Personal Finance
Will you have a lower tax rate in retirement? Maybe not, advisors say
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Most Americans will have a lower tax burden in retirement than during their working years.
However, that may not be the case for some retirees, especially for higher earners and big savers, which could have a significant impact on their financial plans, according to financial advisors.
“Substantial evidence” suggests retirees have lower tax rates than during their working years, according to a 2024 paper published by the Center for Retirement Research at Boston College.
There are a few general reasons for this, according to a joint 2017 research paper by the Internal Revenue Service and Investment Company Institute: People who leave the workforce no longer pay payroll taxes. Their household income often drops, generally meaning less income is taxed. And Social Security recipients only pay tax on a portion of their benefits.
The “overwhelming majority” of people will have a lower tax rate in retirement, “hands down,” said Jeffrey Levine, a certified financial planner and certified public accountant based in St. Louis and chief planning officer at Buckingham Wealth Partners.
But that’s not always the case.
Required minimum distributions may be large
Those who’ve built up a sizable nest egg, perhaps with disciplined saving in a 401(k) plan or individual retirement accounts, may have large required minimum distributions, Levine said.
For example, the IRS requires that older investors take minimum withdrawals annually from “traditional” (i.e., pre-tax) retirement accounts when they reach a certain age. (It’s age 73 for those who turned 72 after Dec. 31, 2022.)
The total amount is based on an IRS formula. A bigger nest egg generally corresponds to a larger RMD.
This matters because RMDs from pre-tax accounts add to a household’s taxable income, thereby raising its total tax bill. By contrast, distributions from Roth accounts aren’t taxable, with some exceptions.
Investors held $11.4 trillion in traditional IRAs in 2023, about eight times more than the $1.4 trillion in Roth IRAs, according to the Investment Company Institute.
Additionally, investors who inherited a retirement account, perhaps from a parent, may have to empty the account within 10 years of the owner’s death, Levine said. Such withdrawals from a pre-tax account would further add to taxable income.
Retirees may not want to shrink their lifestyle
Aside from required withdrawals, big savers may choose to pull ample sums from their accounts to fund their retirement lifestyles, said Ted Jenkin, a certified financial planner based in Atlanta and the founder of oXYGen Financial.
In such cases, their taxable income may exceed that of their working years, said Jenkin, a member of the CNBC Financial Advisor Council.
“Most clients we sit down with today don’t want to see a diminished amount of income when they retire,” Jenkin said. “They still want to take the same level of trips, level of going out to concerts and dining, taking care of grandchildren, and many are still carrying a mortgage into retirement.”
In the first three to five years of retirement, Jenkin actually finds clients generally spend more than they do during their working years due to what he calls “a period of jubilation.”
“A lot of people just don’t want to shrink their lifestyle,” he said.
Consider your income tax assumptions
Investors should consider the income-tax assumptions they’re making for retirement — or ask their financial advisor what tax assumptions they’re making in clients’ financial plan, Jenkin said.
Such assumptions could have a big financial impact, akin to the difference between using a 3% versus 4% average inflation rate when modeling the relative success of a long-term financial plan, he said.
He advocates for planning conservatively. Planning for a tax rate that’s too low may raise the risk of running out of money in retirement, he explained.
“You always have to plan everything on an after-tax basis,” Jenkin said.
Of course, it’s impossible to determine future tax rates.
Congress may change the tax code, for example. To that point, there’s tax fight looming next year that could impact things like the size of the standard deduction and marginal income-tax rates.
That said, even if Congress were to increase the marginal income-tax brackets in the future, most retirees would likely still see their “personal tax rates” fall versus their working years, Levine said.
Many Americans are starting 2025 a little worse off than before, at least when it comes to credit card debt.
Almost half of cardholders — 48% — now carry debt from month to month, according to a new report by Bankrate. That’s up from 44% at the start of 2024. Of those carrying balances, 53% have been in debt for at least a year.
Roughly 47% of borrowers said they carry a balance due to an unexpected or emergency expense, most commonly medical bills or car and home repairs. Others cite higher day-to-day expenses and general overspending.
“High inflation and high interest rates have been a nasty combination, and while the worst is behind us, the cumulative effects are significant and will linger,” Ted Rossman, Bankrate’s senior industry analyst, said in a statement.
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Overall, Americans’ credit card tab has continually crept higher.
The average balance per consumer now stands at $6,380, up 4.8% year over year, according to the latest credit industry insights report from TransUnion from 2024’s third quarter.
By way of example: With annual percentage rates just over 20%, if you made minimum payments toward the average credit card balance ($6,380), it would take you more than 18 years to pay off the debt and cost you more than $9,344 in interest over that time period, Rossman calculated.
Meanwhile, 36% of consumers added to their debt load over the holiday season, according to a separate report by LendingTree.
Of those with debt, 21% expect it’ll take five months or longer to pay it off, LendingTree found.
According to another report by WalletHub, 24% of Americans said they will need more than six months to pay off their holiday shopping debt. In that survey, most consumers said inflation caused them to spend more than they initially planned.
“Many people need months to repay holiday bills after overspending,” said John Kiernan, editor at WalletHub.
The best way to pay down debt
The best move for those struggling to pay down credit card debt is to consolidate with a 0% balance transfer card, Bankrate’s Rossman said.
“You could pay about $300 per month and knock out the average credit card balance in 21 months without owing any interest,” he said.
As it stands, 30% of credit cardholders expect to pay off their credit card debt within a year, while 41% expect to pay it off in 1 to 5 years, Bankrate also found. Another 13% expect it will take more than a decade.
The rally in bitcoin and other cryptocurrency prices has generated excitement among some investors, but investment advisors are largely still skeptical that those volatile assets belong in a 401(k) plan or other qualified retirement savings plans.
Crypto was one of the fastest-growing categories of exchange-traded funds in 2024. The most popular of these funds, the iShares Bitcoin Trust ETF (IBIT), has ballooned to over $50 billion in total assets.
Although crypto is a small part of the 401(k) plan market, it could grow substantially in 2025.
President-elect Donald Trump has suggested he will create a strategic reserve of bitcoin for the U.S. and has nominated Paul Atkins, a cryptocurrency advocate, to chair the Securities and Exchange Commission. The SEC’s approval of spot bitcoin and ethereum exchange-traded funds in 2024 was a key change for the industry.
The law covering 401(k) plans requires plan sponsors to act as fiduciaries, or in investors’ best interest, by considering the risk of loss and potential gains of investments. The Labor Department has cautioned fiduciaries to exercise “extreme care” before adding crypto options to a 401(k) plan’s core investments.
Labor Department officials, however, haven’t required fiduciaries to select and monitor all investment options, like those offered through self-directed brokerage windows, according to the Government Accountability Office. Nearly 40% of plans now offer brokerage windows in their 401(k) accounts, according to a 2023 survey by the Plan Sponsor Council of America.
Pros and cons of crypto in a 401(k) plan
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Views are mixed about how much crypto to add to retirement savings or if it’s wise to allocate any at all.
Some financial advisors say crypto can work for a 401(k) plan because its movements are unconnected to the stock market and it functions even if a fiat currency is devalued.
“Crypto should be a part of a 401(k) plan because it’s a non-correlated alternative asset class,” said Ivory Johnson, a certified financial planner and founder of Delancey Wealth Management in Washington, D.C.
“With that said, investors need to ensure that they take their risk tolerance and time horizon into account which will define the target allocation,” said Johnson, who is also a member of the CNBC Financial Advisor Council. “The more volatile an asset class is, the less you need of it in the portfolio because you presumably get more bang for your buck.”
Johnson recommends cryptocurrencies range from 2% to 8% of an investor’s portfolio.
Other experts point to volatility and risk as reasons to be conservative.
“People saving for retirement should probably be even more conservative, because adding crypto to a 401(k) plan would significantly increase the risk that your retirement nest egg could suffer a large loss at the wrong time,” said Amy Arnott, a chartered financial analyst and portfolio strategist with Morningstar Research Services.
Morningstar found that since September 2015, bitcoin has been nearly five times as volatile as U.S. stocks, and ether nearly 10 times as volatile. That type of volatility adds a large risk to a portfolio even with a small amount invested.
401(k) contribution limits for 2025
Regardless of what assets are in a 401(k) plan, there are limits to how much you can contribute. For 2025, an employee can contribute up to $23,500 in a 401(k) and other employer-sponsored plans — that’s $500 more than in 2024.
People age 50 or older can make a “catch-up contribution” of up to $7,500. And those age 60 to 63 years old can supersize that, with a catch-up contribution of up to $11,250 for 2025.
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Why your take-home pay could be higher
If you’re starting 2025 with similar wages to 2024, your take-home pay — or compensation after taxes and benefit deductions — could be a little higher, depending on your withholdings, according to Long.
“When all the tax brackets go up, but your salary stays the same, relatively, that puts you on a lower rung of the ladder,” he said.
The federal income tax brackets show how much you owe on each part of your “taxable income,” which you calculate by subtracting the greater of the standard or itemized deductions from your adjusted gross income.
“Even if you make a little more than last year, you could actually pay less in tax in 2025 compared to 2024,” because the standard deduction also increased, Long said.
For 2025, the standard deduction increases to $30,000 for married couples filing jointly, up from $29,200 in 2024. The tax break is also larger for single filers, who can claim $15,000 in 2025, a bump from $14,600.
‘It ends up nearly balancing out’
Despite tax bracket changes, many Americans won’t feel the pay increase amid elevated prices for certain expenses, said Sheneya Wilson, a CPA and founder of Fola Financial in New York.
“It ends up nearly balancing out,” she said.
While inflation is no longer accelerating, there was an uptick in the cost of groceries, gasoline and new cars in November, according to the Bureau of Labor Statistics.
Whether take-home pay is higher or lower than expected, it’s important to monitor your state and federal income tax withholdings throughout the year, especially during major income or life changes, Wilson said.
Typically, if you withhold too much from your paycheck, you can expect a refund, whereas not withholding enough often results in taxes owed.
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