Effective tax planning requires a proactive approach for today’s pre-retirees, as neglecting this crucial step can result in a significant tax bill later on. To help minimize your overall tax burden and maximize your spendable income, it’s important to work with a financial professional to adjust your tax strategy as needed.

In this week’s Better Money Boston with WCVB Channel 5, David Shapiro breaks down key factors to consider as you prepare for the impact of taxes in retirement.

Dispel Common Tax Myths

Many people believe that once they retire, their taxes will drop significantly. While it’s true that you no longer have a paycheck, you still need income in retirement. This means drawing money from sources like Social Security, pensions, or other retirement accounts, all of which can be subject to taxation. Retirement may also be the time to take that dream vacation, spend more time with family, or explore long-held passions – all of which come with their own costs.

As you start planning for taxes in retirement, it’s important to dismiss this myth that your tax burden will automatically decrease because you’re no longer working. In reality, your taxes may increase as you live out your retirement goals and become more active in your spending habits.

Understand How Each Account is Taxed

It’s essential to know how each of your retirement accounts is taxed, whether it falls into a taxable, tax-deferred, or tax-free bucket. For example, if you withdraw funds from a traditional retirement account, that money is taxed as ordinary income and subject to both federal and state taxes.

On the other hand, with a Roth IRA, you can withdraw funds tax-free as long as you’re over 59 ½ and have held the account for at least five years. Lastly, if you take money from a checking, savings, or regular investment account, you may incur capital gains taxes or other taxes, though the overall tax burden is typically lower.

Don’t Overlook RMDs

Required minimum distributions (RMDs) can also have a significant impact on taxes in retirement. At age 73, you must begin withdrawing money from your retirement accounts. Every dollar you withdraw is treated as income and will count toward your total income for the year. However, by strategically timing your withdrawals, you may be able to avoid being pushed into a higher tax bracket, potentially decreasing your overall tax liability.