As I’ve been running calculations on whether or not it makes sense to do a Roth Conversion, I came back to the question — what will my effective tax rate be in retirement?
That’s a question a lot of us considering a Roth Conversion should ask, but it’s not one that is easy to answer. What’s important, though, is that the numbers you plug into your calculations are reasonable. After all, expecting a 40% income tax in retirement each year can greatly skew your calculations if in actuality you’ll see a 20% effective tax rate.
This Forbes article by Erik Carter was really eye-opening: Why Your Taxes in Retirement May Be Less Than You Think
- You are probably overestimating what you will have to pay in taxes at retirement
- Withdrawls from Roth accounts are tax-free at 59.5
- Social Security is taxed at ordinary income rates but only part of it is taxable
- Long-term capital gains are taxed at lower rates than income tax (*at least according to current tax law)
- Your income will probably be lower and put you in a lower tax bracket (i.e. experts recommend 80% of your pre-retirement income, but you may need less)
- When you are older than 65, you get different deductions than younger people. For instance, you have a $1550 higher standard deduction than us young folk
- A lot of 401k contributions withdrawn yearly will be taxed at lower rates, especially if you plan on taking out less than $36k per year (note, that’s no where near 80% of my current salary, but I could live on it in another state if I owned a house free and clear)
- Tax rates could be higher when you retire but that’s unlikely (*not impossible)
- Lots of people retire in states that don’t have income tax like Texas, Florida and Nevada. (*check out this handy-dandy state income tax calculator and weep… unless you live in a state with low income tax.)
- Move where all the old people live and you’ll be fine.