Retirement planning for women can be trickier than most people may think. Most women I talk to are more concerned about paying less in taxes today than when they retire. In my opinion, women should shift their focus to paying less over their lifetime. For example, what if a $2,400 refund leads you to pay $100,000 more in taxes over your life?
Women need to think differently!
- Women often make less money because of being in and out of the workforce. This can lead to less money earned in pensions and Social Security. In order to live the same lifestyle as your final salary, you need to save more to make up for the loss in pension and Social Security income.
- This in and out of the workforce leads to saving less than they wish they had. This was often because of supporting children, parents, and partners.
- Most women live longer than men. This means even more money will be spent on retirement. This could compound issues for a lesbian couple.
- Longer lifespans increase the opportunity for more compounding of risk-adjusted returns. However, this may come with a great deal of stress if you frequently look at your account balances.
- The longer a woman lives, the more money it will cost to live, therefore greater the overall lifetime tax bill. For emphasis, my mom is 93. My childhood next-door neighbor lived to 102.
Many people like the idea of paying less in taxes, But how does that relate to retirement planning for women and a financially free retirement? Let’s look at saving money for retirement using a regular account, an IRA, and a Roth IRA.
Individual Retirement Arrangement (IRA)
Let’s take a quick look at a $5000 annual IRA contribution over 20 years. Most people contribute that money from their checkbooks. From the money that has already been taxed. When you file your taxes, the taxes you paid are credited back to you. This turns after-tax dollars into pre-tax dollars.
Assume that you make 10% on that money over 20 years. All of those returns are not taxed while your account balance is growing.
Roth Individual Retirement Arrangement (Roth)
Now, let’s do the same making a Roth IRA contribution. We’ll make that same $5000 annual IRA contribution over 20 years. You will contribute that money directly from your checkbook with money that has already been taxed. When you file your taxes, there is no crediting of the taxes you paid.
Assume that you make 10% on that money over 20 years. All of those returns are not taxed, nor will they ever be again given that you don’t violate the holding rules. Those rules are mainly held for at least 5 years and don’t use before age 59 ½.
Many of the women that I speak with don’t like the age 59 ½ restriction rules on retirement advantaged savings. “What if you want to use it for something else” some say. “What if I just save the $50,00 in a regular account?” Well, you need to understand how this money is taxed! This is important when it comes to retirement planning for women.
Regular Account (Taxable or Brokerage Account)
Let’s examine the difference between short-term and long-term capital gains. When you invest in something and make money over time, you will pay taxes on your gains (earnings). If your gain is short-term (you are invested for less than a year), you need to pay taxes on the profit based on marginal tax rates for the year. But when your gains are for a period of over one year, those gains are considered long-term capital gains. They will also be taxed at what could be a more favorable 20% rate.
Let’s say you invested in a stock that makes hundred dollars in six months and you sell it you are subject to a taxable gain of your marginal tax rate for that amount. If you wait 367 days, your long-term capital gains rate can be 20%.
If you make money every year that needs to be reported, that money will actually reduce your gain. The reduction in gain could reflect dividends appreciation for anything bought or sold — especially if you’re in a mutual fund.
Another curious thing about mutual funds is that you may have to pay both short- and long-term capital gains taxes. Even if you don’t hold the mutual fund for the entire year. Why? Gains are already embedded within the buying and selling activity of the fund. So the end, think of it as being “stuck holding the check.”
IRA, SEP-IRA, SIMPLE IRA, 401(k), 403(b), a tax-sheltered annuity (TSA), and 457 plans offer tax-deferral. In this case, there is no long-term gains rate. If you decided to withdraw money from your plan, you will pay at the then-prevailing tax rate(s).
Tax-deferred does not mean not having to pay taxes. It means delaying taxes. When looking at successful retirement planning for women, that delay may involve you paying a higher tax rate in the future than you would have paid if you paid today.
IRA vs Roth vs Taxable for Retirement Planning for Women?
To illustrate, let’s examine a hypothetical situation where I used Envestnet MoneyGuide Elite software. Our heroine, Roberta, is 37 and will retire at 67. She saves the maximum she can save every year to qualify for the pre-tax benefit. In 2022, that will be $6000. This number will also adjust to going up (every so often) in order to keep up with inflation. Assuming an XX% rate of return. At the end of her 66th year, she has the following amounts saved up:
- Taxable account 661,173
- IRA 798,553
- Roth IRA 798,553
Capital gains taxes reduce the accumulation of the taxable account by an estimated $137,000. The IRA and Roth are equal. If you withdraw money from an IRA, you have to pay taxes on that money the following year. So what if, Roberta wants to pull out $100,000? She would need to withdraw $125,000 in order to net that amount if her combined federal, state, and local tax rate was 20%. That same withdrawal from a Roth would be $100,000.
Now, do you appreciate tax deferral? Wish you could merge the pre-tax benefits of the IRA with the no tax on withdrawal? You can through a health savings account. You can learn more about using the health savings account here and here and here. In short, you save money to pay for health care expenses. As long as this money is used for health care expenses, there are no taxes accessed. You don’t have to wait until age 59 ½ to use the money. However, the longer you wait to use the account, the more time you have for the money to compound its growth. It has a limit of $3550 in 2022 for singles and doubles for married households.
Using a Health Savings Account (HSA)
Using a Roth IRA and Health Savings Account (HSA) you can withdraw dollar for dollar with no thought on a cost for taxes. That is not the case with the IRA, its siblings, and cousins. So, remember, if you go to the “IRA ATM” to pull out money, know that you will pay taxes on that money!
The more you pull out you may pay even more in taxes because you have crossed into a new tax tier. Some people find themselves needing to deal with required minimum distributions demanding greater withdrawals than needed for lifestyle spending. While you don’t have to spend the money, you do have to pay taxes on it. If you decided to reinvest it into a taxable account, you will now be dealing with capital gains taxes.
Taxes are certainly a major factor in not only maintaining a lifestyle but also not running out of money. If you have guaranteed income sources like pensions and Social Security you won’t run out but you can run short. It’s important to consider the tax impact of your savings as soon as you can.
Depending on your income you may find yourself limited today but with options to change tomorrow. It’s important to know how to treat each account to maximize each. The best way to go is to start with a personalized financial plan! This way you can best see the effects of each as well as develop the right balance for yourself. Don’t let unnecessary taxes ruin your retirement dreams!
As a financial consultant, specializing in the financial needs of women (whether they are married, divorced, single, or…), Kathleen Connors understands that you want to work with an adviser who is relatable and trustworthy. She focuses on life’s unique goals and takes the time to educate her clients about their financial future. Kathleen is passionate about helping women reach clarity and confidence around their finances. It doesn’t matter where a client may be in their life’s journey. She brings warmth and compassion to the financial planning process, with no judgments.