Written by Debra Taylor
You may have spent the last decade saving for retirement; the day has come to turn those hard-earned life savings into retirement income! It is important that investors generate this type of income based off their preferences and unique circumstances.
In addition, they should never overlook the impact that taxes have over their retirement income. The truth is that no one can escape or prevent Uncle Sam from taking a chunk of their earnings. If one is not prepared for taxes in retirement, chances are their savings won’t go as far as they think it will. A hefty tax bill – perhaps from owing thousands of dollars in taxes per year – can make it difficult for any individual to enjoy their senior years comfortably.
A little planning can go a long way in terms of protecting one’s retirement income. By understanding how taxes affect your earnings, keeping your personal finances in check and making ends meet is more manageable.
Different Retirement Income Portfolios; Different Tax Statuses
Each retiree’s situation is different, and their funds may be accumulated in one of the following buckets:
- Taxable accounts that are not related to their main retirement savings vehicles
Depending on the source of the investor’s income and their individual marginal tax rates, the income generated from their accounts is most likely taxed at different rates.
- Tax-exempt accounts
Common examples include Roth 401(k) and Roth IRA accounts. Because these contributions are made with after-tax earnings, distributions remain tax-free.
- Tax-deferred accounts
Common examples include IRAs and traditional 401(k) plans. Distributions are taxed at the individual’s ordinary income tax rate that’s based on the year of distribution.
Because annuity/pension benefits, Medicare costs, and Social Security benefits can make one’s situation trickier to navigate, it is recommended that you consult with a professional financial planning services provider. This allows investors to generate an income stream that reflects their unique circumstances.
Understanding Yield’s Tax Implications
Yield may not be the most efficient way to generate income from a portfolio when it comes to taxable accounts. If you are an investor who plans to create a cashflow stream from a taxable account – prefers having greater control over cashflow patterns or doesn’t mind spending the portfolio principal – building a total return portfolio may be a more tax-efficient way to reach your goal.
A Total Return Approach Doesn’t Work for all Investors
A total return approach to retirement income generation and investing typically involves using one’s whole portfolio to generate returns from an array of sources, including growth, dividends, and interest. In addition, the process also incorporates both yield and price appreciation to help increase and smooth one’s income stream. This approach, however, doesn’t work for all investors. For example, investors who plan to draw income only from non-taxable assets or want to avoid touching their principal, should consider a yield-oriented approach instead.
It is important that both retirees and investors alike work with a trusted financial planner to better understand their unique circumstances and develop an income strategy based on the information they have.
If you’d like to discuss any kind of planning for retirement, taxes, insurance planning, or some other financial strategy, contact us today to schedule a 20-minute complimentary phone consultation.
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*Disclosure: Converting from a traditional IRA to a Roth IRA is a taxable event.*