In last week’s post, I discussed tax planning throughout the year to maximize your take-home pay. Ultimately, you want to reduce your taxable income through tax-advantaged investments and ensure you are getting all other available deductions (home mortgage interest, children, etc.) to pay the least amount in taxes.

Today, I’m going to throw a wrench into things by forcing you to think a little bit harder about this question: How do you want to live in retirement?

Do you want to be able to completely retire and travel the world? Or, do you plan on working a part-time job at a golf course where you will have some passive income? Maybe you will retire from corporate America and go into teaching? All of these options are great…. BUT, you need to understand what your tax situation in retirement will look like. What do I mean by this?

If you are saving all of your money into your 401(k) and getting the tax deduction now your money will grow tax-free. However, you will pay taxes on that money when you pull it out. It is difficult to understand what the tax bracket situation will be like in 20 or 30 years; however, you can make an educated guess – taxes will likely be higher.

Let’s say you and your wife plan to travel the world and you need a significant amount of money – $100k/year for a few years. Using information from last week’s tax planning post, we know a couple filing jointly would pay around $16,500 leaving them $83.5k instead of $100k. Do you really want to “throw away” that much in taxes?

So, does this mean you are doomed if you only save into a 401(k)? No! The rest of this post will review some other tax planning options so you can have nice tax advantages in retirement.

  1. The Health Savings Account: I feel within the last few months there has been a revitalized discussion on the triple tax advantages of the HSA. Check out my post specifically on HSAs here. To quickly review, here are the three tax advantages:
    1. Contributions are tax deductible
    2. You can invest the money in your HSA and it grows tax-free.
    3. The money can be pulled out tax-free if used for qualified medical expenses. In addition:
      • When you turn age 65 you can pull the money out like a normal retirement account and you will only be taxed at the ordinary income level you are at for that year.
      • You can also pay out-of-pocket for qualified medical expenses and later reimburse yourself from your HSA (let your money grow tax-free and pull it out tax-free at a later date)!
  2. Roth IRAs: Even though there are no tax advantages (no deductions) for the contributions to a Roth IRA, the money does grow tax-free. Also, you do not get taxed on the distributions. Therefore, any money you pull from your Roth accounts in retirement will have no tax implications. If you have $250k and you want to go buy a Maserati – you can pull the $250k out tax-free and go buy that Maserati!
  3. Roth 401(k)s: Much like the Roth IRA, if your company provides an option for a Roth 401(k) you can contribute to it with post-tax dollars. The money grows tax-free and you can pull out the money tax-free in retirement.
  4. Other investment vehicles (feel free to comment to add more!): Real estate investment trusts (REITs), bonds, money market accounts, and brokerage accounts.

So what is best for you? I see many financial advisors provide the following guidelines, which I also believe are valid:

1: Contribute enough to your 401(k) to get your employer match.

2: Max out your Health Savings Account (if you have a high-deductible health savings plan option).

3: Max out a Roth IRA

4: Go back to your 401(k) and max that out.

5: Now it depends on your situation – maybe you have children and contributing to a 529 savings plan makes sense. Maybe you want to invest in real estate and you save for a down payment on an investment property. Or, you could throw extra money into a brokerage account.

For those wondering, here is the plan that I implement, which is slightly different than what I just wrote above. First, I max out my 401(k) and HSA. In the past, I’ve contributed a mix into my 401(k) – traditional and Roth 401(k) contributions. Second, I contribute to a Roth IRA. Finally, I am working with my financial advisor to determine if a 529 plan makes sense for my family, and if so, how much to contribute. I’ll update you all later on what we decide!

What tax planning strategies do you implement? 

Have you thought about the tax implications for your retirement savings accounts?