Taxes and Your Retirement, What’s the Plan?

Whats Your Financial Plan

Ben Franklin once said that “there were only two things certain in life, death and taxes”. I would suggest that these days there is only one. Congress and local taxing bodies seem to always be changing the tax codes. This makes long term planning a challenge, to say the least.

How To Retire in Uncertain Times

This is the fourth element of what needs to be kept in mind in order to successfully retire in uncertain times. Given how fast things move these days, retiring can feel more and more of a challenge. This is why I focus on helping people to achieve a low stress, high enjoyment retirement.

If taxes were to go up significantly, and you didn’t have a plan in place to deal with that, you could take a significant cut in your net spendable retirement income.

As it is, retired folks pay generally higher taxes than other segments of our population. This has been true since the Tax Reform Act of 1986, when many of the deductions we previously enjoyed were eliminated.

What Happens When Taxes Go Up?

Here is an example: Say you have income of $10,000 per month in retirement. If this income comes from Social Security, a pension and withdrawals from an IRA, all of this will be taxable as ordinary income (except 15% of your Social Security income).

If this was a married couple, they would likely take the current standard deduction of $25,900, leaving taxable income of $94,100 (these are all rough numbers for illustrative purposes only and you should check with your tax adviser for accuracy and how this information applies to your situation).

In this example, according to the federal IRS tax tables, your federal tax would be $11,936 (22% of the amount over $83,550 + $9615). In 2026, under current tax law, we will revert to the tax rates that were in effect in 2017, before the Tax Cut and Jobs Act was passed in December of 2017. Under those rules, assuming only using the standard deduction, the tax would be $19,140 which is about 60% more tax!! This is already the law as it stands and does not assume any other tax increases before then.

Could you use an extra $7,000+ each year to spend? Most of my clients would say yes!

Taxes Are Going Up

Watch Out For Stealth Taxes

In addition to regular income taxes, there are some stealth taxes that can be triggered if you are not careful. You could have certain tax deductions phased out, you could be charged more for your Medicare part B (this can be over $10,000 for married couples), or you could owe the Medicare surcharge on taxable income.

The above is why I encourage my clients to diversify under the tax code. In many ways this can be more important and impactful than diversifying your investments. The younger you are, the easier it is to put yourself in a tax advantaged position.

For example, many folks just put money into their 401k and figure they are saving for retirement and that this is enough. If you accumulate hundreds of thousands or millions in your IRA or other tax qualified plan that you contributed pre-tax deposits, this will all be taxed as “ordinary income” when withdrawn. Since you must withdraw money from these accounts and pay tax once you turn 72, you could be forced to draw tens of thousands from your accounts (or more) and pay hefty taxes on money you really didn’t want to spend.

This happens more often than people think.

To avoid this, you may want to make some of those deposits into a Roth 401k (or other tax-free account), if available, to minimize this effect. If none is available, you may want to look into Roth conversions of existing IRA’s to take advantage of today’s historically low tax rates.

100 Dollar Bill

The Hierarchy of Money

Here is what I call the “Hierarchy of Money”. Keep these in mind when making saving and investing decisions. It can make a huge difference.

From best to worst, the 4 types of money:

  1. Free Money
  2. Tax Free Money
  3. Capital Gains taxed money (these rates are going up in 2026 as well)
  4. Ordinary Income taxed money (IRA’s, Pensions, earned Income, interest, etc.)

See, every dollar you don’t pay in taxes, is a dollar you get to spend yourself!

When people come to me and say; “I’m a millionaire, I have over $1m in my 401k” I have to show them that they owe between 20 and 25% of that, or more, in taxes, so the amount that is actually theirs is a lot less than they thought. This can be a real wake up call for many.

Are You Able To Pivot?

If you are tax diversified among the categories mentioned above, when taxes change you can pivot to take advantage of tax opportunities that will minimize the impact of tax changes. This can reduce stress and make your retirement income security much easier and more predictable.

I suggest that if you ignore taxes and just “pay as you go”, you are leaving yourself open for potential nasty surprises that could really impact your retirement security.

When you are making plans to retire, ignore the tax ramifications of your strategy at your own risk.

Working with advisers who are familiar with the tax impact of different strategies can make a huge difference in your overall security. Creating a big picture, long term strategy is a step that should not be overlooked. The earlier you start the easier it can be.