First, a review of where federal income taxes are coming from, pre-Obama. This interesting data is from a 2008 staff report from the Congressional Joint Committee on Taxation:
• The top 1 percent of taxpayers pay approximately 40 percent of all federal income taxes.
• The top 10 percent of taxpayers pay about 70 percent of all federal income taxes.
• The top 50 percent of taxpayers pay almost 97 percent of all federal income taxes.
The most recent Obama stimulus plan estimates that 95% of all taxpayers will see their taxes reduced, with some who pay no taxes now actually receiving payments from the government. The likely consequence of such a plan is that the percentages reported above will increase.
Obama has also stated that he wants a tax system in which retirees who have incomes below $50,000 will pay no federal income taxes.
This tells us that retirees who want to have a retirement income that is more than their Social Security benefit (and more than $50,000 if Obama gets his way) are heading for a tax bill that may be surprisingly large and burdensome.
So what should baby boomers do in response to this realization?
1. Assess your income needs in retirement. Much has been written about how to do this. I will be doing some of it myself in the near future.
2. Estimate how much of your retirement income needs can be provided by Social Security benefits. 2 (Use the online benefit estimator or your Social Security statement for this.) Add in your pension benefits if you are lucky enough to have them.
3. Think about strategies for permanently reducing your income needs in retirement. One such strategy is paying off your mortgage.
4. Migrate some of your retirement portfolio assets to tax-free and tax-deferred investments. Municipal bonds and funds are one option. Another strategy is a Roth IRA or making Roth 401(k) contributions. For tax deferral, I-Bonds in your retirement portfolio can help.
Don’t forget about state taxes either. Many states are in financial trouble and raising income tax rates is likely in their future as well.
Retirement tax planning for all baby boomers is important. I think it will become even more important in the next few years. I suggest that you start now.
Image credit: Steve Woods