A big misconception that many people have about retirement is that they won’t have to pay a lot of taxes. In reality, there are many different sources of revenue that the IRS can get a piece of.
For example, dividends you receive in a regular brokerage are taxed, and you’ll face capital gains taxes if you sell the investments at a profit. And if you have your retirement savings in a traditional IRA or 401(k) plan, those withdrawals will be taxable as well. Even your Social Security benefits may be taxable, depending on your situation.
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The good news is that there is an easy way to set yourself up with a tax-free income in retirement. But in some cases, you may need to plan for it in advance.
Roth retirement plans are not funded on a pre-tax basis like traditional retirement accounts. But they offer the benefit of tax-free earnings and withdrawals.
Here’s the catch, though. It is not a given that you will be able to fund a Roth retirement plan directly.
If your income is too high, you are barred from contributing to a Roth IRA. And if your company doesn’t offer a Roth 401(k), or a retirement plan at all, for that matter, then that too is off the table.
You can, in such situations, contribute to a traditional retirement account and do a Roth conversion so that you can withdraw from your savings later in life without having to pay taxes on that money. But a Roth conversion is something you need to time very carefully.
When you do a Roth conversion, the money you roll over counts as taxable income that year. This could have major implications.
For one thing, a Roth conversion can move you into a higher bracket. But it can also have an impact on your finances.
If you do a Roth conversion this year with plans to enroll in Medicare in two years, you may face surcharges on your Part B premiums because your 2026 income reaches a certain level. So it is important to plan for a Roth conversion carefully. And if you’re looking to move a large sum of money into a Roth, you may want to spread it out over several years to minimize the tax impact.
But all in all, if you like the idea of avoiding taxes on at least some of your retirement income, it’s worth finding a way to save in a Roth account. You may not be able to contribute directly, but that need not stop you as long as you plan accordingly.