it’s going to be a mortgage payment or rent? Do they think it’s going to be healthcare? Or do they think it’s going to be taxes?
Almost everybody is going to say that healthcare is going to be their number one expense.
And think about it, for the last 15 years, we’ve heard news stories and commentary in the media about how outrageous healthcare expenses are, and how they’re increasing at these astronomical rates.
While that’s certainly true, they’re definitely going up. The truth is that for some people, the top 25% of income earners, the number one expense that they’re going to have in retirement is going to be income taxes.
A recent survey and study of thousands of people across the country showed that for people to make $100,000 to $150,000 per year in income, their taxes are going to be $17,000.
That’s a significant amount of money.
If you have $150,000 to $200,000 of income, your taxes per year are going to be $30,000.
If you make $200,000 or more, your taxes are going to be $80,000. You can see how this problem gets bigger the more money you make.
The truth is the vast majority of people don’t make $100,000 per year of income.
So for the people who are not high income earners, then it is true healthcare is going to be your biggest retirement expense.
A recent study that was commissioned by Fidelity last year concluded that the average married couple age 65, that their expected health insurance and health-related expenses in retirement would be $280,000.
That’s a lot of money.
But it is also true that the average length of retirement for that same couple is 27 years.
This comes out to almost $10,000 a year in the form of healthcare expenses.
While this is a lot of money, $10,000 per year, this is nothing compared to the amount of taxes that you’re going to be paying in retirement.
So, what I would say is that if you’re in this top income category, then perhaps planning for taxes should be your number one priority.
But I know what you’re thinking, you’re thinking I’ve always been told that taxes are going to be lower when I retire.
But for the benefit of the doubt, let’s just say that the taxes stay the same, that they’re never going to change as far as tax rates and that when you retire your taxes are going to be lower because that’s just how it works. You have less income and you’re going to pay less taxes.
What I say to you is that is maybe that was once true, but today, things have changed because tax law has changed.
If we look at the biggest tax deductions that people have today, while they’re still working, the number one deduction that people have is their mortgage interest deduction.
Now, if you listen to the same talking heads on the radio and TV, they’re always going to tell you to pay your home off before you retire, or at least have it mostly paid off.
And if that’s true, your number one deduction today is eliminated. Wouldn?t that be correct?
Furthermore, the second deduction that you have is your 401(k) contribution. You’re not going to be making 401(k) contributions when you retire because you won?t be working anymore, so that will be gone. Right?
Lastly, the child tax credit. Your children are grown and no longer a dependent. ?No child tax credits there anymore.
If all of this is true, that means that all of your former deductions that totaled $20,000 to $30,000 of tax deductions annually while you were working, they are completely gone the day that you retire.
Now this is exactly how you can actually have a lower amount of income in retirement and still pay a higher tax rate because your tax deductions have been eliminated. Would you agree?
Retirement tax example
So, what kind of effect do taxes have on your retirement portfolio?
Well, if you listen to all those same media outlets, and radio, and TV personalities, they’re all going to tell you that the best place to put your money is in your 401(k).
Every year, your CPA is going to tell you to do the same thing, to maximize your 401(k) contributions.
And if you do that, you might end up with $500,000 in your IRA.
If you have a 25% effective tax rate, then that means $125,000 of that IRA balance is not yours. That is owed to the IRS.
If taxes go up in the future, let’s say to 35%, now you owe $175,000.
If taxes go up to 45%, then you will owe up to $225,000 to the IRS.
This would have a substantial impact on the amount of net cash you will have to live on in retirement.
Get started today
I started off this blog asking the question, do you think taxes are going to go up in the future or will they go down? And almost everybody says they’re going to go up.
I pointed out that taxes are as low as they’ve ever been in the past.
With that being said, and hopefully with a deeper realization that taxes can have a tremendous impact on your retirement when the government starts raising taxes. ?If you are in a top income earning category, taxes will be your biggest retirement expense.? My recommendation is you should do some proactive planning today to put your money into tax-preferred or tax-free type of products or investments so that on the day that you retire, you can insulate yourself from those potential future income tax increases or at the very least you lower the amount of taxes that you pay. It just so happens I have the #1 tax minimization strategy to assist you in lowering your taxes. Call me and I will prepare ?A Wealth Report? and explain how to create tax free wealth.
Thank you for reading my blog. I hope this helps you to start thinking about reducing your income taxes.