The moment you start contributing to a 401(k) or IRA account, you have entered into a contract with the "tax man". 

When I meet with clients to discuss beneficiaries on their IRA accounts, they typically discuss wanting to leaving their money to their children. For example, if a couple has an IRA worth $1,200,000 and three kids, they will typically give each child $400,000 when they die.  I unfortunately have to remind them that there is another “beneficiary” out there and they will make sure they get their share of the money also.  Taking this beneficiary into account, the benefit to their children may be closer to $300,000, instead of $400,000.

Who is that forgotten beneficiary? Yep, you’re right…it’s the IRS.

Interest Income…..That is a topic that over the past few years nobody has given much thought too.  You could have big account balance in the bank and basically get pennies on your savings.  That has all changed due to the Federal Reserve raising interest rates this past year.  Savings and CDs rates are actually something you can brag about at the neighborhood barbecue. 

Now comes the taxing part.  While you may be earning more interest, you will more than likely have to pay income tax on that interest income and dividends that you have been receiving.  If your bank pays you more than $10 in interest you will receive a 1099 at the end of the year.  Let’s review the various types of income/dividends and how they are taxed:

One often-overlooked aspect of retirement planning is the effect of taxes. It tends to be the largest expense a household will have in retirement.  Without proper planning, taxes can take a significant bite out of your nest egg. 

A $1 million-dollar portfolio in a 401(k) plan or traditional IRA, for example, might be worth $750,000 or less after taxes. Similarly, if your investments are in a regular, taxable brokerage account the interest and dividend income that money generates may also be taxable.

It is important then to be tax-smart with your investments and account choices to reduce your tax liability during your retirement years. Good news is there are some income sources that are not taxed.  Let’s review those that may be tax exempt.