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Now more than ever, millions of workers are afraid that they'll never be able to retire. With a huge chunk of those workers having put next to nothing toward their retirement savings, they'll be counting on Social Security and any other income sources they may have to make ends meet -- or earning a paycheck as long as possible.

But even those who have already saved up a considerable nest egg can't afford just to assume that everything's going to work out OK. The federal budget looks ugly, and you can count on Uncle Sam to make sure he gets his cut of your savings any way he can.

The flip side of the best tax break ever
During your career, IRAs and 401(k) plans seem like the best deal ever. You get to put your money into a tax-sheltered account where you don't have to worry year in and year out about how much in interest, dividends, and capital gains your investments generated. What happens in your IRA stays in your IRA -- at least until you retire. And even better, the government gives you a tax break for doing so, letting you write off traditional IRA and 401(k) contributions entirely against your regular taxable income.

But eventually, you have to pay the piper, and the cut can be huge. When you take money out of your IRAs, you have to pay income tax on the withdrawals. As a result, assuming you don't have money elsewhere to pay the taxes, you have to pull out more money than you need to spend just to cover the tax bill. For example, if you're in the 25% tax bracket and need to spend $45,000 from your retirement accounts every year, you'll have to take out $60,000 -- with $15,000 of that going straight to the IRS.

What's especially egregious is that you have to pay your higher ordinary tax rate, even if the income within your retirement accounts came from capital gains, dividends, or other income that enjoys preferential treatment in taxable accounts. That makes holding high-growth stocks, as well as high-dividend stocks like Frontier Communications (NYSE: FTR  ) or Telefonica (NYSE: TEF  ) inside an IRA less attractive, because you effectively lose the tax breaks that their income would ordinarily give you. Even Apple (Nasdaq: AAPL  ) shareholders can get the worst of both worlds by having kept long-held shares in a traditional IRA versus a taxable account.

How to solve the problem
Fortunately, there are some smart tactics you can use to cut your tax bill. First and foremost, be smart about which investments you make in your various accounts. For instance, mortgage REITs like Annaly Capital (NYSE: NLY  ) and American Capital Agency (Nasdaq: AGNC  ) make great IRA holdings because their dividends don't typically qualify for lower tax rates. So you aren't losing anything by holding them in your regular IRA. By contrast, consider putting true growth plays, such as biotech upstart Inhibitex (Nasdaq: INHX  ) and video game maker Majesco Entertainment (Nasdaq: COOL  ) , into either a Roth IRA (where their income can be tax-free) or a taxable account (where they could qualify for 15% long-term capital gains taxes).

Second, once you've retired, realize that paying some tax is inevitable -- so take advantage of opportunities to pay as little as possible. For instance, if you start out retirement in a low tax bracket, take money out of your retirement accounts even if you don't need to spend it. By using up your low 10% and 15% brackets now, you could save yourself from bigger taxes of 25% or more down the road, when the IRS forces you to start taking money out of your retirement accounts. Just stick the money in a taxable account -- or even better, convert to a Roth IRA, where you can enjoy tax-free growth as long as you keep the money in the account.

Last, keep control of your expenses as well as you can. Retirement is more expensive than you may think, so look into what you'll want to pursue before you retire and build a realistic budget for your own dreams.

Keep your money
After a career of working hard, you deserve to keep as much of your hard-earned money as you can. By being tax-smart, you can stop the IRS from taking more than its fair share.

Once you've got your taxes figured out, though, you're not done. Our latest special free report reveals the shocking can't-miss truth about your retirement -- and what you can do about it. Grab a copy today and find out everything you need to know.

Fool contributor Dan Caplinger strangely looks forward to tax time, but not to his tax bill. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Annaly, Telefonica, and Apple. Motley Fool newsletter services have recommended buying shares of Annaly and Apple, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy wants you to retire rich.

Read/Post Comments (27) | Recommend This Article (57)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 20, 2011, at 9:56 AM, DJDynamicNC wrote:

    The Roth IRA should be a crucial piece of just about every retiremeny strategy. My employer does not match my 401(k), so I put the majority of my retirement savings into a Roth. After 40 more years of contributions, that's a LOT of taxes I won't be paying in retirement.

  • Report this Comment On December 20, 2011, at 10:14 AM, mtxjohn wrote:

    Completely false. Seriously, how are people like this allowed to post such nonsense? A single person taking only a 60K distribution would pay about $8667 in taxes, not $15,000. Shame on the Motley Fool for printing such falsehoods. I and millions of others depend on information from the internet for investing decisions and when such complete falsehoods are printed it makes me reconsider everything I've read.

  • Report this Comment On December 20, 2011, at 11:46 AM, TMFGalagan wrote:

    @mtxjohn -

    Your answer assumes that the person has no other taxable income. As the article stated, my answer assumed that the person had enough other taxable income to put him in the 25% bracket. While we could debate which assumptions are more realistic, my conclusions are no more false than yours are.


    dan (TMF Galagan)

  • Report this Comment On December 20, 2011, at 12:34 PM, DS31 wrote:


  • Report this Comment On December 20, 2011, at 12:38 PM, DS31 wrote:

    You make a very good point, Dan. If you are going to "swing for the fences," you definitely should do it in a Roth IRA. Because if you do hit it out of the park, the tax liability is zero!


  • Report this Comment On December 20, 2011, at 2:09 PM, AgAuMoney wrote:

    @DS31, But if you "swing for the fences" and miss, it is lost money and lost opportunity in a Roth. At least in a taxable account, your loss can be used to offset other gains or even ordinary income.

    I used to "swing for the fences" in my Roth. But the last 10 years I've been much more conservative and my Roth accounts show the success. OTOH, I've made a few home runs in my taxable account, which when you combine the lower cap gains tax rate and the offsetting losses is much better than a "SWISH" in an IRA.

  • Report this Comment On December 20, 2011, at 2:26 PM, mtxjohn wrote:

    "As the article stated, my answer assumed that the person had enough other taxable income to put him in the 25% bracket." That's funny because I read "assuming you don't have money elsewhere to pay the taxes" to mean just the opposite. For arguement's sake let's assume that the person is already IN the 25% bracket - adding 60K to that would put him into the 28% bracket. Ouch for taxes....

  • Report this Comment On December 20, 2011, at 2:26 PM, wolfman225 wrote:

    Many valid points have been brought up, so I won't repeat the obvious. What is most concerning to me is the possibility that the government may decide to "protect the American worker from the vagaries of the stock market" by nationalizing retirement accounts. This idea was first floated a few years back as a proposal to require that a certain percentage of retirement accounts be held in "safe" government bonds & T-bills.

    Another possibility is that the IRS could be encouraged to eliminate the tax advantages currently available in 401k and ROTH plans in a bid to gain tax revenue that is currently off limits.

    Given the Federal and states' appetite for revenue and their addiction to spending it's hard to believe that government isn't looking at the trillions sitting in retirement accounts the same way the family dog eyes a roast that's left too close to the edge of the table.

  • Report this Comment On December 20, 2011, at 2:32 PM, wolfman225 wrote:

    Also, let's not forget that the Supreme Court ruled in 1960 (I think) that the American worker had no guaranteed right to their SS contributions and went on to rule that the government could alter, reduce, or even suspend SS payments at will!

    Doing so may amount to political suicide, but if it were done under the guise of a national economic emergency (a "crisis")......? It's not inconceivable. After all, they managed to confiscate 99% of the privately held stores of gold in '33, didn't they?

  • Report this Comment On December 20, 2011, at 2:36 PM, mtxjohn wrote:

    @Wolfman225- I have too read how the State could slowly "nationalize" our retirement accounts. What REALLY concerns me is with the ROTH - why is no one concerned that the Roth allows the Govt of TODAY to steal the tax money from the Govt of 30 -40 years from now? Think about it-with Roth they are taking the taxes today that the (future) Govt will need just as the current IRA's of today have taxable distributions-what happens when in 30 years or whenever people start taking tax-free (deserved) distributions from Roth accounts that would have been taxed had they been traditional accounts? The current Govt stealing from the future Govt and no one seems concerned...ROTH is a relatively new concept yes?

  • Report this Comment On December 20, 2011, at 5:56 PM, Doris411 wrote:

    I'm also concerned about the possibility that the tax advantages of the Roth will be negated by changes in the tax laws.

    But I also worry people may be building themselves future accounting nightmares. If all the income will be tax-exempt, then you don't worry about the cost basis. When that assumption fails (OK, IF, but I think it's a real possibility), how do you reconstruct cost basis decades after the fact?

    Do you think your broker will have kept decades of transaction history? Do you plan to stay with the same broker that long -- and expect them not to have merged or been combined in that length of time?

    Speaking as a CPA, it's amazing how many people show up to have their taxes done without any record of cost basis for investments they sold after only a few years. Don't take a chance on finding yourself in that position with your retirement accounts.

  • Report this Comment On December 20, 2011, at 5:59 PM, Gailen wrote:

    It seems to me that this discussion misses a crucial aspect of tax-sheltered accounts. The focus here is on how much taxes one will have to pay on withdrawals. The focus should be on how much I can net after-tax on the withdrawals. Because of the tax deferral at the time of the initial investment (think of it as investing what the government would have taken in taxes), there is simply no way IRA's can be beaten by taxable accounts. I don't care if I have to pay higher taxes at the end so long as I net a greater after-tax amount. The deferral trumps every aspect of this discussion. Work the numbers and you'll see.

  • Report this Comment On December 20, 2011, at 6:00 PM, Lwb52 wrote:

    Who already in the 25% bracket "needs" to spend an /extra/ $45K EVERY YEAR?!? Sounds like spoiled retiree overspending to me, given how many families must live on less than that that amount as a total yearly income, and pray they don't lose any of that due to sickness or layoffs, as well as needing to set some of that aside for their kids' education & their own retirement...

    This story is couched in offensive and political hype, playing on fear and misunderstanding. You should be ashamed.

  • Report this Comment On December 20, 2011, at 6:02 PM, arsenic123 wrote:

    What an amazingly poor headline for a totally mis-focused article. Not once does it point to the fact that without "Uncle Sam", most Americans wouldn't have any retirement at all. None, Zip, Nada. Social Security, 401(k) 457, 403(b) plans, you act like this is something that businesses came up with to reward their workers. Fact is, every one of these retirement plans was created by that evil, evil US Government. The plan numbers, they are from the Tax Code.

    Used to be, you worked your 20-40 and you got Social Security and a big fat defined benefit pension and medical care. After successful looting of pension funds by businesses and Bankruptcy filings that allowed medical funds to be converted into CEO golden parachutes, the Government stepped in, and stopped the looting. The comments are even more mind-blowing. Folks, these plans were all created to remove the burden from businesses of a defined benefit retirement. The only benefit that business would allow the government to write in was favorable tax treatment. Without government intervention where would you have for retirement investment? A fully taxed brokerage account. That's it.

  • Report this Comment On December 20, 2011, at 6:10 PM, DJDynamicNC wrote:

    @Arsenic - 3 cheers!

    @Wolfman - I'm not sure how you see the government nationalizing retirement accounts (in effect, bolstering Social Security) when people are actually talking about cutting SS instead. Seems unlikely, to say the least, but perhaps I am simply not informed on the topic; it's not something I've investigated.

  • Report this Comment On December 20, 2011, at 6:16 PM, Cynic266 wrote:

    Uncle Sam already has stolen our retirements. What entity is largely responsible for the current economic funk this country is now experiencing?

  • Report this Comment On December 20, 2011, at 6:34 PM, leatherneck57 wrote:

    Good comments all but I must confess that I do not see Social Security as the government's money since they have been taking SSI out of my paycheck since the age of 15.

  • Report this Comment On December 20, 2011, at 9:55 PM, JohnnyYuma13 wrote:

    Cynic266 Right on, and what ever is left the big banks (with Washington's blessing) and the hedge fund managers will take the rest. Today the individual investor has no chance.

  • Report this Comment On December 21, 2011, at 1:37 AM, TomH3 wrote:

    When I made my contributions to 401(K) and IRAs dividends were taxed as ordinary income and for some of that time capital gains were taxed as high as about 28% if memory serves. So, for those contributing to retirement accounts now, they need to recognize that the present capital gains rate is likely to change, and I will wager that the preferential treatment of qualified dividends will go away with the expiration of the extension of the "Bush tax cuts". So, not knowing what tax policy lies ahead it is probably best to delay paying taxes as long as you can.

  • Report this Comment On December 21, 2011, at 1:56 AM, wolfman225 wrote:

    DJDynamic wrote:

    <<@Wolfman - I'm not sure how you see the government nationalizing retirement accounts (in effect, bolstering Social Security) when people are actually talking about cutting SS instead. Seems unlikely, to say the least, but perhaps I am simply not informed on the topic; it's not something I've investigated.>>

    I haven't heard of anyone talking about actually cutting SS benefits. Unless you're talking about the talk from both sides of the aisle about means testing? The nationalizing comes from the idea that was floated a couple years ago to require that a certain percentage of money contributed to tax-deferred retirement accounts like traditional IRA's and 401k's be invested in US government bonds and Treasuries. This was presented as a way to protect the investor, but was seen by many to be a way for government to gain additional revenue by trading workers' contributions for low-yielding investments. The fact that this was proposed as a mandatory investment selection was/is an issue for many. It also led to speculation that the table was being set for a future takeover of retirement accounts by the government siHmilar to what Hugo Chavez has done in Venezuela.

    Nationalizing retirement accounts would not be "bolstering Social Security". SS is a separate entity, funded by FICA tax withholding. ROTH's, IRA's, 401k's, 403b's, etc. are retirement plans controlled by the individual in an attempt to better the paltry return provided by SS. Any takeover of private retirement plans by the government would only serve to put a ceiling on what people could hope to gain out of investing for their retirement.

    If government recinds the tax advantages of the various retirement vehicles, we can expect our returns to drop dramatically, as the tax bite will kill any gain before we have the chance to build enough of a balance to make our money work for us.

  • Report this Comment On December 21, 2011, at 2:32 AM, wolfman225 wrote:

    ^DJ--Here's a link to an article about this topic I found on Bloomberg:

    Here's a quote from the opening two paragraphs:

    "Jan. 8 (Bloomberg) -- The Obama administration is weighing how the government can encourage workers to turn their savings into guaranteed income streams following a collapse in retiree accounts when the stock market plunged.

    The U.S. Treasury and Labor Departments will ask for public comment as soon as next week on ways to promote the conversion of 401(k) savings and Individual Retirement Accounts into annuities or other steady payment streams, according to Assistant Labor Secretary Phyllis C. Borzi and Deputy Assistant Treasury Secretary Mark Iwry, who are spearheading the effort. "

    Since we can already purchase Government bonds, T-bills, and annuities within retirement plans now (if we wish) I don't see any way this would be a voluntary program. If implemented, it is virtually certain to become mandatory. After all, if we are so reckless as to invest too aggressively, it's the duty of government to step in and protect us from ourselves, right?

    It would simply become a companion to government-run SS which, as I pointed out earlier, the Supreme Court has ruled that we don't have any individual right to and which can be altered or ended at the sole discretion of government. Boy, I sure feel more secure. Don't you?

  • Report this Comment On December 21, 2011, at 8:33 AM, stlmikey wrote:

    As for investments, it makes sense to be tax diversified. IRAs and Roth IRS are after tax equivalent if your tax bracket at deferral is the same as the tax bracket at distribution.

    To me, it makes sense to hold some of both. The IRA wins if we end of going to a national sales tax or something equivalent. The Roth IRA will win if tax brackets are raised in the future.

    I don't know what will happen, but if I've got some money in both types, I have greater control over the tax liability in the distribution phase.

    As for the annuity comments, another opportunity for income stream diversification. For basic needs it may make sense to have some sort of fixed income stream - social security or pension equivalent. For wants, one can be more flexible because in bad markets, they can be deferred

  • Report this Comment On December 21, 2011, at 9:32 AM, wolfman225 wrote:

    ^I agree that putting a portion of your retirement fund into an annuity may make sense, but only if you have a large enough portfolio to make it practical. Annuities are expensive insurance policies, basically. Unless you have a large enough sum that you can afford the costs and still have plenty left over for discretionary expenses, it's usually not a good idea. My problem with the idea is the "conversion of 401k's and IRA's". That doesn't sound like I'll have much say in the matter, if it's a government-approved plan.

    I also have both a 401k and a ROTH. I am hoping to use the tax-free income from the ROTH to offset the mandatory (and taxable) withdrawals from the 401k. This is all speculation for now, but if "Uncle" decides to change the rules later on I have we're ALL going to be left scrambling.

  • Report this Comment On December 21, 2011, at 9:36 AM, eugooglizer wrote:

    It's a shame that everyone was too busy voicing their political agenda, or calling the other posters stupid (or both), to discuss what I think might be the most important question from this, particularly at this time of year. How does this affect the decision to do a ROTH conversion? I think the postings about trying to determine what the future tax rates are going to be are spot on. It's hard to tell the future, but I'd say there's a very good chance they'll be higher than they are now.

  • Report this Comment On December 21, 2011, at 1:54 PM, steveelcpo wrote:

    Interesting reading and comments. The title attracted my interest since as I approach retirement,, and listen to the rhetoric coming out of the White House and Democrats in Congress, I am worried that Uncle Sam will truly take away my private retirement accounts. Demonizing the "rich" sells but when our government is running $1.5 trillion annual deficits, the national debt is now over $15 trillion, ($4.5 trillion increase since Jan 09), and the national debt is now nearly equal to GDP, we are in serious trouble fiscally. Instead of cutting government spending, which doesn't seem likely under the current structure, the only viable solution is to drastically increase taxes. I'm still putting money into a Roth every month and contributing toward my 401K at the rate my employer matches, but I'm really concerned if something doesn't change in Washington next November.

  • Report this Comment On December 23, 2011, at 11:53 AM, MarionContrarian wrote:

    Some of the commenters question how an investor could be in the 25% bracket if there was no other income. The point is that it's likely that there WILL be other income (unless you don't plan on taking Social Security benefits), and that WILL push you into a higher Federal (and State) tax bracket(s).

    Exhibit A: My mother, who is in an assisted living facility and paying for her expenses with a combination of IRA withdrawals and Social (in)Security. Because here expenses exceed $5K/mo*, her net annual AFTER TAX needs are over $60K*, which means that BEFORE TAX withdrawals north of $90K* are required to satisfy Federal and California income taxes along with here needs. BTW, 85% of her Social Security is taxable because her Modified Adjusted Gross Income (i.e., her IRA withdrawals) exceeds the $34K threshold.

    Welcome to retirement....

    *amounts are approximated for illustration purposes

  • Report this Comment On December 28, 2011, at 8:55 PM, itskash wrote:

    Mr Caplinger, let's say an individual is in his late 20's and into buying [and holding] stocks in a traditional ira, roth ira and a taxable online brokerage. This person also sees some lots of bargains in fairly high yielding ADR stocks at attractive valuations. There's sideline cash in all three accounts. The horizon is likely to be long and the turnover likely to be low. Which account would you buy the ADRs and why?


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