A retirement phase can last 25-30 years. Saving for it can take just as long, if not longer. Hard-earned savings dwindling in retirement due to poor financial strategy has all the makings of a bad dream. Taxes are one culprit behind decreased wealth since many retirees rely on taxable income from Social Security benefits, retirement accounts, and investments. The uncertainty of future tax rates adds to the complexity of planning for the future, but a strategy that mitigates the tax burden in the years ahead can ensure that more of your money stays with you.
The Changing Landscape of Taxes
While the cost of goods and services has increased over time, today’s tax rates are relatively low. Additionally, deductions and tax credits that were historically unavailable exist today, easing the burden on middle-income families. The federal income tax brackets for 2024 and 2025 are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Tax rates are complicated, fluid, and impacted by government priorities and economic conditions. So, it’s important to examine them in context. To illustrate, the highest federal income tax rate was in 1944 during World War II, but the 94% rate applied to income above $200,000 (more than $3.4 million today). On the surface, that number is staggering. However, few paid that rate, and those in other brackets were significantly lower. The Tax Reform Act under President Ronald Reagan reduced the top marginal rate to 28%, shifting from decades of high taxation on the wealthy. In 2024, the highest marginal income tax rate is at 37%, with the highest capital gains rate at 20%, compared to 1978, when capital gains tax reached nearly 40%. The new administration in 2025 may adjust tax rates, along with the following administration, and so on. In summary, tax rates are a moving target with many influences, but they can impact retirement savings, especially with inflation and rising healthcare costs. Tax preparedness is a vital part of a comprehensive retirement plan, which makes a financial advisor an important asset in creating a Retirement Road Map® that can withstand changes in economic conditions.
Social Security: Taxation Pitfalls
Currently, about 68 million Americans receive monthly Social Security benefits. A 2020 study found that 40% of retired Americans relied solely on them. Social Security benefits are taxable depending on combined income, which is the sum of adjusted gross income, nontaxable interest, and half the Social Security benefit amount. The tax applies up to 50% of a combined income total of $25,000 or more for single filers and $32,000 for married couples filing jointly. Up to 85% of Social Security benefits are taxable at $34,000 for a single filer and $44,000 for married filing jointly. While it’s difficult to avoid taxes entirely, there are strategies for mitigating the tax burden, such as waiting to claim benefits, timing withdrawals from other retirement accounts, and coordinating with your spouse’s benefit.
Retirement Accounts: Taxable and Tax-Free Options
The second most popular source of retirement income is tax-deferred accounts like 401(k) and individual retirement accounts (IRAs). Under Internal Revenue Service (IRS) legislation, Required Minimum Distributions (RMDs) ensure individuals pay tax on the funds in these retirement accounts by forcing regular taxed withdrawals beginning at age 73.
Retirees can circumnavigate RMDS by converting their traditional retirement accounts to Roth IRAs. After-tax dollars feed Roth IRAs and Roth 401(k)s, but qualified withdrawals from these accounts are tax-free in retirement when individuals most need to conserve their money. Additionally, by paying tax up-front for tax-free withdrawals later, individuals effectively lock in a tax rate, shielding them from future tax rate increases.
Potential Legislative Changes: Estate and Inheritance Taxes
Concern surrounding the possible elimination of the step-up in basis loophole has proved inconsequential, but it has been under threat. Under current legislation, inherited assets receive a “step up” to their fair market value at the original owner’s passing. This provision reduces the capital gains obligation for beneficiaries, who could owe substantially more tax on appreciated assets. Legislation changes with tax implications are always possible, so it’s important to be armed with a tax plan to counteract it.
Preparing for Tax Uncertainty
Here are some ways to be proactive in combating the unpredictability of future tax responsibilities:
- Diversify income stream: Construct a portfolio with assorted taxable, tax-deferred, and tax-free accounts.
- Take advantage of Roth conversions: Convert some traditional 401(k) or IRA funds to a Roth account when taxable income is low. Depending on an individual’s financial situation and tax bracket, converting all retirement account money may not make sense.
- Plan for Social Security taxes: Time withdrawals from other counts, coordinate with your spouse, and delay the benefit claim to stay below income thresholds that would result in taxation.
- Monitor legislative changes: Keep abreast of reforms and changes in tax law that impact retirement accounts, particularly surrounding capital gains and estate taxes.
Tax preparation lives in the present, but tax planning optimizes one’s tax position in the future. At SHP Financial, we create personalized Retirement Road Maps® for our clients that neutralize the effects of changes in tax rates and legislation. We ensure our clients are prepared with annual check-ups to make updates and adjustments. Contact us today for a complimentary review of your finances and get started on your path toward a relaxing retirement.
