Will You Really Spend Less and Pay Lower Taxes in Retirement?
Retirement does not automatically mean lower spending or a lower tax bracket. Your expenses depend on how you live, and your taxes depend on your income and the accounts you use.
I have been playing more golf lately. Kristen has pointed out that this creates two expenses: the golf itself and paying someone to do a few things around the house while I am out playing.
She has a point.
I am not retired, but it is a good reminder of what can happen when you make more room for the things you enjoy. More free time can create more opportunities to spend.
Will my expenses go down when I retire?
Some might. You may spend less on commuting or work clothes. But you may replace those savings with travel, hobbies, dining out, or time with your grandchildren.
Being home more can also change your priorities. That couch you barely noticed while working suddenly looks like something you would like to replace.
I remember a gentleman who confidently told me he had read that he would need only 80 percent of his working income in retirement. As we talked, I learned that he and his wife were already spending almost everything coming in.
So I asked him: “What 20 percent of what you are doing now are you willing to give up?”
That question made the assumption feel real.
An income replacement guideline can start a conversation. I would rather build a budget around your actual life. What expenses will end? What will continue? What new activities are you looking forward to? What irregular costs, such as a car or home repair, should we include?
The goal is to help you enjoy retirement with a clear understanding of what it takes to support it.
Will I automatically be in a lower tax bracket?
No. Leaving work does not make every other source of taxable income disappear.
I remember a client whose IRA had grown substantially. When he had to take required minimum distributions, he was frustrated. He did not need the money for living expenses, but the withdrawals created taxable income.
Generally, traditional IRA distributions are taxable except for amounts attributable to applicable after-tax basis. Required minimum distributions can mean taking money out even when you would prefer to leave it invested. The required amount depends on the account balance and the applicable IRS distribution factor.
That is why I want to have the tax conversation before those withdrawals become mandatory. We need to understand how your income sources will fit together over time.
What should a retirement tax plan consider?
I want to look at which accounts you hold, when you expect to use them, and how withdrawals could affect your taxable income.
For some people, that conversation includes evaluating Roth conversions. A conversion generally creates taxable income to the extent the converted amount has not already been taxed, so it needs a careful comparison of the cost now and the potential benefit later. It is not an automatic answer for everyone.
The point is to make deliberate decisions rather than assume your tax bill will take care of itself.
How can I replace assumptions with a realistic plan?
Start by describing the retirement you actually want. Include the golf, the trips, the family visits, and the ordinary bills. Then estimate your income and how much you may keep after taxes.
Your retirement budget and tax plan should work together. Knowing what you can spend is more useful when you also understand where that money will come from.
If you would like to talk through those questions, our team is available throughLegacyRetirementGroup.com.
The information provided is for educational purposes only and should not be considered tax or legal advice; please consult with a qualified tax professional regarding your individual circumstances or visit IRS.gov for additional information.