Retirement planning is comprised of decades of planning and implementing comprehensive tax and investment strategies. However, when it comes to structuring your withdrawals, you want to ensure that they don't bump you into a higher tax bracket. 

For the vast majority of retirees, the most practical types of retirement accounts will be either a Roth IRA, a traditional IRA, or a 401(k). Each account will have different tax characteristics, which can be either a benefit or detriment, depending on how you structure your withdrawals and their size. 

Understand the disparities between the different accounts to ensure you don't find yourself in a higher tax bracket paying unnecessarily high amounts of taxes. 

Confused about taxes and RMD penalties in retirement? Consult a fiduciary investment advisor at Global View to ensure your retirement plan is on track.

Traditional IRA & 401(k) Accounts

Both traditional IRAs and 401(k) accounts are tax-deferred, meaning they are funded with pre-tax dollars. You can deduct all contributions to a traditional IRA, provided that it is not an employer-sponsored plan, which funds your retirement while simultaneously reducing your taxable income. 

IRA owners are subject to restrictions on how much they are allowed to contribute; $6,500 if you are younger than 50 and $7,500 with catch-up contributions if you are older. 

401(k) account holders are subject to contribution limits as well. For 2023, the allowance is $22,500, with an additional $7,500 given in catch-up contributions to those over 50. 401(k) account owners are not required to claim any deductions, as long as it's employer-sponsored, as contributions typically come directly from your paycheck, using pre-tax dollars. 

With either one of these accounts, both contributions and earnings grow tax-deferred until you are ready to begin taking distributions in retirement. 

Roth IRA & Roth 401(k) Accounts

Both Roth IRAs and Roth 401(k) accounts are funded with after-tax dollars, meaning you don't get any tax breaks right away like with a traditional IRA or 401(k). However, you will receive a tax break upon withdrawing the funds (initial contributions and earnings) as they will be tax-free, assuming that you meet certain criteria. 

You are allowed to withdraw any contributions from a Roth investment product for any reason with zero tax implications or penalties. However, any earnings on your account will only be tax-free upon withdrawal if you are at least 59 1/2 years old and made your first contribution at least five years ago. This is also known as the five-year rule. 

If you anticipate your retirement tax bracket will be higher, then a Roth account might be the best option. If you decide to invest in a Roth, be aware of the contribution limits. Any individual earning more than $153,000 in 2023 will not qualify to invest in a Roth, nor will joint filers earn $228,000. Similar to a traditional IRA, you are only allowed to contribute the IRA maximum per year. If you are over 50, you are eligible for catch-up contributions. 

Roth accounts do not require any RMDs, unlike traditional IRAs and 401(k)s. However, Roth 401(k)s do need to take RMDs unless they are either still working or own at least 5%. For retirees who don't need the money, letting it sit and grow tax-free for your beneficiaries may be a good option. 

Penalty-Free IRA Withdrawals

Early IRA withdrawals will incur a 10% penalty; however, there are exceptions to the rule: 

• You are disabled
• You inherited the IRA
• You use the funds to buy or build a home (there is a $ 10,000-lifetime limit)
• You put the money towards qualified education expenses
• You have unreimbursed medical expenses exceeding 7.5% of your adjusted gross income (AGI).

401(k) Hardship Withdrawals

Just like with an IRA, taking early withdrawals from a 401(k) will result in a 10% penalty. However, if you qualify for a hardship distribution due to an "immediate and heavy financial need," then you may be able to take a distribution without incurring a penalty. Per the IRS, to qualify for a hardship distribution, you must use the money for medical and educational costs, costs associated with buying a home, funeral expenses, or certain expenses related to repairing damage on your home. 

Consult with a financial advisor in Greenville, SC, at Global View to see if taking a hardship withdrawal is something you should consider for your current situation and a list of options. 

Tax Brackets and Retirement

Taxes are ubiquitous when it comes to retirement and financial planning. However, just because you make withdrawals, that does not mean that you will necessarily be bumped up into a higher bracket. 

Most retirees should expect their tax bracket to be lower in retirement, particularly if they will be taking in smaller amounts of income. However, since future taxes are anyone's guess and never guaranteed, things aren't so simple; there are many other factors, such as if retirees earn or take advantage of tax deductions. These factors, particularly how you approach (or don't) deductions, may put you into a higher tax bracket. 

Your tax bracket is income-based, and the limits won't change in retirement. However, your income will, as your pension, Social Security, and retirement accounts determine how much you make and whether or not your tax bracket changes. 

Consult Your Advisor

Tax planning in retirement can be tricky, as there are many moving parts, changes, and strategies that come along with it. But the good news is, you don’t have to go about it alone. Contact your local financial advisor in Greenville, SC, to begin taking the necessary steps to lower your taxes in retirement as much as possible.