No truly holistic retirement plan would be complete without thoroughly addressing long-term tax planning. After all, the difference between $10,000 a month of taxable income and $10,000 a month of tax-free income is dramatic.
So while the Bucket Plan is the best way to structure your financial assets to tackle today’s market challenges while meeting your immediate, short-term, and long-term goals, you also need to consider the tax consequences of all those assets you’ll be relying on to generate your retirement income over the next 30 years or more.
In order to better understand this, we need to divide your assets into three categories: Tax Deferred, After Tax, and Tax Free.
Tax deferred assets are not taxed as they grow, but they are taxed when they are withdrawn for use.
After Tax assets may or may not be taxed as they grow, but they are never taxed just because you withdraw them for use.
Lastly, tax-free assets are never taxed on their growth, nor when they are withdrawn for use. (spoiler alert – these are the best assets to have in retirement!)
The biggest problem I see is that people these days tend to have the majority of their money in tax-deferred assets, because we’ve all been encouraged to pour money into our tax-deferred retirement plans. The idea being that we’ll be in a lower tax bracket when we retire. But unfortunately, these are the worst assets to have during retirement because they’re the most taxable.
You see, while it’s true you might get a tax deduction when you place money into your tax-deferred accounts, it is still taxable. You’re simply putting off paying the tax. Think about it this way – you’re choosing to not pay tax on the seed you’re planting, but you will have to pay tax on the harvest you reap down the road. So if you place $10,000 into a tax-deferred account today, you might save $2,000 in taxes. But if that $10,000 grows to $40,000 over 20 or 30 years, you will owe $8,000 when you go to spend it – and that’s assuming tax rates never go up!
The second biggest problem I see is that most people don’t incorporate long-term tax planning into their retirement plan. So they never diffuse this tax time bomb and then at age 70 or 72 – bam! It’s too late. I meet with lots of retirees who can’t believe they have a tax problem at age 72, because no one ever explained it to them, much less helped them design a solution. And most of these people have advisors! Unbelievable!
Most people, including accountants, only think about taxes in terms of this year, or maybe next. We want to help you think about taxes in terms of the next thirty years!
This is why it’s so important to have a detailed retirement income plan that considers the interactions between social security, pensions, tax-deferred, after-tax, and tax-free income sources over time.
We really just scratched the surface here in terms of taxes in retirement, but if you’d like to learn more about creating a tax-free retirement, just call the office and schedule an in-person or virtual appointment. We serve clients throughout the US and we’d be happy to help you, too.