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How to Build a Solid Tax Foundation for Retirement (Long before You Retire!)

Retirement should be a time of enjoyment in your life — filled with financial security and peace of mind. Your retirement could span decades, and carefully curating investment strategies while planning for your retirement can help ensure that you’ll be making the most of your savings to last you through your golden years. 

One important aspect of retirement planning is making sure that you establish a good tax foundation now so that you can optimize your income in the future. You’ve worked hard to grow your wealth and prepare for retirement, and it’s an unfortunate fact that taxes can have a significant impact on the income and assets that you’ve accumulated over time. But if you begin implementing smart tax strategies in your retirement planning well before you reach retirement age, you can help build a strong tax foundation to make the most of your retirement and keep more of your wealth.

The Impact of Taxes on Retirement

Taxes can play a pivotal role in shaping your retirement financial landscape. It’s essential to understand how different sources of retirement income are taxed so that you can minimize your tax liability and maximize the longevity of your retirement savings and investments. If you establish a robust retirement investment strategy that focuses on spreading your retirement income among tax-diverse accounts, you can help your assets last longer through retirement.

How to Prepare for Retirement with Tax Diversification

Here are the different types of tax treatments on retirement income sources:

  • Taxable Accounts: Taxable accounts include investments (stocks, most bonds, CDs), and cash accounts (savings and money market accounts). Contributions to these types of accounts are made with your after-tax money. Taxable accounts are taxed annually on earnings from distributed dividends, interest received, or capital gains with the sale of stock. Taxable accounts are attractive as they offer more flexibility on when you can make withdrawals, and you aren’t obligated to follow required minimum distributions (RMDs) after age 73.
  • Tax-deferred Accounts: Tax-deferred accounts include pension plans, retirement accounts like 401(k), 403(b), and 457(b), traditional individual retirement accounts (IRAs), and annuities. Tax-deferred accounts are funded with pre-tax deductions from your paycheck. The money in these accounts accumulates and grows tax-deferred. Tax-deferred accounts are typically taxed as ordinary income at the time of distribution or withdrawal. These accounts are appealing if you anticipate that you’ll be in a lower tax bracket in retirement.
  • Tax-free Accounts: Tax-free accounts include retirement accounts like Roth IRAs, Roth 401(k), certain municipal bonds, cash value life insurance, and health savings accounts (HSAs). Because contributions to tax-free accounts are generally made with your post-tax income, you won’t be taxed on earnings or at the time of withdrawal (HSAs are the exception, as health savings accounts are funded with pre-tax income). Tax-free accounts are beneficial if you want to withdraw money in retirement without being subject to a higher tax bracket.

The key to benefiting from tax diversification in retirement is to contribute to each of these different accounts during your working years before you retire so that you can establish a well-built tax foundation for when you retire. Having your income strategically allocated in all three of these types of accounts can increase your tax savings during retirement.

Many people tend to favor tax-deferred accounts such as 401(k)s while they’re working, and they can end up overweight in investments that will then be taxed in retirement. By diversifying your investments across all tax treatments, you can gain more flexibility in how you access your retirement income and take better control of your financial future in retirement.

It’s also important to create a tax-efficient withdrawal strategy for your income during retirement. The timing and nature of your withdrawals from your retirement accounts and investments can impact your taxes. You can optimize your tax situation with careful planning and management of these withdrawals.

Tax-Efficient Investment Strategies in Retirement Planning

There are also several additional tax-efficient strategies to consider in your retirement investment planning that can help you make the most of your wealth:

  • Tax-Efficient Asset Allocation: Consider investing in tax-efficient vehicles, such as index funds, exchange-traded funds (ETFs), or low-turnover stock funds. These investment funds tend to have less trading activity, which can reduce the impact of taxes from capital gains or dividends.
  • Long-Term Capital Gains: Hold your equity investments for the long term, rather than selling them in the short term. You’ll benefit from the tax advantages of lower capital gains tax rates, as short-term gains are generally taxed at higher ordinary income rates.
  • Tax-Loss Harvesting: Strategically time the sale of your low-performing investments at a loss, to offset your gains from other investments sold at a profit. You can use the proceeds from the sale to purchase other similar investments so that you can maintain your portfolio balance while reducing your tax burden.
  • Estate Planning: Explore various gifting strategies to pass on assets tax-efficiently to your heirs. Make sure you understand the tax implications of inheritance and estate planning in order to better preserve your wealth.

Tax law is constantly changing, and the impact of taxes on your retirement income can shift with these changes. It’s important to stay informed on the latest rules and regulations and be prepared to adapt your retirement investment strategies accordingly.

How Legacy Planning Can Help You Prepare for Retirement

Building a strong foundation for retirement is a strategic and proactive process that starts early and evolves over the years. By taking advantage of tax diversification strategies, you can maximize your retirement income while minimizing your tax burden. Starting your retirement investment strategies early with careful consideration of tax implications can allow you to enjoy a more financially secure and prosperous retirement.

At Legacy Planning, we are dedicated to helping you reach your investment and retirement goals. We closely collaborate with you to create a financial plan to help you grow and manage your wealth. To see if we can help you build a strong tax foundation to prepare for your retirement, click here to schedule a conversation today.

Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.


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