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  Sunday December 9, 2018

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Learn even more about this topic with the Encyclopedia of Personal Finance™

The taxes you will owe on your retirement money depend on the decisions you make before and after you retire. The longer you can put off paying your taxes, the more likely it is that you can make your money work for you.

Paying taxes later instead of today is known as tax deferral. By investing in tax-deferred investments, money normally used to pay taxes stays in your account, building your investments faster. Even after paying taxes in retirement, you will generally have greater income and account values than by investing in regular taxable accounts along the way. Individual retirement accounts (IRAs), 401(k) plans, and annuities are examples of tax-deferred savings plans.

The amount of tax you owe at retirement depends not only on your income, but also on the timing of your withdrawals. Distributions from retirement plans and annuities are taxed at regular income tax rates. You must begin receiving minimum distributions from most retirement plans at age 70? or there will be a considerable tax penalty. The exceptions to this rule are Roth IRAs and nonqualified annuities (annuities outside of retirement plans). In most cases, you will also be penalized for withdrawing retirement income before age 59?. This applies to retirement plans and nonqualified annuities.

You also have the choice of putting your money into tax-efficient or tax-managed mutual funds. Tax efficiency refers to the after-tax return of an investment in comparison to its pre-tax return—in other words, how much of your investment return is lost annually to taxes.

A fund with low turnover rates and few dividends is probably tax-efficient. By investing in a tax-efficient fund, you defer paying most of your taxes until you sell your shares.

A tax-managed fund invests with tax efficiency as its goal. Tax-managed funds use trading strategies to reduce taxes. Stocks and stock-based funds are subject to capital gains taxes. Tax rates on long-term capital gains are not only lower than on regular income for most individuals, they're also lower than the rate at which other kinds of investment returns are taxed, such as most bond interest and even income from retirement plans such as IRAs and 401(k)s. Other tax-efficient investments include municipal bonds, most of which generate tax-exempt income, and U.S. savings bonds, which allow you to defer your taxes until your bonds are redeemed.

Are you ready to begin planning your retirement? Let's go over what we have covered.


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