Retirement should be on everyones’ minds, regardless if you are just starting out, or closing out your final working years. Making the necessary contributions, alongside proper budgeting, is essential to a successful and comfortable retirement. However, many forget during their calculations the potential high cost of taxation throughout retirement. Benjamin Franklin, just after signing the Declaration of Independence, spoke for mankind when he was quoted saying “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes”.
Although we can all count on taxation being certain no matter our retirement date, we can plan to maximize our retirements through methods of minimizing taxation. There are a variety of different IRS accounts/plans, which have potential tax benefits, many of which we have all heard mentioned in the past. However, choosing the current buckets, to both contribute and withdraw from, can make an astonishing difference in our nest egg value through the accumulation of our nest egg as well as the distribution phase.
This will all be discussed during our next events on June 22nd or June 24th with David Kennerly, CPA and owner of PDK Accounting, Tax & Payroll Services, and KCA Wealth advisors Brian Kennedy and Vince Catalano. Spots still remain for all sessions (12pm and 6:30pm both days), but won’t last long, so register here today!
During the session the following topics will be discussed at length:
- Tax consequences on IRAs
- The difference between Traditional vs. Roth
- Why you will pay MORE taxes when you retire, and what you can do about it
- The four retirement surprises that can have a dramatic impact on your life savings
- Income, Capital Gains, and Estate Taxes --Your Federal and State tax requirements
Tax consequences on IRAs
An IRA, or Individual Retirement Account, is a tax-advantaged account that individuals use to save and invest for retirement. There are many types, but the most common include traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. There are many rules, commonly assessing penalties if withdrawals are made before 59½, alongside income and maximum contribution rules.
These accounts, among many others, provide you the opportunity to invest tax free earnings in some cases, and in others withdraw earnings tax free. However, rules must be followed, or penalties can eat away at your next egg. In fact, if not done properly, fees could crush the calculation and feasibility of one's retirement! This is why it is essential for anyone, absent a qualified and experienced financial expert, to be guided through the retirement planning process.
The difference between Traditional vs. Roth IRAs
Although these terms are used interchangeably at times, these IRAs boast many differences, and both can be advantageous to different individuals. So much so, that some individuals have both types.
Traditional IRAs allow you to contribute income prior to taxation, whereas Roth IRAs are built on post-tax funds. Although a Traditional IRA may seem more advantageous, taxes must be paid at withdrawal (retirement), while Roth IRAs are protected, if properly used, from income tax at withdrawal. Thus, depending on your current income tax bracket, and your projected bracket at retirement, this can be a challenging decision to make. Traditional IRAs also allow for tax write-offs for contributions during the year, further complicating decision making.
Further, these accounts have specific contribution limits, so contributing to both can not only be a great idea, but may be your only choice. Roth IRAs are more restrictive at higher levels of taxable income, and Traditional IRAs lose fully tax-deductible status at certain levels as well.
Distribution rules, including pre-retirement withdrawals, are also handled and taxed differently for each. Traditional IRAs have “Required Minimum Distributions” (RMD), that begin as early as 70½, or as late as 72. Roth IRAs do not require withdrawals until after the death of the owner. Further, withdrawing from a traditional IRA, before age 59½, will trigger a 10% penalty. These penalties can also be assessed on Roth IRAs, however, one can withdraw amounts equivalent to your Roth IRA contributions, without penalty, at any time even before age 59½, in many cases.
This is only the start to the differences between these funds. For instance, Roth IRA earnings (from investments) can also be withdrawn tax-free, in some situations, whereas traditional IRAs would not allow this. Case in point, creating, maintaining and making any withdrawals should be well planned, and consulting with a financial advising professional is highly recommended.
Income, Capital Gains, and Estate Taxes
Tax policy, and what is deemed ‘estate’, ‘income’, and ‘Capital gains’ can vary greatly, particularly in the way your assets are classified. A Capital Gain is defined as an increase in a capital asset's value and is considered to be realized when the asset is sold. Income tax is a tax that governments impose on income generated by businesses and individuals within their jurisdiction. Estate tax is a tax levied on estates whose value exceeds an exclusion limit set by law ,with only the amount that exceeds that minimum threshold being subject to tax.These levies are calculated based on the estate's fair market value (FMV) rather than what the deceased originally paid for its assets. The tax is levied by the state in which the deceased person was living at the time of their death.
These taxes can be extremely confusing, and like other areas of financial planning, there are financial vehicles and strategies to properly classify and invest to minimize tax obligations. For instance, particular trusts won’t eliminate taxation, but can help to classify and manage your capital to avoid overtaxation.
Don’t forget to join us June 22nd or 24th, where we will be offering a one hour educational webinar covering all of this, and much more, at both 12:00pm and 6:30pm on both days. Click here and sign up now before spots fill!
At KCA Wealth Management our mission is to be there every step of the way in supporting the members of our community with the financial and educational resources they need and deserve to prosper in retirement.