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The 1 Retirement Myth You Can't Afford to Believe

By Maurie Backman – Sep 30, 2020 at 6:18AM

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Buying into this misconception could hurt you big time as a senior.

Many seniors wind up financially stressed in retirement, and in some cases, it boils down to poor planning. But even those who try to plan for retirement often fall victim to one giant myth that throws their financial projections off-course.

It's the myth that you'll pay less in taxes during retirement. Many seniors assume that once they stop working, their tax burden automatically shrinks, and in some cases, that does indeed happen. On the other hand, some seniors find that their tax rate increases during retirement, and it's that very scenario you'll need to prepare for.

Why might your taxes increase during retirement?

Many seniors are forced to live on a fraction of their former earnings once they stop working. But that's not true for everyone.

Older man holding a cellphone and standing at laptop

Image source: Getty Images.

If you've saved nicely for retirement and are entitled to a healthy Social Security benefit, then there's a chance your income might increase during your senior years. The same could hold true if you have investments in a traditional brokerage account that do well, you have a generous pension, or you decide to open a business in retirement or hold down a part-time job. As such, you really can't assume that your income will decline in retirement, and if it increases, your tax burden will, too.

Furthermore, you may be surprised to learn that a number of key retirement income sources are, in fact, taxable. Specifically:

  • Non-Roth retirement plan withdrawals.
  • Pension income (there are some exceptions for military or disability pensions).
  • Social Security benefits.

Knowing how you'll be taxed on your retirement income is a key step on the road to planning and budgeting for your senior years -- and avoiding unpleasant surprises once your career comes to a close.

How to lower your tax burden during retirement

Lower taxes in retirement aren't a given, but you can take steps to help ensure that your IRS burden is minimal. First, consider housing your retirement savings in a Roth IRA. While you don't get a tax break at the time you contribute to one of these savings plans, your withdrawals in retirement are tax-free and don't count as taxable income. And if you earn too much at present to fund a Roth IRA directly, you can always open a regular IRA and convert it to a Roth account afterward.

Another way to lower your taxes? Invest wisely. Many seniors load up on bonds because they're far less volatile than stocks, and because they pay semiannual interest that serves as a great retirement income boost. But if taxes are a concern, opt for municipal bonds over corporate bonds. Municipal bond interest is never subject to federal taxes, and if you buy bonds issued by your home state, you can avoid state and local taxes on that interest as well.

Taxes can be troubling at any stage of life, but during retirement, they can be a major source of stress. This is especially true if they wind up being much more substantial than you bargained for. As you plan for your later years, don't just assume that your tax rate will go down. Rather, take steps to make that happen. Otherwise you may be in for a very rude awakening.

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