Dubai: When it comes to retirement costs, most people think about food, shelter, travel and entertainment. Yet, there’s a more common expense that requires some very detailed planning: taxes.
Taxes are particularly significant as the number of people that are to retire over the next two decades will be more in number than those that have retired in the previous 20 years worldwide, estimates show.
This is because by the year 2040, the world will have more retiree adults than children, which are those aged 65+ versus those younger than 18.
Financial advisors and tax planners are called upon increasingly to help retirement investors like expats navigate the tricky world of taxes and to help them build a tax-efficient income stream in retirement.
Will I need to pay taxes in retirement?
In almost every country – unless the country where you earn your retirement income doesn’t levy taxes – unless your taxable income falls at or below the standard deduction level every year, you probably will.
How much you’ll pay is another story. There are numerous increasingly complex strategies to help retirees minimise their tax burden.
While how each strategy plays out varies with each country, the overall aim is to pay less in taxes by assessing the overall portfolio and trying different strategies, such as the size and timing of withdrawals in retirement and making most of income-splitting opportunities that may arise.
The planning starts when investors are in their working years and evolves as they enter their golden years. At the same time, more than $50 trillion (Dh183 trillion) is sitting in retirement accounts that must be withdrawn.
This is why the retirement market is central to the investment industry, having been shaped over the last 40 years by regulation and global demographics.
Nearly 60 per cent of retirement assets now reside in individual retirement accounts worldwide, some statistics show.
As you plan for retirement, it’s vital to keep in mind that governments worldwide hold numerous ways to tax you, and that it can move the goalposts. That could be a significant problem if you are unprepared.
Factoring in the cost of the unknown
Even the best-laid plans can be derailed by unknowns about retiree’s entire financial picture, advisors explain, which is why they are asked to give a full view of all their assets.
An example is a discount brokerage account that a retiree may not disclose unless advisors ask explicitly.
Real property, inheritances and even small business assets are other often overlooked sources that can affect tax-efficient plans devised by advisors negatively because they would be unaware of these assets’ existence.
The more the advisor is aware of these, the less likely retirees are going to hit a tax trap. Much like retirees themselves, advisors are best served by planning and asking the right questions to ensure nothing is missed.
Certainly, advisors we’re working with are having these more precise conversations five to seven years prior to retirement.
Part of that job involves helping pre-retirees understand taxation and, in turn, how their decisions regarding their assets can affect sustainable, after-tax income streams during retirement.
Although most advisors recognise tax traps and know how to avoid them, their clients may not. This is why having even a basic knowledge helps most people avoid most tax-related traps at any stage in life.
What tax traps do I need to avoid?
What types of income might you receive in retirement? How will your retirement income be taxed? In a recent retirement poll, 74 per cent of respondents said they worry about having enough income in retirement.
Yet the majority of respondents didn’t know how retirement income is taxed, which may result in lost opportunities to implement strategies that might reduce the tax you pay by hundreds or even thousands annually.
One in five (21 per cent) of respondents did not know how much annual income they might have in retirement. And some of the participants expected to leave at least a portion of their retirement to chance, relying on windfalls such as gifts or inheritances (27 per cent), or lottery winnings (7 per cent).
Are my annuities taxed as well?
Annuities grow tax-deferred and are taxed depending on the type of annuity, how the annuity was purchased and its term, and how withdrawals are made.
Because of annuity taxation complications, you might want to consult with a financial professional. A qualified annuity is mostly purchased with money from a pre-tax or tax-deferred account. Withdrawals are then made at ordinary income tax rates.
Conversely, a non-qualified annuity is purchased with money that comes from a taxable bank or brokerage account. Only earnings will be taxed.
The term of the annuity (period or lifetime) also plays a factor. A period annuity comes with a set term length whereas a lifetime annuity is what it implies — a regular amount dispersed over someone’s lifetime.
Early pay-outs and lump-sum distributions are taxed at ordinary income tax rate instead of the benefit of capital gains.
Save on tax by withdrawing before you need it
Some of the methods that allow you to save on taxes also require you to take out more from your retirement accounts than you actually need.
If you can trust yourself not to spend those funds – in other words, save or invest the extra – this can be an easy way to spread out the tax obligation, matter experts often reiterate.
Certified financial planners (CFP) and certified public accountant (CPA) view that if you take out distributions earlier while you’re in a lower tax bracket, you could save on taxes, versus waiting until you’ll have possible income from other retirement vehicles.
While there are several (complicated) options for reducing taxes on your retirement account withdrawals or cushioning their impact on future taxes, whichever method you choose, it always helps to talk to an advisor to figure out which works best for your individual circumstances.