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COVID May Increase Your Future Taxes! Do You Know These 3 Options Lower Your Taxes in Retirement?

While this stimulus has helped millions of people and small businesses, it’s very likely that state and local governments will look to increase revenue to compensate for this spending in the future. One possible way they may do this is by increasing income tax. As you plan for your retirement, you need to consider this potential expense.

Approximately 49% of Americans say that running out of money is their top concern in retirement. Having a plan can provide many pre-retirees with confidence and help them avoid this fear. That said, many Americans who developed their plan prior to the COVID-19 pandemic likely didn’t account for an unexpected increase in future taxes. Now is the time to reassess your retirement plan and ensure you are utilizing income streams that will minimize your taxes.

A solid retirement plan is made up of multiple sources of income. Having various income options in retirement grants the retiree the flexibility to re-strategize to minimize the overall taxation on their income. With anticipated increases to future taxes, it is especially important to consider what your non-taxable income options are.

One option pre-retirees should look at including in their retirement plan is a Roth IRA.

When you contribute to a Roth IRA, you pay tax on the money that you are putting in at the time that you invest it. By paying taxes upfront, contributions and earnings become tax-free when they are withdrawn in retirement. The tax-free withdrawals also apply to beneficiaries who may eventually inherit your Roth IRA. There are income limits that will exclude some people from being eligible, but you may be able to modify your eligibility if you do a Roth Conversion with other retirement account assets.

A second option to consider is Roth 401(k) or 403 (B) accounts. If your plan allows it, this is an excellent option. Like the Roth IRA, you won’t have to pay tax upon withdrawal, but unlike the Roth IRA, Roth 401(k) and 403 (B) accounts don’t have income eligibility limits. In this plan, contributions are taken from paychecks before tax is deducted, so you have to pay tax on those contributions at the end of the year. Paying tax on your yearly contributions will reduce the amount of traditional 401k contributions you can make. However, like a Roth IRA, because you pre-pay the tax on contributions, withdrawals on both contributions and earnings in retirement are tax-free.

A third option is an HSA or Health Savings Account. It is a great option offered by many employers. It allows you to set aside tax-deductible or pre-tax dollars to pay for medical costs not covered by insurance. Funds in an HSA accumulate tax differed and qualified withdrawals are tax-free. Additionally, there are no income limits. Funds in an HSA are held by a plan administrator and can be invested for long term growth; however, this differs from plan to plan. As long as you follow the plan-specific rules laid out regarding which expenses are reimbursable, you will not have to pay taxes on your withdrawals.

Like with any investment, there is no one-size-fits-all solution. The options we’ve highlighted are just a few you can consider including in your retirement plan. No matter which you choose, it’s important to remember that having multiple sources of retirement income is extremely important to a successful retirement.

COVID-19 has impacted so many areas of our lives that sometimes it’s hard to keep track of everything. No matter how solid you think your retirement plan is, now is a great time to re-evaluate and update accordingly. Schedule an appointment with your financial advisor. If you do not have one or would like a second option, we are available to help at (716) 906-8121.

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