After April 15^th, most Americans stop thinking about taxes.

But that could cost you in the long run — specifically when it comes to taxes on your retirement savings.

Many people assume taxes will go down in retirement. But that’s not always true. If you’ve been a good saver, you could end up with more taxable income in retirement than in any of your working years. Potentially putting you in a higher tax bracket, paying higher marginal tax rates. Plus triggering taxes on up to 85% of your Social Security benefits, and increased Medicare premiums.

That all sounds like bad news, but there’s some good news.

During retirement, you could have more control over your taxes than at any other point in your life.

And if you’re recently retired, or plan to retire soon, it could be the perfect time to identify significant potential tax savings.

The secret? Tax planning.

You’re probably very familiar with tax preparation.

This is what you do every year, leading up to April 15^th. Looking back at the past year, and adding up how much you owe. Unfortunately, tax preparation is mostly reporting on the past. What’s done is done. And aside from a handful of deductions, you have little power to reduce your taxes due.

Tax planning is very different.

Tax planning involves looking forward at your future tax obligations — especially in retirement. And determining what strategies could potentially reduce those future tax bills.

This year’s tax savings are limited. A good tax preparer could save you a few hundred or a few thousand dollars with the right deductions.

But your long-term tax savings could be much more. Some good savers uncover $10,000s or even $100,000s in lifetime savings through strategic tax planning.

What triggers taxes due in retirement?

Many of us have spent a lifetime contributing to tax-deferred retirement accounts. This includes traditional IRAs and 401(k)s.

The premise of these accounts is simple. We get a tax deduction for every dollar we save in these accounts. And as long as we leave the money in the account, we don’t pay taxes on it — no matter how much it grows.

Many good savers end up growing these accounts high into the six-figures, even to $1 million and beyond.

And that’s wonderful!

But it also comes with tax consequences. Because this is all untaxed income. And every dollar you withdraw from these accounts in retirement will finally be taxed.

All qualified withdrawals count as taxable income for the year. And depending on how much you withdraw in a given year, this could trigger a significant tax bill.

Beyond your retirement account, there are many other sources of income that could add to your taxes due in retirement.

• Up to 85% of your Social Security benefits could be taxed, depending on your taxable income for the year.
• Investment income can be taxable, too — including dividends, interest, and capital gains.
• Pensions and annuity income (if you have it) is also taxed as ordinary income.

Any other sources of income you have in retirement, including part-time work, rental income, business income, royalties, or even potentially some inheritances may add to your taxable income as well.

All of this to say, if you expect taxes to go away in retirement, you could be in for a big (potentially expensive) surprise!

What can lead to surprisingly larger tax bills in retirement?

One of the biggest tax surprises in retirement can come from Required Minimum Distributions, or RMDs.

Basically, Uncle Sam gets tired of waiting for you to withdraw money out of your tax-deferred retirement accounts.

So each year — starting when you turn 73 (or 75 if you were born in 1960 or later) — you have to start withdrawing money. And those withdrawals continue until the account is empty, or until you are!

This forces you to turn your tax-deferred savings into taxable income. And it can get very expensive. We’ve seen great savers suddenly have twice as much taxable income in their mid-70s as they ever had while working.

This is often called the “Tax Time Bomb.” Because of how big these tax bills can be.

This income is often in higher marginal tax brackets. It can trigger those taxes on Social Security benefits. And it can push up your Medicare premiums.

Each additional dollar of income can create disproportionately higher tax consequences.

And by the time RMDs kick in, there’s little you can do to stop them.

But it’s not just RMDs. Any other significant source of income during retirement could have a similar impact.

• For example, if you take a large withdrawal from your tax-deferred accounts — for any reason — that will count as taxable income for the year.
• Or in other taxable accounts and investments, a sale of stocks, funds, or property could lead to big tax consequences.
• Even if it doesn’t feel like income and you’re not taking the money out of the account, there are many transactions that could lead to tax surprises.

The key is being clear about what will and will not be taxed in retirement — and then making strategic decisions — within the US tax code — that could lower your total taxes due.

What tax planning can I do now that could reduce my lifetime tax obligation, especially in retirement?

The earlier you get started with tax planning, the more flexibility you could have.

First, you need a clear picture of the current tax status of all your savings and investments.

Next, you can make a plan for which accounts to draw from and when. Because prioritizing withdrawals from certain accounts at certain times during retirement could make a big difference to your long-term taxes due.

(This one thing — a withdrawal plan — should be a critical part of financial planning for retirement. It’s fairly simple to create a personalized plan. It doesn’t require you to move money around. And it’s a huge step towards using your money as tax-efficiently as possible in retirement.)

Finally, you may be able to make certain moves during retirement — such as a Roth conversion — to move some or all of your savings from one tax treatment to another.

In a Roth conversion, you’re moving money from a tax-deferred IRA or 401(k) to a tax-free Roth account.

When you do this, you pay taxes on the amount you convert, in the year of the conversion. The first few years of retirement can be advantageous for this move. After you stop receiving a paycheck, and before Social Security and RMDs kick in, your other income may be lower. So more of your conversion may be able to happen within lower tax brackets.

Then, once the money is in a Roth, it can grow tax-free for as long as you leave it there.

No taxes on investment gains or growth. And you’re not taxed on withdrawals, either — which can reduce your overall taxable income later in retirement and potentially reduce or eliminate taxes on Social Security benefits.

Plus, because there are no longer taxes due, money in a Roth is not subject to RMDs. Not only is it tax-free, you have the freedom to do (or not do) whatever you want with that money.

This is one of many moves a financial advisor may potentially suggest, based on your situation. The key is to sit down, identify what potential tax-savings strategies could apply based on your personal and unique circumstances, and take action based on what you find.

And if you’re like many of us, right after April 15^th — after you’ve added up another year’s tax bill — is a very motivated time to dive into tax planning.

This article was written for financial advisory clients of Asset Strategies. If you’re not yet a client and you’d like to speak with a financial advisor about potential tax-saving strategies for your retirement, request a Retirement Tax Strategy Review here.