Let’s talk taxes. Especially in today’s economy, when you start putting money away for retirement, you might be thinking of the tax benefits or consequences you’ll incur.
More than a third of current retirees (35%) did not consider how taxes would affect their retirement income when planning for retirement, according to the Nationwide Retirement Institute’s Tax-Efficient Retirement Income Study. And many express regrets. Roughly one-third wish they had better prepared for paying taxes in retirement — and roughly one-fourth believe they’ve paid several thousand more than they expected.
When you’re planning for retirement, it’s easy to ignore the elephant in the retirement room: How much taxes will I owe on my retirement income? What will my tax rate be after I retire? Given these unknowns, it’s still possible to plan for a potentially better tax outcome with the right strategy in place.
Cons of Retiring in Iowa
Property taxes in Iowa are as high as the summer corn. That’s the main reason why the state gets a poor tax rating for retirees. The median property tax rate in Iowa is the 11th-highest in the nation. That proves pricey for Iowa homeowners.
Income taxes are on the high end in Iowa, too. That’s especially so for retirees with an above-average income. Plus, over 200 school districts and Appanoose County add their own income taxes on top of the state-level tax.
Iowa sales taxes are about average. There’s also an inheritance tax in Iowa, which your heirs might have to pay.
Pros of Retiring in Iowa
There are some advantages to retiring in Iowa, one of the biggest advantages is that persons over 65 with an income of less than $32,000 are exempt from the state income tax.
This exemption only applies to married couples and widow/widowers in Iowa. To get it a couple would have to file a special Iowa state income tax return called an Alternate Tax Calculation. Even if the couple does not get the exemption they could end up paying a lower Iowa tax rate.
Iowa also allows for you to exclude your retirement income from your state return.
Pension/Retirement Income Exclusion
If you or your spouse receive a pension, an annuity, a self-employed retirement plan, deferred compensation, IRA distribution, or other retirement plan benefits, you may be eligible to exclude from Iowa income tax part – or all of the retirement income that is taxable on your federal return. The Roth conversion income, included in net income, is eligible for this exclusion.
Those not included in the exclusion are individuals with Social Security benefits, railroad retirement benefits, and military retirement pay. The exclusion is up to $6,000 for individuals who file status 1, 5, or 6 and up to $12,000 for married taxpayers who file status 2, 3, or 4. (If, for example, an individual has $5,000 in pension / retirement income, the exclusion will be the actual $5,000, not the maximum of $6,000.)
To take this exclusion the pensioner or retirement income, the Iowa Department of Revenue explains recipient must meet one of the following conditions:
- 55 years of age or older on December 31, 2020, or
- Disabled, or
- A surviving spouse or a survivor having an insurable interest in an individual who has qualified for the exclusion in 2020 on the basis of age or disability. A survivor other than the surviving spouse is considered to have an “insurable interest” if the survivor is a son, daughter, mother, or father of the annuitant or pensioner.
How to Help Mitigate Taxes During Retirement
We all know that the sooner you begin saving for retirement, the more you will benefit from the power of compounding. And the sooner you prepare for the impact of taxes in retirement, the more likely you’ll be to help generate more income for more years.
There are a range of different retirement savings accounts and qualified plans that provide tax advantages for long-term savers. Mainly, the SECURE Act allows you to make contributions to these accounts after age 72, as long as you meet certain requirements. In certain cases, you’ll need to consider the impact of required minimum distributions (RMDs).
Some of the most popular tax-advantaged accounts include:
- Tax-Deferred Plans
Tax-deferred accounts allow you to realize immediate tax deductions on the full amount of your contribution, but future withdrawals from the account will be taxed at your ordinary-income rate. The most common tax-deferred retirement accounts in the U.S. are traditional IRAs and 401(k) plans. Essentially, as the name of the account implies, taxes on income are “deferred” to a later date.
- Tax-Exempt Accounts
Tax-exempt accounts, on the other hand, provide future tax benefits because withdrawals at retirement are not subject to taxes. Since contributions into the account are made with after-tax dollars, there is no immediate tax advantage.
The primary advantage of this type of structure is that investment returns grow tax-free. Popular tax-exempt accounts are the Roth IRA and Roth 401(k). With a tax-deferred account, taxes are paid in the future but with a tax-exempt account, taxes are paid right now. However, by moving when you pay taxes and realizing tax-free investment growth, you could see more financial future gains.
- Tax-Advantaged Investments
Tax-advantaged investments shelter some or all of an investor’s income from taxation, allowing them to help minimize their tax burden. To incentivize more investors to purchase these bonds, the interest income received by investors is not taxed at the federal level.
In many cases, if the bondholder resides in the same state where the bonds were issued, their interest income could also be exempt from state and local taxes.
- Tax-Advantaged Accounts
Tax-advantaged accounts allow an individual’s investing activities to be tax-deferred and, in some cases, tax-free. Traditional Individual Retirement Arrangements (IRAs) and 401(k) plans are examples of tax-deferred accounts in which earnings on investments are not taxed every year.
Instead, tax is deferred until the individual retires, at which point s/he can start making withdrawals from the account. Withdrawing from these accounts without penalty is allowed once the account holder turns 59½ years old.
Understanding taxes is critical when it comes to retirement planning and investing. You should also have an understanding of how your taxes in retirement might affect your savings and your future income.
Whether your retirement is decades away or just around the corner, the retirement income advisors at Johnson Wealth and Income Management can provide you guidance every step of the way, and help you fill out all the right tax forms necessary.
Contact us here today to learn more.
All written content on this site is for informational purposes only. Opinions expressed herein are solely those of Johnson Wealth & Income Management and our editorial staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. Investing involves risk. There is always the potential of losing money when you invest in securities. Asset allocation, diversification and rebalancing do not ensure a profit or help protect against loss in declining markets. All information and ideas should be discussed in detail with your individual advisor prior to implementation. The presence of this website, and the material contained within, shall in no way be construed or interpreted as a solicitation or recommendation for the purchase or sale of any security or investment strategy. In addition, the presence of this website should not be interpreted as a solicitation for Investment Advisory Services to any residents of states where otherwise legally permitted to conduct business. Fee-based financial planning and Investment Advisory Services are offered by Sound Income Strategies, LLC, an SEC Registered Investment Advisory firm. Johnson Wealth & Income Management and Sound Income Strategies LLC are not associated entities. Johnson Wealth & Income Managementis a franchisee of the Retirement Income Store. The Retirement Income Store and Sound Income Strategies LLC are associated entities. © 2021 Sound Income Strategies.