Why Some Retirees Save Hundreds of Thousands in Taxes—And Others Don’t

Many retirees accidentally pay far more in taxes than necessary. And sometimes we’re talking hundreds of thousands of dollars over your retirement.

We call this your retirement lifetime tax bill.

Now, I’ve sat down with hundreds of families one-on-one as they’re getting ready to retire. We build blueprints and tax maps. I’ve seen situations where Roth conversions make very little sense, and I’ve seen other families where proactive tax planning could potentially save over a half a million dollars.

Now, this is the same tax code, similar retirement years, and similar retirement windows, but completely different outcomes. So let’s dig into why.

Most people think taxes in retirement work the same way they did while working, and they don’t. There are completely different rules. I want you to think about this as a rulebook.

You get used to playing by one set of rules, and then imagine football suddenly changes. Instead of eleven players, there are only seven. Touchdowns count for five points instead of six, and extra points count for ten.

If they changed the rulebook, the game would be drastically different. It would be confusing. That’s very similar to what happens when someone retires.

Let’s talk about the two different phases.

First, there are the working years. We have wages, salary, and maybe business income if we own our own business. Most income is determined for us because it comes from a paycheck. There’s limited flexibility, and most people spend 30 or 40 years living under these rules.

This also includes investing. Many retirement accounts grow tax-deferred, meaning you’re not paying taxes along the way.

Then all of a sudden you get ready to retire. You start looking at the numbers, maybe you see a video, hear something on the radio, and realize this is completely different.

Let’s talk about the retirement years because it’s important to understand how different they really are.

Let’s start with Social Security.

Social Security has something called provisional income. Depending on your situation, none of your Social Security may be taxable, or up to 85% of it could be included in your taxable income.

That’s something completely new.

Then you have investment income. Maybe you have a pension. Maybe you’re pulling money from a 401(k). Maybe you inherited money and are withdrawing from a brokerage account.

All of those sources are taxed differently.

Then we have Roth conversions.

We have Medicare premiums and IRMAA, where higher income can result in higher Medicare costs.

We have withdrawal sequencing. Which account should we pull from first?

We have tax brackets. During our earning years, we don’t often think much about tax brackets. During retirement, it can be very advantageous to pay attention to them.

Let me give you an example.

One year, a client called me in November. They had retired earlier that year and wanted to complete a kitchen remodel. They needed approximately $30,000.

We reviewed their situation and estimated where their tax brackets were likely to land. It appeared that taking the withdrawal immediately would push them from the top of the 12% bracket into the 22% bracket.

Because they had recently retired, we knew their income would be lower the following year.

We suggested waiting until January.

The client decided to move forward with the remodel immediately using a line of credit, and we sent the money in January.

As a result, the withdrawal was taxed at 12% rather than 22%.

That simple decision saved several thousand dollars in taxes.

That’s the power of understanding tax brackets.

Now let’s talk about Required Minimum Distributions, or RMDs.

At age 73 or 75, depending on your birth year, the government requires you to begin withdrawing money from many retirement accounts.

Throughout your working years, you received a tax deduction when you contributed to those accounts. Eventually, the government wants its share.

If you fail to take the required amount, there can be significant penalties.

This is another retirement rule that didn’t exist during your working years.

The good news is that retirement brings more decisions, but it also brings more flexibility.

One of the most important opportunities is what I call the Golden Window.

For many people, the Golden Window exists between age 59½ and the age when RMDs begin.

During this period, several things may happen.

Income may drop.

Social Security may not have started.

You may intentionally delay Social Security.

RMDs haven’t begun.

One spouse may retire before the other.

As a result, income may temporarily decline, creating planning opportunities.

That’s why we call it the Golden Window.

Now, the Golden Window only becomes valuable when we take a long-term view.

We use planning software because these decisions are difficult to estimate accurately over decades.

We look at your income, Social Security decisions, retirement spending, account balances, travel goals, and future withdrawals.

Then we estimate what I like to think of as three different tax brackets:

The bracket you’re in today.

The bracket you’ll likely be in after retirement.

And the bracket you may be in once RMDs begin.

Many people are surprised to learn that RMDs can push them into higher tax brackets later in life.

There’s another issue many people overlook.

If you’re married, one spouse will eventually pass away.

When that happens, the surviving spouse often moves from married filing jointly tax brackets into single tax brackets.

The brackets shrink dramatically, but the retirement accounts and RMDs may still be substantial.

This is often referred to as the widow’s tax.

Again, this highlights why the Golden Window can be so valuable.

The goal is not to tell everyone to do Roth conversions.

That’s not the lesson.

The goal is to understand your situation.

If a tax map shows that Roth conversions create meaningful long-term benefits, then they may make sense.

If they don’t, then they don’t.

Every situation is different.

The key is being intentional.

Let’s look at another example.

Suppose you retire at age 62.

Your income drops significantly.

You delay Social Security.

RMDs are still years away.

You may find yourself in a lower tax bracket with more flexibility and more planning options.

The mistake is assuming taxes will simply take care of themselves.

Many people continue thinking about taxes exactly as they did during their working years.

But retirement is different.

Social Security, pensions, investment withdrawals, tax withholding, Medicare, and future RMDs all interact.

I’ve also seen retirees look at their tax return and say, “We’re not paying much tax.”

What they don’t realize is that their tax-deferred accounts continue growing.

Their future tax liability continues growing.

Their future RMDs continue growing.

It’s like a ticking tax time bomb.

Meanwhile, they feel great because taxes appear low today.

The Golden Window provides an opportunity to look ahead instead of simply looking backward.

When we prepare taxes each year, we’re usually looking at the previous year and asking how to legally and ethically minimize taxes.

When we engage in retirement tax planning, we’re looking forward 5, 10, 15, 20, or even 25 years.

We’re asking different questions.

What will RMDs do to future tax brackets?

What kind of income do we want?

Do charitable strategies make sense?

Do gifting strategies make sense?

Should we leave tax-deferred assets to our children or convert assets and potentially leave tax-free money instead?

Should we consider Roth conversions because we believe tax rates may rise in the future?

These are the types of decisions that can have a significant impact not only on your retirement, but on the people you care about most.

One of the most important retirement questions you can ask is this:

Do I understand my tax opportunities before my RMDs begin?

Because the answer to that question could have a significant impact on how much of your money you ultimately get to keep.

Thanks for watching. I’ll see you next time, and make sure to subscribe.