NEXT AVENUE - SPECIAL SECTION
What to Do Now to Avoid a Retirement Savings Tax Problem
By Ed Slott
If you have an eye towards retirement or even semi-retirement, you are probably (hopefully) saving more than you could in the past in your retirement accounts. You may have paid off the mortgage and paid for college and other expenses of raising children. That all sounds like you are on your way, except for one problem: the tax debt building up in your Individual Retirement Account (IRA), 401(k) or other retirement savings plans. It can quickly deplete the very savings you were relying on for your retirement years. While you may be watching your savings balances grow from your continuing contributions and the rising stock market, a good chunk of that growth will go to Uncle Sam. That's because most, if not all, of those retirement savings are tax-deferred, not tax-free. The funds in most IRAs are pre-tax funds. But they will be taxed, when you reach in to spend them in retirement. That's when you realize how much of your savings you get to keep and how much will go to the government. The amount going to the Internal Revenue Service will be based on what future tax rates are. Given our national debt and deficit levels, those tax rates could skyrocket, leaving you with less than you had planned on, just when you'll need the money most. If you are still working, you can change the way you are saving in your retirement plans. If you have a 401(k) at work, you could make contributions in a Roth 401(k) if the plan offers that. A Roth 401(k) lets your retirement savings grow 100% tax-free for the rest of your life and pass to your beneficiaries, too.
For 2021, you can contribute up to $26,000 (the standard $19,500 contribution limit plus a $6,500 catch-up contribution for people 50 and older). With some Roth 401(k) workplace plans, you might be able to put in even more.
See if you can convert some of your existing 401(k) funds either to your Roth 401(k) or to a Roth IRA. Once you do this, you will owe taxes on the amount you convert. The conversion is permanent, so make sure you only convert what you can afford to pay tax on.
Get more practical advice on retirement planning at NextAvenue.org
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