Spending What the Government Lets You Keep

By Gary Silverman, CFP®

An important part of planning for your future finances is realizing that you only get to spend what the government lets you keep. If that’s not obvious, let me give you an example.

Let’s say that you have a pension that will pay $1000 a month. That’s great, however you don’t get to spend the $1000 unless you are in the zero tax bracket. Assuming that’s not the case, you only get to spend what’s left over after taxes are paid.

If you are already in the 12% tax bracket, the $1000 pension you’re about to receive is also going to be taxed at least 12%. I say “at least” because, depending on where you are in the 12% bracket, you might have some of that pension income get pushed into the 22% bracket.

There’s more! A surprise awaits many when they find out that Social Security retirement benefits can be taxed. People with low incomes will have none of their Social Security taxed. Those with more moderate income can have 50% of their Social Security taxed. Higher income earners might have up to 85% of their Social Security added to their income and taxed.

As the late-night infomercials might say, “And that’s not all!” For your income can impact what you pay in Medicare premiums. If your income drifts up, it can add thousands to your annual Medicare costs.

This same problem affects most people’s 401(k) and Traditional IRA savings as pulling money from them adds directly to taxable income. Interestingly enough, taxable mutual fund and brokerage accounts can be less taxing as some of the money they generate will likely qualify for lower-taxed long-term capital gains or qualified dividend tax treatment. Even better, Roth IRA accounts usually won’t generate taxable income when you pull money from them in retirement.

Whether you are in retirement or still planning for it, you need to take all of this into consideration to know just how much of your retirement income you actually get to spend.

Does this all sound a bit confusing? It is! There are a lot of different income taxes, tax rates, and taxability issues that come into play (or will) when you retire. We use software, a lot of study, and our accountant friends to figure this all out. You probably should, too.

Knowing what will happen tax-wise, you can incorporate that with all your other retirement preparation. There are even situations where pulling money out of IRAs and such that you don’t currently need and paying taxes on it now will end up with you paying less taxes in the long-term.

But you won’t know unless you analyze your own situation and make your plans accordingly. Just waiting for stuff to happen is not recommended.

May Ukraine stay free.

Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing.